New draft guideline in Germany to prevent greenwashing

The German Federal Financial Supervisory Authority (BaFin) said sustainability is becoming a selling point for funds but that financial products labeled as sustainable are not always ecologically or socially oriented. To prevent this phenomenon, known as greenwashing, BaFin has published a draft guideline for sustainable investment funds and launched a consultation.

The guideline defines how funds should be structured if they are to be advertised as sustainable. Comments on the draft can be submitted until September 6.

The German Investment Funds Association (BVI) considers the new draft guideline an improvement to an unofficial preliminary version from April of this year. According to BVI, in the new draft, BaFin has addressed concerns of the industry, but not all critical points have been eliminated. Experts still consider the guideline problematic, especially since it is a solo German effort.

Dorothee Atwell, investment fund and asset management expert at Pinsent Masons, the law firm behind Out-Law, said: "BaFin addressed several of the industry's concerns and modified the guideline accordingly. We also welcome that the regulator intends to provide more legal certainty on the issue of greenwashing. However a coordinated approach on a European level is necessary. A solo operation by BaFin that leads to stricter requirements for Germany as a fund location than is the case in neighbouring European countries would counteract the goal of the recently enacted Fund Location Act and could lead to an exodus of sustainable funds to Luxembourg, for example. Not least, this would also call into question Germany's role as pioneer in sustainability."

The new requirements of the draft directive would only apply to domestic mutual funds; special funds for professional investors would not be covered. Funds that bear terms such as 'ESG', 'sustainable' or 'green' and their German-language equivalents in their names or that are advertised as sustainable in sales documents and prospectuses would be affected. In the future, all mutual funds marketed as sustainable would have to demonstrate a share of at least 75 percent in sustainable assets. This would have to be reflected in the investment terms of the fund product.

To determine what is sustainable, BaFin intends to use the requirements of the EU Disclosures Regulation and the EU Taxonomy Regulation. The decisive factor would be that the investment contributes to achieving one of the environmental goals mentioned there without significantly compromising other environmental goals.

The draft guidelines provide three options for investment conditions to reflect a fund's sustainability: This is to be ensured either through a minimum investment quota, through the investment strategy, or by tracking a sustainable index.

The minimum investment quota would require the fund to be at least 75% invested in sustainable assets.

If no minimum investment ratio is to be specified, the investment conditions may instead stipulate that sustainability considerations are of decisive importance in the selection of assets for at least 75% of the fund or that the fund as a whole pursues a sustainable investment strategy, which must then also be described in specific terms.

In the case of passive investment strategies, the sustainability of a fund can also be demonstrated by tracking a sustainability index. The investment conditions must describe this index in more detail. Here, too, a quota of 75% of sustainable assets must be met.

If the investment terms of a fund were approved before 2 August, the fund will be exempt from the new rules.

"This grandfathering of previously approved funds was not included in the first draft, but will be welcomed by the industry," said Ruth Rawas, investment fund and asset management expert at Pinsent Masons. "The fact that the threshold for the proportion of sustainable assets has been lowered from 90% to 75% is also positive. In fact, it may be hard enough to reach this lower threshold, as there is currently still a lack of suitable assets in the market."