A recent report from sustainability technology platform Clarity AI sheds light on the compatibility between sustainability-labeled investment funds and proposed fund labeling rules aimed at reducing the risk of greenwashing.
The study examined data from over 18,000 funds across Europe and found that a significant majority of funds classified as Article 8, which promote environmental or social characteristics, would meet the criteria proposed under the new regulations.
The report also revealed that only a small fraction of funds labeled as 'sustainable' would meet the proposed fund naming rules across the European Union (EU), the United Kingdom (UK), and the United States (U.S.). This finding indicates a potential misalignment between current labeling practices and the forthcoming regulatory requirements.
ESMA Consultation Proposes Thresholds for ESG-Related Terms
The European Securities and Markets Authority (ESMA) initiated a consultation in November 2022 to propose rules on the use of environmental, social, and governance (ESG) or sustainability-related terms in the names of investment funds. The consultation primarily focuses on setting thresholds for the proportion of investments required to support ESG-related fund names.
For instance, one proposal suggests an 80% threshold for using ESG-related terms, with an additional 50% threshold for the use of "sustainable" or any sustainability-related term. The consultation also addresses funds using exclusion criteria and specific types of funds like impact funds.
Highlighting Regulatory Challenges and Compliance Costs for Fund Managers
Similar proposals for addressing the risk of greenwashing in fund names have been announced by other regulators, including the Financial Conduct Authority (FCA) in the UK and the Securities and Exchange Commission (SEC) in the U.S.
Clarity AI's study revealed that while more than a quarter of Article 8 funds contain ESG or sustainable terms in their names, only a tiny portion of these funds would meet the criteria proposed in the new regulations. For example, only 20% of funds using the term "sustainable" or similar language plan to meet ESMA's 50% investment threshold, and an additional 20% plan to make less than 10% sustainable investments.
Similar results were observed across the EU, UK, and U.S., with only 15% of funds with "sustainability" in their names meeting the criteria of at least one proposed regulation. Funds with ESG-related terms fared somewhat better, with 59% meeting the criteria.
Furthermore, the report highlighted that a considerably smaller number of funds would be able to comply with the labeling requirements of multiple proposed regulations. Of the funds labeled with "Sustainability" that met the requirements of at least one proposal, only 15% complied with two regulations, and a mere 4% met all three.
The report underscores the potential need for renaming or restructuring of over 95% of funds to align with the proposed regulations in order to be marketable across all three regions. Patricia Pina, Head of Product Research and Innovation at Clarity AI, emphasized the report’s varying interpretations of ESG and sustainability concepts among regulators. The findings suggest that fund managers may face added compliance costs due to the divergent approaches taken by different regulatory bodies.
Companies that Are Combatting Greenwashing
Several apparel companies are actively combatting greenwashing by implementing sustainable practices and transparent initiatives.
Patagonia is renowned for its strong commitment to sustainability and environmental responsibility. The company emphasizes transparency, ethical sourcing, and reducing its ecological footprint. It has been a vocal advocate for sustainable practices and encourages consumers to repair and reuse their clothing to minimize waste.
Reformation is a sustainable fashion brand known for its stylish and environmentally-conscious clothing. The company utilizes eco-friendly materials, implements water-saving practices, and focuses on ethical manufacturing. Reformation provides customers with information about the environmental impact of its products through its "RefScale" tool.
Outerknown, co-founded by professional surfer Kelly Slater, is committed to creating sustainable and ethically-made apparel. The brand emphasizes fair labor practices, uses organic and recycled materials, and strives to minimize its environmental impact. Outerknown promotes transparency by providing detailed information about its supply chain and production processes