Raising Private Funds In The EU: ESG Promotion As The Dominant Sustainability Route To Tap Into EU Capital – New York Office Snippet

The EU does not impose sustainability standards on private fund offerings, but private funds must make pre-contractual sustainability disclosures the type of which depends on their ambitions. 

There are three categories of disclosures namely for:

1. funds that do not promote sustainability (so called article 6 funds);
2. funds that promote sustainability possibly in combination with making sustainable investments (so-called article 8 funds); and
3. funds that have sustainable investments as their objective (so-called article 9 funds). 

Apart from some EU investors that actively target funds in the third category, EU institutional investors generally demonstrate a preference for article 8 funds. They typically do not require sustainable investment in that second category but only that such funds promote environmental and/or social (E/S) characteristics combined with good governance practices (ESG). The concept of promoting means that the E/S characteristics are communicated to potential investors and are embedded as binding elements in the investment policy of the fund. 

Some article 8 funds are E/S-light (applying only certain E/S related exclusions), while others are E/S-heavy (applying E/S related selection criteria or even a minimum proportion of sustainable investments). That room to manoeuvre stems from the fact that article 8 funds select their own E/S elements and the mechanics to screen these elements and can apply the screening only to a proportion of the investments (subject to ramp-up and ramp down), provided that the E/S elements are concrete, measurable, binding and relevant to the investment policy.

Despite the push for article 8 funds, not all US fund managers venture into the EU market with an article 8 labelled fund. Some prefer article 6 funds based on a combination of drivers, such as limited EU commitments, the fact that the specific pool of EU investors is comfortable on an article 6 fund, a preference not to include ESG related restrictions in the investment policy nor to comply with periodic reporting obligations as to whether the promoted E/S objectives are met, or because the non-EU investors in the fund complex may shy away from a fund that promotes E/S elements.

Practice has proven that starting with article 6 fund for an EU wide offering often results in an upgrade to article 8 during the fund marketing process. The argument that an upgrade, as opposed to a downgrade of the ESG status, is not a “material change” potentially impacting the fund’s marketing process in terms of timing is sometimes made.

These disclosure rules will be subject to an overhaul (SFDR 2.0), which is likely to become effective at the earliest towards the end of 2027. For funds that come to market before that date, the above remains relevant.