What advisers need to know about the FCA's ESG labels

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What advisers need to know about the FCA's ESG labels

With the M25 regularly being brought to a standstill; Van Gogh and King Charles suffering the indignity of being 'souped' and 'caked' respectively, and commentators debating the rights and wrongs of protestors’ methods, one thing is clear: we are facing a climate emergency. 

Against this backdrop, with growing lines at food banks in the sixth largest economy in the world, investors are increasingly looking to put their money to work to help solve pressing environmental and social challenges.  

This is not a new phenomenon. Impact and environmental, social and governance investing have been hot topics in the investment world for some time, particularly given the increase in interest that the ongoing generational shift in wealth is expected to bring.  

New sustainability disclosure requirements and investment labels 

It is also high on the regulator's list of priorities.

In October, the Financial Conduct Authority published consultation paper CP22/20, which set out the proposed SDR and investment labels for sustainable investment products.  

While these proposed rules are primarily aimed at funds and portfolio management, they have application to advisers as 'distributors' of the products in terms of providing information to consumers.  

Advisers have plenty of time before they need to think about this, don’t they?

The FCA has made clear that it will be consulting separately on suitability rules, which will be aimed at advisers.

The proposals introduce three labels for sustainable products:

  1. Sustainable focus;
  2. Sustainable improvers; and
  3. Sustainable impact

The labels are accompanied by disclosure requirements at product and entity level and rules regarding the naming and marketing of investment products, intended to help consumers distinguish between products that have earned a label and products that display certain sustainability characteristics but do not qualify for a label.

The FCA expects the labelling, naming, marketing and certain disclosure requirements will become effective in June 2024.

Advisers have plenty of time before they need to think about this, don’t they?

Given the focus of the new rules and the fact that the FCA has told advisers to 'watch this space' for suitability rules, many advisers will be planning to sit tight and wait for further updates.  

Advisers will need to ensure that information regarding sustainable products is provided in a manner that enables consumer understanding.

However, it is important not to lose sight of the fact that sustainability-linked investment products are already available, and the new consumer duty will become effective in July 2023 for all new and existing products on sale or open for renewal.

CP22/20 has got us thinking about sustainable investing and the consumer duty and what 'good outcomes' for consumers will look like in the context of sustainable investment products (even before the new rules become effective).

Regardless of suitability rules introduced in respect of new sustainable products, to comply with their obligations under the consumer duty, advisers will need to ensure they have clear processes to address.

Provision of information regarding sustainable products

Advisers will need to ensure that information regarding sustainable products is provided in a manner that enables consumer understanding and for consumers to make informed decisions under the consumer duty.  

Information will need to be presented in a digestible form to avoid overloading consumers with data and be as simplified as possible to enable understanding of the sustainability credentials of different products.  

The new sustainable investment labels could further complicate advisers’ lives.  

Advisers will need to have a good understanding of sustainability issues and the differences between products so that they can answer questions about and explain a category of investment products that will likely be relatively novel to many consumers.

Suitability

Sustainable investing complicates the advice process by adding new factors that advisers and consumers must grapple with.  

Advisers will need to ensure they have a full and frank discussion with consumers regarding their appetite for sustainable investing and the options open to them.  

Advisers will also need to ensure they capture a detailed record of their clients’ sustainability goals and the importance they place on such goals relative to risk and investment return. Advisers will then need to weigh all these factors when analysing the products available and making their recommendation.  

This will be crucial to ensuring good outcomes in the context of the product and services outcome and the price and value outcome under the consumer duty.

The new sustainable investment labels could further complicate advisers’ lives.  

The FCA has emphasised that the labels are not intended to operate or be seen as a hierarchy of sustainable products – from least to most sustainable.  

It is going to be crucial for advisers to have robust conversations with clients about the importance to the client of sustainability objectives.

Instead, the labels are intended to identify three distinct and mutually exclusive product categories, each intended to cater to different consumer preferences.

While it can be relatively straightforward to determine suitability for traditional investment products without a sustainability focus, it is harder to do this in a sustainable investing context.  

The products and services outcome and the price and value outcome can, to a large extent, be objectively assessed in traditional products. However, this becomes more challenging when sustainability is added to the mix.  

A client might be determined to pursue a sustainable investing strategy but the returns on such investments might not be sufficient to meet the client’s financial demands and needs over time even if the investments selected over-perform in terms of their sustainability objectives.  

What then should an adviser do?  

In such circumstances, it can be shown the client has a good understanding of the investments chosen and that the products and services selected are in line with and have met the client’s sustainability objectives, however certain of the client’s other demands and needs have not been met.  

It is not a given that a sustainable investment product will see lower returns, but it is not uncommon.

Would this be seen as a good outcome for purposes of the consumer duty? Could the adviser face a complaint or claim as a result of the poor financial performance of the products selected if there was always a heightened risk that the products would not meet the client’s financial demands and needs compared with a non-sustainable product?

It is not a given that a sustainable investment product will see lower returns, but it is not uncommon.  

The fact that the new labels are not a simple hierarchy of products that focus more on sustainability at one end and more on returns at the other means that it is going to be crucial for advisers to have robust conversations with clients about the importance to the client of sustainability objectives and that detailed and auditable records are maintained with sustainability being a key factor in advisers’ assessments of clients’ demands and needs.

For now, as part of preparations for implementation of the consumer duty, advisers should consider how they will approach sustainable investing with clients and it is vital that advisers keep on top of developments in sustainable investment products, including any new FCA suitability rules and guidance.

Adam Edwards is partner and head of financial services at Freeths