ESG InvestingNov 8 2022

Will SDR rules see greenwashing consigned to history?

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Will SDR rules see greenwashing consigned to history?
(Dreamstime/Fotoware)

It was a huge relief when I learned the sustainability disclosure requirements consultation would be published on October 25.

As a member of the DLAG – the Financial Conduct Authority’s Disclosure and Labels Advisory Group – and deeply committed to improving this area, I had started to fear it might be delayed.

The reality is that transitioning our entire economy to become clean, green and fair is complex. 

My first thought when I saw it was that it was longer than I expected (although the last 70 or so pages are mostly annexes). My next impression was pleasure. Even though there are areas that need further work, the proposals were sensible and as discussed. So it was easy to welcome. 

Greenwashing

The accompanying media release happily packed no punches. The FCA’s focus was greenwashing – making sure clients are not misled. 

Greenwashing is a tricky concept as it takes different forms. Commentators sometimes use the term when what they should be saying is that they disagree with a strategy. More often, however, it is borne of overstated environmental credentials, omitting key information, and\or meaningless, unproven marketing statements. 

And whether greenwashing is intentional or accidental – it has damaged the credibility of ‘sustainable investment’ as a franchise.

Greenwashing has been turbo charged by the recent boom in sustainable investment, underpinned by a lack of relevant knowledge, experience or ambition.

Use of the labels will be optional, but only labelled funds will be able to use certain terms.

I do not believe that intent to mislead is common, but in the real world it is actions not words that matter, so this needed to be dealt with. And preferring principles to rules, like many I am pleased the FCA is talking about "guardrails".

You may be aware that I have made it my mission to help retail intermediaries understand what funds in this area ‘actually do’ for many years. Accepting that there is no magic formula or strategy is something many find hard to accept – and there are many imperfections. 

But the reality is that transitioning our entire economy to become clean, green and fair is complex. 

FCA labels

In order to continue to thrive as a species most sectors will have to change significantly – some entirely. We must also do what we can to supercharge businesses that are solving problems, ensure higher sustainability standards are rewarded, and clients’ preferences are met. This is why the FCA has three proposed client-friendly labels.

These are:

  • Sustainable focus: for funds that invest in assets that are widely regarded as sustainable.
  • Sustainable improvers: for funds that aim to encourage a transition primarily through engagement (stewardship) activity.
  • Sustainable impact: for funds that focus on delivering measurable real world environmental and social benefits.

The labels distinguish between different intentions. 

The proposed labels are a victory for informed common sense in my view, and summarise core strategies well, by focusing on how funds are helping to deliver a sustainable future.  

We need to position sustainability firmly within the "clear, fair and not misleading" landscape.

Use of the labels will be optional, but only labelled funds will be able to use certain terms – funds will only be able to use one label; portfolios will be able to describe their breakdown of each label, subject to a proposed 90 per cent rule. 

The FCA knows there will be variation within and crossover between these groups, which is in part why disclosures are needed. 

This will put clear water between funds that are forward-looking, trying to change our collective outlook, and the bulk of funds that are rightly increasingly focused on managing environmental, social and governance risks.  

Disclosure requirements

Underpinning these necessarily broad labels will be two sets of disclosure requirements: consumer-facing and more detailed. Some requirements will relate to funds, others to entities (see 5.22, figure seven).

The proposal is that there will be the requirement to publish a core sustainability objective, a sustainable investment policy and strategy, KPIs and metrics, and information on governance, resourcing and stewardship.

This may appear onerous to some – and to some extent it should be. But this need not be overly burdensome. Funds will require the support of teams that understand the issues a fund covers, but by focusing on what an informed and interested client needs there are many ways strategies can be run. 

The regulator knows that success requires the support of the entire investment chain.

Other proposals, notably the "naming and marketing rules", which restricts the use of certain sustainability-related terms unless the product uses a sustainable investment label, and the general "anti-greenwashing rule" should also prove very helpful.

We need to position sustainability firmly within the "clear, fair and not misleading" landscape. The proposed "unexpected investments" or, in my words, a ‘surprise holdings’ rule (5.38) also supports this. Together these proposals should reduce the risk of greenwashing accusations. 

Regarding distribution, there is work yet to be done here. But broadly, the regulator knows that success requires the support of the entire investment chain, which includes distributors, for example platforms and advisers.  

And importantly, this is a consultation. We will all have opinions, and should be feeding them into the FCA.

The proposals set out in the consultation will make it easier for like-minded clients and fund managers to find, understand and trust one another.

I am uncomfortable with the proposed 70 per cent rule for the "sustainability focus" label, for example. In my opinion a fund that wants the space to invest up to 30 per cent in unsustainable assets should be called an "improver" fund, in part to avoid confusion.

Either way, I believe the proposals set out in the consultation will make it easier for like-minded clients and fund managers to find, understand and trust one another. The mass of research and consultation carried out by the FCA has facilitated this.   

The UN report published on October 27 entitled "Emissions Gap Report 2022: The Closing Window" highlights the need for urgent action, stating: "Only an urgent system-wide transformation can avoid an accelerating climate disaster."  

This clearly will not happen without investment markets functioning far better and clients trusting the system. It is time to confine greenwashing to history.   

Julia Dreblow is a director of SRI Services and founder of Fund EcoMarket database

Her insight fed into the FCA's consultation, but she remains independent of it