UK regulator launches guidance to prevent ‘misleading’ ESG funds

FCA issues principles for asset managers and highlights examples of poor quality application of ESG

The UK’s Financial Conduct Authority (FCA) has set out a series of principles for ESG labelled funds, prompted in part by the number of poor-quality fund applications seen by the regulator.

With increasing numbers of applications for new and refocused sustainability-labelled funds, the FCA said it was essential that assertions made about fund goals were reasonable and substantiated, and that the inability of consumers to judge whether funds met their needs and preferences could undermine trust in the ESG market.

RI reported earlier this month that the regulator was preparing to issue guiding ESG principles for investment funds. 

The three principles, published today, relate to fund design and disclosure, delivery and ongoing monitoring of holdings, and the accessibility of disclosures for consumers: 

  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.
  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.
  3. ESG/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 judgement 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.

Key considerations under each principle include ensuring that voting rights are exercised in line with fund investment objectives, and that where fund holdings might appear contradictory to an ESG investment strategy, fund managers should explain this inconsistency to end investors. 

Funds which use an ESG or sustainability label without any material difference in management compared to a fund which did not take such considerations into account would be considered “misleading”, and only funds that seek a measured and monitored non-financial impact should use the term “impact” or “impact investing”.

In addition, the principles say investment firms should consider doing due diligence on any ESG and sustainability data they rely upon – including third-party ratings, research and data – to be confident they can validate their funds’ sustainability claims. This comes just days after the FCA said in its 2021/22 business plan that it will gather market intelligence on “how well firms are supported by service providers, such as ESG ratings providers”. 

Meanwhile, the FCA gave a number of examples of poor quality ESG applications it had seen, including a passive ESG fund which did not track an ESG index and included very limited exclusions. A second example given was a sustainable investment fund which had two high emissions energy companies in its top 10 holdings “without providing obvious context or rationale behind it”.

The idea of the principles, which were developed in consultation with the investment industry and are intended to be complementary to the EU SFDR, was first announced in November 2020 by the FCA’s Director of Strategy, Richard Monks, who said that they could help protect consumers from potential greenwashing.

“Innovation can’t come at the expense of undermining trust in the sustainable finance market,” he said. “Trust is hard won but easily lost… We will act where we find firms are not upholding the standards we expect.”

Separately, the FCA and the Treasury are also working together to develop a sustainable investment label. The Treasury said that the label would be a “quality stamp”, which would allow consumers to “clearly compare the impacts and sustainability of their investments for the first time”.