According to the Securities and Markets Stakeholders Group, which advises ESMA, 80% of Article 8 funds currently calling themselves sustainable may need to change their names because of the proposal. Alternatively, they'd need to change the fund strategy.
Meanwhile, the EU has yet to provide much needed guidelines on what it means by a "sustainable investment."
"The manner and timing of this particular intervention by ESMA is not helpful," said Sonali Siriwardena, partner and global head of ESG at Simmons & Simmons in London. "It is not ideal to suggest a minimum threshold on sustainable investments when the industry is still awaiting further guidance on the definition of what constitutes a sustainable investment."
Other members of the asset management industry have also criticized the ESMA proposal, including the Global Impact Investing Network.
Lawyers at Linklaters have looked at the ESMA proposal and say it oversteps the legal parameters within which the regulator is supposed to operate.
ESMA is empowered to interpret legislation such as SFDR, said Julia Vergauwen, an attorney at Linklaters who advises fund managers. But setting investment thresholds represents a "substantive" change that goes "far beyond" its interpretative powers, she said.
Ms. Vergauwen said the proposed limits on labeling may add confusion. That's because ESMA says thresholds would need to be met by funds with terms related to ESG and sustainability in their names, but hasn't produced a list of those words.
"It could be everything, pretty much," Ms. Vergauwen said. "So water, is this a neutral term or is this an ESG term? Can you use the term water in your fund's name without falling under this scope of ESMA consultation?"
AIMA is also contesting ESMA's legal authority to impose exclusion criteria. Raza Naeem, a partner at Linklaters, has referred to the exclusion proposal as the "most problematic" corner of ESMA's plan. He also said that "funds with multi-asset strategies, or those which use derivatives" are most likely to be in the firing line.
Given the potential fallout, Mr. Jacobs-Dean said he hopes Europe won't allow the ESMA proposal to pass in its current form.
SFDR "already exists and there's no getting around that," he said. The regulation "was developed through the normal legislative process, and to change it you have to equally follow that process."