By Virginia Furness

LONDON (Reuters) - Green bond funds in the European Union are free to continue investing in bonds sold by big polluters such as power and energy companies, after the securities watchdog introduced allowances to its new fund naming guidelines.

The European Securities and Markets Authority (ESMA) on Friday clarified fund managers could continue to hold green or other use of proceeds bonds that meet certain sustainability exclusion criteria without changing their fund names or divesting assets.

The watchdog in October sparked an industry backlash with new rules that investors warned would make it harder for utilities and power companies to raise money to decarbonise, particularly via green bonds.

The rules, which applied to new funds from November, set out how funds using words including "green", "environmental" or "impact" could label themselves as sustainable. The rules bar funds from investing in oil, coal and companies deriving more than 50% of their revenue from gas, as well as the most polluting electricity companies.

Fund managers must change their fund names or sell assets that breach the criteria, a process that has started.

However, ESMA has excluded green bonds issued under its Green Bond Standard, due to be launched on Dec. 21, from its fund naming guidelines, it said in its clarification. It also introduced a provision to allow investors to hold green or other use-of-proceeds bonds used to finance renewable or other green projects sold by companies in carbon-intensive sectors which themselves fall short of the broader exclusion criteria.

This 'look-through' provision does not apply however to companies which fail to meet UN Global Compact principles or OECD guidelines for multinational enterprises, the watchdog said.

Agnes Gourc, BNP Paribas' head of sustainable capital markets, said the update removed significant uncertainty ahead of a traditionally busy time for bond borrowers.

"In Q1 we would have seen some issuers hold back on green bond issuance until they had more clarity," she said. "The timing is good."

Energy and power companies represented a fifth of the global green bond market and had issued more than $70 billion-worth of debt by September this year, according to LSEG data.

(Reporting by Virginia Furness; Editing by Tommy Reggiori Wilkes and Tomasz Janowski)