The Financial Conduct Authority's standards for "responsible" funds risk misleading investors that these vehicles are 'greener' than they actually are, according to two industry bodies.
Last year the FCA published a discussion paper on potential criteria to classify and label investment products.
The proposals involve categorising funds as "sustainable", within which there will be three sub-categories, "responsible" or "not promoted as sustainable".
The criteria to market a fund as "responsible" will be lower than those to market a fund as "sustainable" - there will only have to be ESG integration, evidence of ESG analytical organisational capabilities and resources, and demonstrable stewardship.
But in its response to the discussion paper, the UK Sustainable Investment and Finance Association said more clarification was needed on this criteria.
It said: "In part, this is because in our view this term is less commonly referred to and we have seen the following terms, in sequential order, used most frequently by firms over time: ethical, ESG, responsible and now sustainable.
"The term ‘Responsible’ could inappropriately raise expectations and over-promise what it could deliver for clients and savers, with this term implying higher sustainability attributes than what it possesses in reality (namely ESG integration), according to the regulator’s classification criteria set out.
"While ESG integration is generally seen as synonymous with responsible investment within the industry, the wider public could understand responsible investment as incorporating a greater focus on sustainable investing and this gap in understanding will need to be addressed."
UKSIF also encouraged the FCA to undertake consumer testing to ensure that the three sustainable categories suggested for funds do not lead to investors feeling misled.
The Association of Investment Companies agreed, saying this category should be adjusted.
It said: "It should also be clear that a Responsible investment does not have any specific sustainability or social purpose objectives.
"The approach to labelling/classification must minimise the potential for a ‘responsible’ label to give consumers an inflated view of the non-financial impact of the investment approach."
UKSIF also warned that the FCA risked ‘baking-in’ errors previously made by the EU in its existing Sustainable Finance Disclosure Regulation.
For example it highlighted that SFDR's Article 8 fund categorisation was is “too broad” and included “too many funds” in its scope.
This is because SFDR was originally envisaged as a disclosures framework before becoming a “de-facto” product labelling system, it said.
“The UK should be very alert to the possibility of ‘baking in’ some of the errors of SFDR into SDR.”
UKSIF warned the regulator needed to be cautious in automatically granting ‘equivalence’ for all of the EU’s Article 8 funds in order to secure any of the three ‘Sustainable’ labels in the UK to ensure the integrity of the UK’s system.