RegulationJan 12 2022

FCA's ESG criteria risks 'over-promising' to investors

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
FCA's ESG criteria risks 'over-promising' to investors
Angel Garcia/Bloomberg

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.”

Unfortunately, we are still in a situation where too many ESG claims do not stand up to scrutinyRichard Stone, chief executive, AIC

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.

“Getting the underlying definitions right for the three categories (and indeed all the categories) is hugely important,” it said.

SFDR came into force at the start of 2021, however its rules were not on-shored before the UK left the EU, leaving it up to the FCA to define how sustainable funds would be regulated here.

The FCA's labels and criteria are intended to help consumers navigate their sustainability characteristics and the input received will guide the regulator's policy design in this area, ahead of consultation on new proposals in spring next year. 

Richard Stone, chief executive of the AIC, said: “People buying investments that are labelled ESG or sustainable expect them to make a real difference, rather than being a marketing opportunity for product providers. Unfortunately, we are still in a situation where too many ESG claims do not stand up to scrutiny, as the FCA has already highlighted.

"This threatens to undermine investors’ confidence in ESG investing as well as getting in the way of positive change.

“We believe the bar for investment products to call themselves sustainable should be set high enough to clearly differentiate them from other products. Product labels should be clear, and disclosures should be short and jargon-free. It’s also important that investors know whether those products are focusing on environmental sustainability, social issues, or both."

The AIC also encouraged the FCA to extend these proposed standards to all retail investment products that fall under the Priips and Ucits regimes.

sally.hickey@ft.com