By Huw Jones

LONDON (Reuters) – The European Union’s securities watchdog on Friday proposed strict curbs on how investment funds are sold in the bloc if they tout environmental, social and governance (ESG) credentials to attract cash.

ESG funds have grown in popularity in recent years and in the second quarter of this year accounted for 27% of share assets under management in funds across the EU, according to figures from the European Securities and Markets Authority (ESMA).

This has raised concerns among regulators over so-called ‘greenwashing’, whereby funds make sustainability claims which are exaggerated or unverified.

ESMA on Friday published a consultation paper which proposes two criteria for using ‘ESG’ and ‘sustainability’ in a fund’s title.

“Funds’ names are a powerful marketing tool,” ESMA said in a statement.

“Competitive market pressures create incentives for asset managers to include terminology in their funds’ names designed to attract investor assets, leading in certain instances to greenwashing, for example by making false claims about sustainability practices.”

If a fund has any ESG-related words in its name, at least 80% of its investments should meet environmental or social objectives as set out in the EU’s rules on sustainability related disclosures in the financial sector, ESMA said.

“ESMA believes that the proposed threshold of 80% is high enough to meet investors’ expectations that a large majority of the fund’s actual or intended investments is made in assets consistent with its name thus avoiding fund names to be deceptive or misleading,” the watchdog said.

There is an additional threshold if the fund is using ‘sustainability’ in its title, so that at least half of initial 80% threshold for investments should be in sustainable assets.

There may also be a need for “safeguards” on remaining investments in a fund so that investors are not misled, ESMA said.

The public consultation closes mid-February and ESMA will then publish final guidelines in the second or third quarter of 2023, followed by a six-month phase in.

(Reporting by Huw Jones; Editing by Mark Potter and Louise Heavens)