Industry calls for more clarity on FCA sustainability disclosure proposals

Investors and industry bodies have called for more clarity on proposals made by the UK’s Financial Conduct Authority for a sustainability disclosure and labelling system.

While most respondents to the FCA’s consultation – which closed on Wednesday – welcomed the fact that anti-greenwashing and labelling rules were being introduced, and praised the ambition of the proposals and effect they will have in restoring trust in the market, they submitted a long list of concerns and suggested changes.

The new regime would introduce three separate labels for ESG funds: an impact label for funds that aim to achieve a measurable contribution to sustainability outcomes; a “sustainable focus” label for funds with 70 percent of assets meeting an environmental or social standard or aligned with a certain theme; and a sustainable improvers category for non-sustainable assets that have the potential to improve.

The proposals also include a specific sustainability marketing rule and restrictions on the use of ESG terms in fund naming.

Respondents generally supported the idea of the three labels – especially the introduction of the “improvers” category – but raised concerns over the execution of this and other aspects of the proposed system.

Royal London Asset Management (RLAM) said that a rule that would ban the use of ESG-related terms for retail-marketed funds outside of the three categories would unfairly penalise managers of “responsible” funds that use stewardship and ESG integration but do not hold purely sustainable assets and therefore would not be eligible to use related language in marketing.

This was echoed by UKSIF, which said that proposals on marketing restrictions are overly restrictive for funds seeking to communicate to consumers in a transparent manner, especially those which fall outside of the labelling system.

By contrast, consultancy Redington called for the rules to apply to products marketed to institutional investors as well, claiming that they would otherwise introduce “significant complexity” to the market.

‘Risk of greenwashing’

RLAM also raised concerns that the improvers category could become a “catch-all” for ESG funds, with “a related risk of greenwashing”, and called for further guidance on the requirements for evidencing engagement actions and outcomes.

These concerns were echoed by a second asset manager that declined to be named.

The manager supported the improver category in principle, but said it had concerns over what criteria will be applied to funds. It argued that Article 8 under SFDR makes no sense as a label because it is a catch-all category for any kind of fund with ESG characteristics, and said the FCA’s improver category “mustn’t” become a catch-all for non-impact or sustainable funds.

RLAM also called for the labelling system to be applied to pension products, which are under a different regulatory regime overseen by the Department for Work and Pensions. A spokesperson for the DWP said it had nothing to add, when asked if any such plans were under consideration.

Two respondents also raised issues over the quality of available ESG data. Redington said that the FCA should consider requiring external verification of labels given the inconsistency in data quality, while pensions advisory firm Isio noted “the industry-wide need for consistent and verified ESG data” when meeting disclosure requirements.

Redington also called for more clarity on what enforcement measures would be taken against funds breaching the labelling rules, as well as potential penalties.

‘Serious concerns’ raised by IIGCC

One of the more critical responses to the consultation came from the Institutional Investors Group on Climate Change (IIGCC). While the group agreed that revision to previous proposals were “broadly sensible” and said it was “particularly pleased to see” the transition label, it expressed “serious concerns” over the mutually exclusive approach to labelling.

The IIGCC’s net-zero investment framework is one of the most commonly used by UK investors, with more than 50 asset owners and managers employing it. “We are concerned that the FCA’s proposals as they stand do not fully reflect how institutional investors are implementing blended climate investment strategies in practice, and would prevent those using frameworks like NZIF from being able to apply labels,” the group said.

Its response called for more guidance on how investors who are pursuing “blended” strategies within their funds should approach categorisation, noting for instance that there was no clear guidance on what should happen when the assets within an improvers fund improved enough to be considered sustainable.

Ensuring impact and defining sustainability

The IIGCC also submitted a number of comments on the exact requirements for the three label categories.

For the sustainable focus funds, it argued that the 70 percent threshold would likely be need to be increased over time as it was unlikely to be an “appropriate bar for ambition” in 2030 or 2040. However, the group noted that the investable universe for sustainable companies at the moment is relatively small, which could cause problems for investors seeking to hit this threshold.

It also called for more clarity on how the remaining 30 percent of assets should be treated, arguing that it could create greenwashing risk if these were companies with a negative environmental or social impact.

For the impact fund proposal, the IIGCC recommended that the definition of impact investing be aligned more closely with that of the Global Impact Investing Network (GIIN).

Pensions advisory and investment management Cardano also suggested revisions to the definition of impact, calling for references to committing new capital, underserved markets and “addressing market failures” to be removed. The current definition, it said, is too narrow.

This was echoed by the UK’s Impact Investing Institute, which said that current requirements might make it hard for even some current best-in-class impact products to qualify.

It also called for additionality requirements to be replaced, noting that the GIIN definition does not include additionality, and that the concept is poorly defined by asset managers and even more so by consumers.

Penalising lower risk appetites

AJ Bell, one of the UK’s largest retail investment platforms, was supportive of the FCA’s objectives and the concept of non-hierarchical labels, but expressed concern about the impact of the labelling system on model portfolios from discretionary fund management firms and funds of funds, which may incorporate approaches under different labels.

“The practicalities of the rules could mean it would be challenging, or in some cases almost impossible, for some portfolios to meet the requirements to use an investment label, even if they are legitimately introducing sustainability considerations into their investment process,” AJ Bell continued.

There could also be unintentional penalties for funds designed to meet investors with low risk appetites, which hold higher allocations of cash and fixed-income assets and may be unable to meet the required threshold of sustainable assets, the firm said. It called for cash to be excluded from calculations and for the FCA to consider how sovereign bond holdings should be treated.

These concerns were echoed by UKSIF, which was also strongly supportive of the FCA’s objectives and said the proposals were “a clear step forward in the right direction”.

At the same time, UKSIF – a member of the FCA’s disclosures and labels advisory group – noted that it would be difficult to classify government bonds as sustainable, which could “disproportionately exclude” investors with a lower-to-medium risk appetite who wanted to invest sustainably.

UKSIF also noted issues around multi-asset and funds of funds, noting that there are “questions over the extent to which the labels are primarily designed for actively-managed equity funds with other asset classes and investment strategies arguably facing relative disadvantages under the framework”.

In its response, the group also noted the need for more clarity on the FCA’s approach to overseas funds and called for more information on the approach to company level disclosures under the SDR regime to avoid sequencing issues seen with SFDR.