FCA 'clearly listened' to industry over ESG labels

Earlier this week (October 25), the regulator released a consultation laying out its proposed sustainability disclosure requirements (SDR) and investment labels for the first time.

The FCA had been encouraged by the industry to engage with it through the creation of these labels, after the EU was criticised for developing its sustainability rules behind closed doors.

James Alexander, chief executive officer at the UK Sustainable Investment and Finance Association, told FTAdviser the FCA had clearly learnt from the EU’s process.

[The regulation] has sidestepped the need to harmonise the meaning of sustainabilityPhil Spyropoulos, Eversheds Sutherland

“The FCA has done a good job of getting the industry involved in the development process of this…it was very open,” he said, adding that the UK regulator had listened to experts in its Green Technical Advisory Group (GTAG).

The regulations, which will be implemented next year after a consultation period, aim to clamp down on greenwashing, and restrict how investment managers use terms such as “ESG” and “green”.

Greenwashing not only undermines trust in the industry, Alexander, said, it harms those companies and organisations who are going the extra mile in creating products that do have a tangible positive impact on ESG issues.

“If a competitor is not doing all this extra effort and [instead] just has a good marketing team behind them, it is hard for retail investors and even financial advisers to tell the difference between the two," he said.

“That’s a problem.”

Proposed labels

The regulation includes three labels for sustainable products, which are ‘sustainable focus’, ‘sustainable improvers’, and ‘sustainable impact’.

The first requires at least 70 per cent of the product to be invested in assets aiming to achieve a high standard of ESG, with the second looking at assets that are not sustainable now but are aiming to be in the future.

The ‘sustainable impact’ category will be for products with an explicit objective to achieve a positive and measurable contribution to sustainable outcomes, and products that do not align with any of these will be label-less.

Investment products that qualify for the regulation will also be required to meet certain principles in order to use a sustainable label, including their sustainability objective, investment policy and strategy, key performance indicators, resources and governance and investor stewardship.

The amount invested in funds that sit in the IA's "responsible investment" category totalled £90.3bn in August 2022, out of a total £1.4bn of funds under management in the UK.

This is £10bn higher than the £81.1bn sat in these funds in August last year.

Criticism of the labels

There has been some criticism that these labels do not go far enough in terms of defining exactly what constitutes green investing.

Phil Spyropoulos, partner at Eversheds Sutherland said the FCA’s thesis could be summarised as “say what you do, then do what you say”.

“In this way, it has sidestepped the need to harmonise the meaning of sustainability since it is looking at what the firms themselves claim to be offering,” he added.

The regulator said that a green taxonomy, which defines what can be called sustainable, would be a way of enforcing products’ definitions of sustainability, however it said it is deliberately not being prescriptive at this stage.

These measures will be of limited effect in urgently directing capital flowsOttilia Csoti, Fladgate

“These attributes should ensure there is greater transparency over how firms are determining ‘sustainability’ in relation to the products they offer, while recognising that this is an evolving space and that other standards may emerge,” it said.

Ottilia Csoti, associate at Fladgate, said the proposals allow for the inclusion of coal, gas and oil investments under certain conditions.

“Given the relatively long lead time for these measures and the scale of the climate crisis, [this] likely means these measures will be of limited effect in urgently directing capital flows away from investments that further the consumption of fossil fuels,” she added.

Financial advisers and investment managers are going to play a crucial role hereBeth Lloyd, Quilter

Head of investment analysis at AJ Bell, Laith Khalaf, said the rules might inadvertently slow the rate of new ESG fund launches.

The combination of these “regulatory hurdles” and the underperformance of ESG strategies this year compared with other funds that have greater exposure to profit-making oil and gas companies, has made it a more challenging environment for ESG fund sales.

“That may be no bad thing given the glut of offerings we have seen brought to the market in the last few years,” he said. 

“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.”

Beth Lloyd, head of responsible wealth management strategy at Quilter said that this is not the final part of the “journey”.

The upcoming consultation on the role financial advice will play within these regulations is a “fundamentally” important next step, she said, and it is vital to see consistency across all parts of the industry.

“The FCA has been clear on its intentions and how information should be presented to the end consumer…however, this will not be a substitute for proper research, interrogation and direct discussions with the end-client.

“Financial advisers and investment managers are going to play a crucial role here.”

Sustainability regulation

The EU was the first country to implement sustainable investment regulations in summer 2020, which included the Sustainable Financial Disclosure Regulation.

The UK decided not to implement the EU’s regulation in legislation since it left the bloc at the beginning of last year, instead choosing to work on its own taxonomy. 

It created a working group, the Green Technical Advisory Group (GTAG), to oversee the delivery of this including giving advice on developing the framework,  supporting investors, consumers and businesses to make green financial decisions and clamp down on greenwashing. 

There was concern that the rules would be “perpetually kicked down the road” after they were delayed earlier this year, however the FCA stuck to the timeframe announced in the delay, saying it wanted more time to examine the Securities and Exchange Commission’s own rules which had just been released.

The UK’s regulations go further than the EU’s regime, which has turned into a quasi-labelling system despite not being designed as one.

Regulators have been treading a careful line between pushing forward with their own reforms, and waiting for other jurisdictions to release their own, to ensure asset managers and investors aren’t overwhelmed with conflicting systems.

Behind this is the urgency with which some think these measures should be enacted, to ensure the positive impact on the environment is not delayed any longer than necessary.

sally.hickey@ft.com