Asset manager stewardship approaches ‘not aligned with expectations’, warns FCA

Review of manager alignment with guiding principles finds some progress, but improvements needed on stewardship and 'unexpected' ESG fund holdings.

The UK’s financial watchdog has warned that the design of fund managers’ stewardship approaches does not meet its expectations, in a wider review of how firms are aligning with its guiding principles on ESG funds.

The Financial Conduct Authority published the review on Thursday ahead of its final rules on sustainability disclosure requirements and fund labelling, expected before the end of the year.

The principles, published in July 2021, were prompted by the number of poor-quality fund applications seen by the FCA.

The FCA said it had found evidence of good practice and progress, but many firms still have further to go in order to meet its expectations.

While many managers said they used stewardship as a tool to further funds’ sustainable investment objectives, the FCA said it was difficult to identify these approaches from fund literature alone. It also said it was challenging to identify how firm-wide activities related to fund-level objectives.

The FCA said it expected that measuring stewardship impact may be an ongoing challenge, as some managers demonstrated “longstanding, developed and transparent” engagement programmes but it was difficult to identify clear examples of progress as a result.

Some firms in the review “appeared to rely heavily on stewardship activities without being able to demonstrate how they set, assessed and monitored outcomes, and how these linked to the investment objectives of funds”, it said.

The most effective stewardship approaches were seen at managers where the stewardship activity was embedded within investment teams, “providing investment managers with ownership of engagement activity with the support of a central stewardship resource”.

Among the FCA’s other findings was that some ESG or sustainability-labelled funds did not have specific ESG objectives alongside their financial goals; that disclosures on financed emissions were sometimes incomplete; and that while governance arrangements have evolved over time, there were issues in oversight for older funds and those that had been adjusted to include ESG objectives and policies since launch.

The FCA also took issue with ESG funds that held firms in the oil, gas, mining and manufacturing sectors. While documentation explained that these firms were held because they were on a path to net zero, in some cases these firms lacked a Scope 3 target and this absence was not made clear in fund literature.

The guiding principles state that managers should consider explaining contradictory holdings in an ESG fund, and the FCA said managers should have a credible approach to the treatment of these holdings. The FCA has previously consulted on including mandatory disclosures of “unexpected” investments held by ESG funds under its labelling and disclosures system.

The FCA also highlighted examples of good practice across the principles. These included a strong focus on investment research and due diligence for asset selection, due diligence on third-party data providers, and active engagement and voting policies. Firms are also making efforts to measure and record stewardship outcomes, it said.

The review looked at 12 managers of varying sizes, reviewed fund disclosures available to retail investors and visited managers to discuss their approaches. However, it did not cover marketing materials.

Moving forward, the FCA said it expected managers to assess how they are meeting its rules in relation to their ESG funds, and that it would continue to monitor the market including during the fund authorisation process.

“We expect boards to take the lead in monitoring and ensuring firms make any changes required to further enhance sustainability disclosures and practices,” said Camille Blackburn, the FCA’s director of wholesale buy-side.