Laraib Shahid reports on how the UK regulator plans to encourage transparency and restrict the use of sustainability-related terms in the naming and marketing of funds.
In October last year, the UK’s Financial Conduct Authority (FCA) proposed new rules to counter greenwashing in the industry, focusing on asset managers and their UK-based fund products and product management services to establish a UK sustainability disclosure regime (SDR).
Concerned that firms are making exaggerated or misleading sustainability-related claims, the FCA reiterated that funds must be transparent, fair and not misleading.
As the interest in sustainability grows, so do the chances of exaggerated claims about environmentally friendly products. According to the Investment Association, more than a third of net inflows into UK retail funds in 2021 went into “responsible investment” products.
Seeking to bring anti-greenwashing rules into force in the middle of this year, the FCA opened a three-month consultation with a closing date of January 25.
Existing funds will be given a year to comply, and new funds must meet the updated standards to be approved.
Informed choices
The three labels – sustainable focus, sustainable improvers and sustainable impact – and disclosure requirements strive to give consumers the details they require to make informed choices about which products fulfil their preferences.
While firms are free to decide whether or not they use such labels, they must meet qualification criteria, requiring firms to corroborate their claims if they do so.
The ‘sustainability improvers’ label is a particularly strong element of the new rules and will play a significant role in creating a greener economy, says Carola van Lamoen, head of sustainable investing at fund manager Robeco.
“We are in general positive on the FCA’s new rules, although we would prefer the emergence of a single regulatory framework.”
A weakness of the EU’s Sustainable Finance Disclosure Regime (SFDR) is its lack of transitional elements, says van Lamoen. More broadly, she adds, the UK’s SDR is more ambitious, with more rigorous requirements.
Under SFDR, the hundreds of different shades within a single classification of Article 8 or 9 funds could potentially lead to misselling, thereby eroding trust in the industry. For example, says van Lamoen, most Article 8 funds apply limited exclusion criteria. These, in many cases, are then marketed as sustainable and are arguably misaligned with the client’s expectations.
“We are in general positive on the FCA’s new rules, although we would prefer the emergence of a single regulatory framework,” she adds.
Greenwashing
Regulators frequently cite greenwashing as a concern, and it is a pressing issue for retail and institutional investors worldwide, says Gabriel Wilson-Otto, head of the sustainability investment strategy at Fidelity International.
In September 2021, the UK’s Competition and Markets Authority (CMA) found that globally, 40% of firms’ green claims could be misleading.
“Greenwashing is clearly an issue”, says Lamoen, adding that it could undermine the financial industry’s progress towards a more sustainable economy.
According to Wilson-Otto, it is important to distinguish between two kinds of greenwashing, namely “differences of opinion, such as what activities are ‘green’ and exaggerated, [and] misleading or unsubstantiated sustainability-related claims”.
Greenwashing arising from intentional or negligent behaviour leads to more severe consequences, such as reputational risk, fines and regulatory sanctions, he adds.
Proposed rules
Wilson-Otto is optimistic that the FCA’s proposed rules will encourage better transparency. They will restrict the use of sustainability-related terms in the naming and marketing of funds and establish a robust set of ESG label requirements, he says.
However, the draft rules still need to define critical elements of labelling requirements. “The nuance in interpretation and implementation of the requirements will play a significant role in determining effectiveness in combating greenwashing,” he adds.
In van Lamoen’s view, whether these rules can tackle greenwashing, and lead to more significant flows towards sustainable products, will depend on whether asset owners, funds selectors and end investors factor this supplementary information into the decision-making.
Painting over the cracks – As interest in sustainability grows, so do the chances of exaggerated claims about environmentally friendly products.
German sustainability
The regulatory focus on greenwashing extends across the EU. In Germany – where police and prosecutors raided the office of asset manager DWS in May last year as part of a greenwashing investigation – sustainable funds have seen impressive growth.
Assets managed by retail funds and ‘Spezialfonds’ with sustainability features amounted to €717 billion by the end of September last year. This corresponded to a 7.1% growth since the end of 2021, according to figures from the BVI, Germany’s fund trade body.
The volume of the conventional fund market has declined by 16.9%, in part because of the pandemic and inflation.
A BVI ‘Snapshot of Sustainability’ report says Article 8 funds (with environmental and/or social features) and Article 9 funds (contributing to at least one sustainability objective) made up 47% of the total retail fund market.
Sustainable Spezialfonds for institutional investors managed €127 billion. Their investment strategies are usually tailored to the individual preferences of their investors, the report said.
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