This summer has seen a continued commitment by the FCA to its role in promoting ESG-related investments, with three recent publications all highlighting the importance of firms providing accurate, consistent and high-quality information to market participants and demonstrating the FCA’s likely target areas in its focus on greenwashing. Most importantly, on 19 July 2021 the FCA published a letter to the chairs of authorised fund managers setting out its expectations on the design, delivery and disclosure of ESG and sustainable investment funds, together with specific guidance on how to apply its existing rules in an ESG context. The guidance closely follows the results of the FCA’s ‘Consumer Study on ‘Sustainable investing: objective gradings, greenwashing and consumer choice’ and echoes the commitments made in relation to ESG in the FCA’s 2021-2022 Business Plan.
Guiding Principles on design, delivery and disclosure of ESG and sustainable investment funds
ESG and sustainable investment funds are currently the fastest-growing segment of the European funds market, and the FCA notes in its letter to fund managers that consumers are placing significant value on ESG-related investment opportunities. The FCA’s new guidance is intended to improve the quality of applications for authorisation of funds with a sustainable focus, and to help firms apply its existing rules in this context. The guidance has been developed to be compatible with prospective future disclosure rules for responsible and sustainable investment fund products (including the planned UK Green Taxonomy, which was announced by the Chancellor in November 2020, as explained in our recent blog post here). It is also intended to be complementary to obligations under the EU’s Sustainable Finance Disclosure Regulation, which although not onshored in the UK, will be relevant to the cross-border business of some UK authorised firms.
The guidance consists of both high-level principles and specific examples of how the principles work in practice. The overarching principle is that a fund’s ESG and/or sustainability focus should be reflected consistently in its design, delivery and disclosure (including its name, stated objectives, documented investment policy and strategy and its holdings). The three supplemental principles are:
- Principle 1: References to ESG (or related terms) in a fund’s name, financial promotions or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.
- Principle 2: The resources (including skills, experience, technology, research, data and analytical tools) that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way that a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives on an ongoing basis.
- Principle 3: ESG and/or sustainability-related information in a key investor information document should be easily available and clear, succinct and comprehensible, avoiding the use of jargon and technical terms when everyday words can be used instead. Funds should disclose information to enable consumers to make an informed judgment about the merits of investing in a fund. Periodic fund disclosures should include evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of the fund’s stated aims.
In its letter, the FCA also described recent applications for authorisation which had fallen below its expectations, including a fund allegedly investing in companies described as “contributing to positive environmental impact” where it was not obvious that any of the companies in question would contribute to positive environmental impact, and a fund with statements made about its sustainability focus which set high expectations and which did not adequately explain the rationale for the high-carbon energy companies in its holdings.
Consumer Study on ‘Sustainable investing: objective gradings, greenwashing and consumer choice’
In early July 2021 the FCA published exploratory analysis on how different information about the ESG and/or sustainable characteristics of a fund may affect consumer investment decisions. The study sought to answer two main questions:
- What ESG/sustainability information about a fund sways how consumers say they will invest?
- What is the effect of greenwashing on how consumers say they will invest? More specifically, what is the effect of implying a fund is ESG/sustainable when a grading presented as more objective says that the fund is not?
The study found that ESG fund images, descriptions and strategies had no statistically significant effect on investment decisions and participants appeared to be no more likely to choose funds based on an ESG attribute compared to a neutral one. A fictitious grading system presented as ‘medals’, however, did have a significant effect on participants’ investment choices, suggesting that an apparently objective grading of a fund’s ESG and sustainability credentials would have a significant effect on which funds consumers decide to invest in. With regard to greenwashing, the study found that participants’ investment choices were not swayed by ESG information that conflicted with the medal’s grading, suggesting either that consumers do not always spot greenwashing, or that they do not respond to it. The FCA is likely to see the study as good support for its focus on the accuracy and quality of market disclosures in an ESG and/or sustainability context.
FCA’s Business Plan 2021 – 2022
As well as highlighting ESG as a priority across the whole financial services industry generally, the FCA’s business plan for the coming year confirms that it will continue adapting its regulatory framework to support the transition to a net-zero economy by 2050. The ESG-related outcomes it wishes to achieve for the year are:
- Having high-quality climate- and sustainability-related disclosures to support accurate market pricing, helping consumers choose sustainable investments and drive fair value;
- Promoting trust and protecting consumers from misleading marketing and disclosure around ESG-related products;
- Regulated firms having governance arrangements for more complete and careful consideration of material ESG risks and opportunities;
- Having active investor stewardship that positively influences companies’ sustainability strategies, supporting a market-led transition to a more sustainable future;
- Promoting integrity in the market for ESG-labelled securities, supported by the growth of effective service providers – including providers of ESG data, ratings, assurance and verification service; and
- Driving innovation in sustainable finance, making use of technology to bring about change and overcome industry-wide challenges.
The plan sets out how the FCA intends to achieve these outcomes, including continuing its work to standardise climate-related disclosures by extending the current requirements for mandatory TCFD-aligned disclosures (including via its open consultations CP 21/17 and CP 21/18, which propose extending disclosures to asset managers, life-insurers and certain pension providers, and standard listed companies, respectively), by collaborating domestically and internationally to develop global reporting standards, by gathering market intelligence on how well firms are supported by service providers such as ESG ratings providers, and by developing economy-wide Sustainability Disclosure Requirements for businesses and new investment products, and a new sustainable investment label. It is clear from the framing of its priorities that greenwashing will remain a key concern for the FCA over the coming year, and that many of its plans are intended to tackle the potential greenwashing of investments. (For a summary of the other key aspects of the FCA’s business plan, see our blog post here.)
All of the FCA’s publications relating to ESG and sustainability over the summer demonstrate its ongoing focus on firms providing consumers and the market with accurate and thoughtful information about ESG products, services and strategies. The FCA’s guidance for fund managers marks the first set of guidance that it has produced in relation to greenwashing in any context, and suggests that the FCA is likely to take a more interventionist approach from now on when it identifies specific greenwashing concerns. Although the guidance is aimed at fund managers, the basic principles of accuracy and consistency of information and strategy are of much wider application, as is the FCA’s recommendation to ensure that aspects of a sustainability strategy which are not obvious to a reasonable investor are fully explained. The FCA’s business plan for the coming year confirms that this sharpened focus will continue.
The FCA’s guidance for fund managers marks the first set of guidance that it has produced in relation to greenwashing in any context, and suggests that the FCA is likely to take a more interventionist approach from now on when it identifies specific greenwashing concerns.