What’s in a name?
Fund names are coming under regulatory scrutiny, where those names include sustainability related terms, managers must have appropriate evidence to back up the activity.
William Bryant, Head of Advisory
In asset management, your name can mean a lot, I am not talking about an individual portfolio manager’s name, but rather a fund’s name. This is especially true with the increased investor demand for investments with sustainability credentials. Asset managers have, on occasion, used their Fund’s name as a means of overstating, advertently or inadvertently, the extent to which sustainability factors impact the investment process. Fund names can give strong and clear impressions of the fund’s sustainability objectives and investment process, which may not aways be reflected by the fund’s investment processes or objectives. Although institutional investors, with their sophisticated due diligence processes are unlikely to only review a fund’s name, this does impact retail investors (approx. 52% of global assets under management in 2022), who have less time, resources or experience to fully dissect the investment process of their fund managers.
As such, regulators have felt it necessary to introduce new rules to provide investors with protection and confidence that funds bearing sustainability-related names genuinely adhere to their stated objectives.
The following is a brief, non-legal, summary of the leading regulation that is currently in force or coming down the road. With such regulatory scrutiny, it is important that asset managers seriously consider their choice of fund name, and the impressions that it provides to investors as it relates to the fund’s interaction with sustainability factors.
The EU has been leading the way when it comes to the regulation of sustainability practices within the investment space, under the wider umbrella of the EU green deal. ESMA, that looks to provide investor protection within the EU, has put in place guidelines on funds’ names using ESG or sustainability-related terms that will come into effect towards the end of November. The guidelines recommend that fund managers using specific terms such as ‘transition’, ‘environmental’, ‘social’, ‘governance’, etc. along with words that give an investor an impression of the promotion of these characteristics have a minimum threshold of 80% of investments that meet these characteristics.
Furthermore, ESMA adds in further requirements to the naming guidelines, any funds that use ‘environmental’, ‘impact’, or ‘sustainability’ related terms in their name must also exclude investments in companies with specific characteristics. Including characteristics that would not directly be associated with name used, for example the exclusion of tobacco companies from funds using ‘environmental’ in their name.
In the UK, the FCA has introduced a specific anti-greenwashing regulation. This regulation includes, within it, rules on fund names, with a prescribed non-exhaustive list of words that cannot be used in products, unless they are also using a specific sustainability label (discussed later). Where managers are not using a sustainability label, they may only use the specific list of words in their fund names if this accurately reflects the investment activity in relation to the specific term. These funds must also provide disclosure to investors through both pre-contractual disclosures and sustainability reporting. The disclosures should also detail why the product does not use one of the specific sustainability labels.
In support of the anti-greenwashing rules and having seen the market misuse the sustainability disclosure regulations of the EU SFDR, as a de facto label, the FCA has introduced four specific sustainability labels. Each label has a specific definition detailing the objective of the fund and at least 70% of assets must be invested in line with the objectives, as defined by the label. While the FCA does not formally approve the use of the four sustainability labels, managers looking to apply a sustainability label to a product must notify the FCA and provide the pre-contractual disclosures for approval of changes to the document; changes which will detail how the fund is meeting the objectives defined by the label.
The FCA have recently announced a push back of the implementation of the labelling regime from December 2024 to April 2025.
In the US, the SEC has responded to similar concerns of greenwashing with amendments to the ‘names rule’ with specific reference to thematic investment focuses, including the incorporation of ESG factors. The names rule stipulates that at least 80% of assets in a fund must be invested in a manner consistent with the fund name and have an investment policy that details this. The recent amendments to the rules have introduced the requirement that a manager should do an assessment of their portfolio on a quarterly basis to confirm assets are in compliance with the investment policy.
Whether you are merely incorporating sustainability as a risk factor within the investment process, or more explicitly targeting sustainability objectives or outcomes, it is important to have a well-documented investment process that details how the sustainability characteristics of an investment opportunity have been considered, and how this is aligned with the mandate of the fund as defined by its sustainability disclosures, marketing, communications and name.
As with all regulation there are questions that come about, and a one-size fits all approach cannot cover all investment approaches or eventualities. This is particularly the case for alternative managers that may have active short books or have periods of ramp up or harvest when portfolios can be skewed. As experts in the responsible investment space, NorthPeak are well positioned to be able to practically support asset managers work through their own approach to meeting these regulations while remaining practical with the investment process in place.
For further information on how NorthPeak Advisory can help you implement appropriate sustainability investment practices for your firm, please reach out to info@northpeakadvisory.com.