The Financial Conduct Authority (FCA) published the ‘Sustainability Disclosure Requirements and investment labels Consultation Paper’ in October 2022. This followed a Dear Chair letter and Discussion Paper and as expected, aligns itself with Policy Statement PS22/101 *, but with a focus on the marketing of sustainable investment products to consumers. Tara Swaminathan and Oliver Wannell review the proposed changes.
ESG investing – sometimes referred to as socially responsible investing (SRI) – has grown considerably in recent years, with socially conscious investors choosing products that have a positive environmental or social outcome, beyond a pure financial return. Regardless of whether you consider ESG investments as “falling short of your expectations” [1], or a “darling of the investment world” [2], the increased popularity in SRI, undeniably, shows a change in priorities and attitude of the current-day investor.
The FCA considers that this growth in SRI has led to some firms making exaggerated or unsubstantiated claims about the sustainability or ESG outcomes of their investment. Its concerns are primarily on the ‘greenwashing’ of investment products, with firms carrying out this practice in a bid to attract more socially conscious investors. According to the FCA, this practice threatens to undermine the trust between investors and firms and the integrity of the ESG sector as a whole.
Trust and integrity underpin the investment market, especially the retail investment market. This, contextually, supports the work the Government is doing in relation to the Financial Services and Markets Bill (FSM Bill) and the Edinburgh Reforms, with a key area of growth being investment and capital markets. For the FCA, alongside the concerns of harm to consumers, it says that if “consumers can’t trust the claims firms make about their products, they will shy away from this market, slowing the flow of much-needed capital to investments that can genuinely drive positive change”[3].
The FCA’s 2021 publication ‘A strategy for positive change: our ESG priorities’ reinforces the FCA’s current approach. The FCA considers that financial services sector could be a “force for good”, with institutions having a voice, influence and sway to encourage positive change, whilst supporting the transition to a net zero economy.
The ‘harms’
In its latest Consultation Paper, the FCA highlighted two main issues with the ESG investment products market:
- it is difficult for consumers to navigate; and
- there is an inherent lack of trust in the market by consumers, because of misleading sustainability-related claims.
The FCA provided further commentary on why consumer and market harms arise in this area, identifying the following issues:
- A lack of standardisation in product information – there is a lack of standardised reporting requirements for firms in relation to its sustainability objectives and strategies. This means it’s not always clear to an investor what a particular investment product is trying to achieve, and which of its investment strategies are being pursued.
- Asymmetric information – there is a lack of clear information being provided to investors by firms on how sustainability-related risks and opportunities, or the sustainability-related features of an investment product, are being managed.
- Coordination failure among firms – this is where a firm has concerns about being the ‘first-mover’ in making sustainability-related disclosures, because of a fear of reputational damage or an adverse market response to the disclosure.
- Coordination failure among clients and consumers – investors, especially retail investors, have a lack of bargaining power, which affects a market-led improvement in this area.
Proposed areas of change
To tackle this, the FCA is looking to introduce the following new measures:
- Sustainable investment labels – firms may apply one of three * labels, to assist consumers when choosing a ‘sustainable’ product.
- Consumer-facing disclosures – at product level, providing consumer-friendly, accessible disclosures to help consumers understand the sustainable features of a product. This includes any unexpected investments within it, and applies, regardless of whether a product has a ‘sustainable investment label’ (as above) ascribed to it or not.
- More detailed disclosures – at both product and entity level at the pre-contract, ongoing sustainability-related performance, and/or entity level stages. Unlike the other measures, the application extends to include institutional investors.
- Naming and marketing rules – this is where the ‘anti-greenwashing’ rule will sit; to ensure that sustainability-related claims are clear, fair, not misleading, proportionate and not exaggerated. Other naming and marketing rules for ‘in-scope’ firms, promoting ‘in-scope’ products to retail investors, are also dealt with here.
- Requirements for distributors – building on rules currently in place, to ensure that relevant information is clear and accessible to consumers and investors.
Who is affected by these measures?
The proposed rules are aimed largely at asset managers of products falling within the scope of the consultation, and those that distribute those products to retail investors. Some provisions, including the ‘anti-greenwashing rule’, will apply to all regulated firms. As the rules are at the consultation stage, there is further scope for the measures to be extended to regulated asset owners in relation to their investment products.
When will the proposed changes take effect?
The consultation closed on 25 January 2023, with final rules currently expected to be published by 30 June 2023.
The FCA plans to introduce the anti-greenwashing rule immediately after publication, whilst the remaining rules (labelling, disclosures and distribution) are expected to apply from 30 June 2024 onwards.
* This policy statement is the ‘Strengthening our financial promotion rules for high‑risk investments and firms approving financial promotions’
* The three labels are (i) sustainable focus; (ii) sustainable improvers; or (iii) sustainable impact.
