FCA raises the ESG bar to prevent greenwashing – comment from AJ Bell’s Khalaf

by | Oct 25, 2022

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Laith Khalaf, financial analyst AJ Bell

Laith Khalaf, head of investment analysis at AJ Bell, comments on the FCA’s proposed crackdown on greenwashing:

“The FCA is raising the bar for sustainable funds, after widespread concern that the ESG bandwagon was getting suspiciously overcrowded. The three new sustainable labels introduced by the regulator should help ethical investors to back their preferred investment approach. The greater regulatory hurdles to marketing a fund as sustainable should also force asset managers to start walking the walk or stop talking the talk.

“It seems likely that the ‘sustainable focus’ category will become the main label sought after by ESG funds, especially seeing as a minimum of 70% of such a fund’s portfolio will need to be invested in sustainable assets, leaving some scope for flexibility. The ‘sustainable improvers’ label might provide a home for fund managers who seek a broader investment universe, though it seems unlikely to garner a huge amount of support from ESG investors who will probably prefer to go green or go home. The qualifying criteria set down by the FCA should prevent the ‘sustainable improvers’ category becoming a back door for greenwashers, as there will be a number of hoops funds will need to jump through to obtain the label. The ‘sustainable impact’ label will have its members too, though these are likely to be limited in number due to the specialist nature of such funds, at least as things stand at the moment.

“There will also be an ‘anti-greenwashing’ rule, which will require sustainability-related claims to be clear, fair, and not misleading. It’s not entirely evident what this adds beyond the existing requirement for firms to ensure all consumer communications are clear, fair, and not misleading, apart from emphasising that this applies to sustainability claims too.

“Both the regulator and the industry face the immense challenge that sustainability characteristics are dynamic and complex, and that needs to be squared with simple communications that allow investors to make informed choices. Existing fund factsheets are not always easy to find and not universally rewarding when investors do find them, so the industry will need to up its game to present ESG information in an appropriate place and format. If it does, we may even find ourselves in the slightly absurd situation that sustainability disclosures tell us more about investment processes than longstanding fund factsheets and Key Investor Information Documents.

“As well as accessibility, standardisation of information is also key to helping investors make comparisons. Hence why the regulator is encouraging the industry to produce its own market-led template for consumer-facing sustainability information. It’s a good idea to get buy-in from the asset management industry to a centrally agreed format, though there is the question of whether a template without the force of the FCA behind it will be sufficient to achieve universal adoption. Data providers are also driving fund manager investment decisions through sustainability ratings and definitions, so the regulator may wish to consider how their activities join up with the requirements being proposed.

“ESG investing has clearly taken off in recent years, but it’s important to keep some perspective. ‘Responsible investments’, as they are currently categorised by the Investment Association, currently make up 6.4% of all assets under management, so the vast majority of investors’ money is invested in non-ESG funds. In the here and now, consumers are struggling to pay their energy bills and mortgages and by and large aren’t prioritising whether we should be using fossil fuels, but how we can access them more cheaply. The relative performance of ESG strategies has also rolled over this year compared to funds which have greater exposure to the oil and gas companies, which have been enjoying high levels of profitability from higher energy prices.

“This presents a more challenging environment for ESG fund sales, and combined with the increased regulatory hurdles being proposed, might lead to fewer fund launches. That may be no bad thing given the glut of offerings we have seen brought to the market in the last few years. Clearer labelling and disclosure will hopefully give us a better picture of how many truly sustainable funds are out there, as well as giving investors greater confidence in their ethical investment decisions.”

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