The Financial Conduct Authority said fund managers will have improvements to make ahead of the introduction of new ESG regulation.
The regulator carried out a review of current practices ahead of its roll out of new labelling of ESG products.
It comes nine months after the body last wrote to fund managers outlining concerns over “misleading or inaccurate” claims about ESG and sustainable investments.
The review focused on both active and passive retail funds that included a reference to ESG and/or sustainability-related terms in their name, including: responsible, ethical, climate or social.
The review is a follow up to a 'dear chair' letter sent to the bosses of authorised fund managers in July 2021 which set out guidance on the FCA's existing requirements in this area and the 'guiding principles' expected of the industry.
It found that while funds “typically showed good intent” there was evidence of products referencing ESG or sustainability in their name but not having this objective.
The FCA added: “In some instances, fund holdings appeared inconsistent with a fund’s ESG or sustainability objectives.
“Some authorised fund managers were not able to explain how these holdings were consistent with the ESG or sustainability characteristics of the fund.”
It also found a number of cases where key sustainability information was not clearly presented or made accessible.
The FCA is expected to introduce its delayed sustainability disclosure regulations (SDR), which govern how sustainable funds are labelled and promoted, in the fourth quarter of this year.
In today’s (November 16) update, the FCA said it expects fund managers to review their ESG and sustainable fund ranges and assess whether disclosure material meets the requirements of the planned rule change.
The three principles
The review sets out three guiding principles expected of fund managers: Design, delivery and disclosure.
Design, it said involves developing or using ESG scoring systems or benchmarks and also includes fund managers measuring and recording the outcomes of their 'stewardship activity' - the oversight that they have of the allocations of their clients' funds.
The FCA review found fund managers could do more to explain their stewardship approach to clients. It added: "This includes how their approach enables them to deliver on a fund’s objectives, how they measure delivery of stewardship outcomes and any associated challenges."
In the delivery point, the FCA said it reviewed funds that had holdings in oil, gas and mining.
While the documentation explained they were included due to having zero emissions targets, however targets for scope three emissions were not included.
Scope three refers to emissions companies are not directly responsible but so occur up and down its value chain.
The FCA said in some cases fund managers had not explained this exclusion from fund literature, but the guiding principles state where holdings might appear contradictory to a fund’s sustainability credentials, the AFM should explain this to investors.
To abide by the second principle, fund managers should focus on investment research, carry out due diligence on third party data and ensure data accuracy on an ongoing basis.
On the third principle of disclosure, the FCA found cases of fund managers failing to fully explain the ESG features of their funds.
Examples of this included managers disclosing carbon emissions data but omitted explaining that they excluded scope three emissions - even though these are often the majority of a fund’s carbon footprint.
The FCA advised fund managers explaining their use of benchmarks in a fund’s prospectus, including methodology, limitation and ESG data.
It also told them to test how well information on a fund’s sustainability features was understood by investors.
'Embedding transparency through the system'
The FCA urged fund managers to consider the impact of the proposed SDR now and take action ahead of the implementation of the rules.
The regulator added: “This package of measures proposes an anti-greenwashing rule for all authorised firms, which reinforces the importance of sustainability claims being fair, clear and not misleading and consistent with the sustainability profile of the product or service.
“For investment products specifically, the proposals include investment labels for products seeking positive sustainability outcomes; naming and marketing requirements; consumer-facing and detailed product-level information; and disclosures on how the firm is managing sustainability risks and opportunities.
“This package of measures seeks to embed transparency through the regime to help consumers navigate the market for ESG and sustainable investment products.”
tara.o'connor@ft.com
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