The Financial Conduct Authority (FCA) has proposed new requirements for ESG funds sold in the UK to stamp out “exaggerated, misleading or unsubstantiated sustainability-related claims”.
The draft rulebook will form the UK equivalent of the EU’s anti-greenwash fund disclosure regime, known as the Sustainable Finance Disclosure Regulation (SFDR), which introduced stringent reporting requirements for ESG funds across the bloc in early 2021.
Today’s proposals go a step further than the strictly disclosure-based SFDR by setting out a fund-labelling framework that will require funds to meet a series of performance thresholds. However, key elements of the FCA’s proposals will need to be fleshed out, notably its references to the UK’s green taxonomy and global corporate sustainability disclosure rules – both of which are still under development.
“I am proud that we have gotten this over the line despite all that is happening globally and closer to home,” said Sacha Sadan, the FCA’s director of ESG. “What we have put out today is more than just a starting point, I think it will make a big difference compared to what is out there at the moment.
“This is something that we have been wanting to do for a long time. We probably won’t please everyone, but we have tried to listen to both consumers and industry as much as possible.”
The consultation – which was initially scheduled for Q2 this year but was delayed “to take account of other international policy initiatives” – proposes a set of three labels for sustainable funds.
The first, a “sustainable focus” label, will require 70 percent of fund assets to meet a credible environmental or social standard, or to be aligned with a specific environmental or social theme. The FCA noted that taxonomies could be one way of demonstrating credibility, but said it would not be prescriptive as to how this could be measured.
The second label, “sustainable improvers”, will cover funds where assets are not expected to be sustainable initially but have the “potential to deliver improvements in sustainability”. Funds with this label will require clear disclosures on investment restrictions, as well as asset selection and stewardship processes. Clear KPIs for sustainability improvements must also be disclosed.
Initially, a transition label had been suggested for the “improvers” category – but Sadan said the FCA had received feedback that the term could be confusing for retail investors.
The final label is for “sustainable impact” funds, which must aim to achieve a positive, measurable contribution to sustainability outcomes. Firms managing impact funds will be expected to report against KPIs, and be able to evidence and measure the additionality of investments if they involve new capital.
A fourth label was originally proposed for funds with ESG integration characteristics or that carried out stewardship activities on ESG topics. The idea was abandoned after a majority of respondents to previous consultations opposed it on the grounds that the name could be misleading and that ESG integration should not be enough to qualify a product for a responsible label.
The latest consultation proposes a ban on the use of sustainability-related terms such as ESG or net zero from funds marketed to retail investors that do not qualify for one of the three labels. A similar move for institutional investors was rejected as “disproportionate”. An FCA spokesperson said: “We do not consider there to be the same degree of potential harm to those investors.”
Fund disclosure requirements
Fund managers will be required to disclose a host of category specific ESG information for individual products. For example, Sustainable Improvers-badged funds must include information on the frequency and proportion of engagements that have led “to a material positive change in the environment and social sustainability of firms”.
At the same time, all managers of sustainability-themed funds must disclose investment objectives, the proportion of assets aligned to environmental and social goals, and information on the extent to which ESG objectives have been met.
Many of the requirements are not underpinned by strict definitions or benchmarks, unlike the EU’s SFDR – however, the FCA said it will expect reporting entities to use credible and transparent reference points to determine the sustainability of an asset. The regulator has not made independent verification mandatory.
Asset managers will also not have to show that their investments do not harm other environmental objectives – as with the EU’s Do No Significant Harm requirement – or disclose the potential negative impacts of their products.
The FCA warned that not every fund currently classified as Article 8 under SFDR will qualify for a sustainable investment label. “We will not expect every Article 8 fund to just get in,” said Sadan. “Otherwise, what’s the point of doing all this work and learning from what we’ve seen from other regulators?”
Sadan said the FCA had tried to avoid having the same tiering effect as SFDR. “In Europe, there is a perception that Article 9 funds are better than the others, which can be confusing. Investors quite rightly might want to own a diversified portfolio which includes these different elements, such as impact and improvers.”
The requirements are expected to “evolve”, according to the FCA, to incorporate alignment to the UK taxonomy and global sustainability disclosure rules being developed by the ISSB, once both are finalised.
The FCA is also proposing a general anti-greenwashing rule for regulated firms, requiring all sustainability claims for financial products and services to be “proportionate and not exaggerated”.
The consultation closes on 25 January. Finalised rules are due to be published by the end of H1 next year and will come in force no earlier than the end of June 2024.
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