On 19 July, the UK's Financial Conduct Authority (FCA) published a letter to the chairs of UK authorised fund managers (“AFMs”), setting out its long-awaited expectations and principles regarding greenwashing in the context of UK authorised funds.
The principles build on existing FCA rules that apply to AFMs (in particular the obligations to make fair, clear and not misleading communications) and are intended to be complementary to the EU’s Sustainable Finance Disclosure Regulation (SFDR) requirements.
The letter also foreshadows further UK reforms in this space: “…the guiding principles are not the end point of setting out our expectations in this space, and they have been developed with the aim of being compatible with prospective future [UK] disclosure rules for responsible and sustainable investment fund products”.
The principles are presented as “guiding” principles, but do prescribe strict requirements in certain areas (e.g. fund names) and are quite similar to the AMF’s French doctrine for significantly engaging funds (albeit the UK reforms are a lot less prescriptive overall).
The principles also echo the overall SFDR framework as AFMs are expected to:
(i) have clear and accessible pre-contractual ESG disclosures;
(ii) report on the attainment of ESG objectives and characteristics; and
(iii) ensure that product marketing / labelling is proportionate to the materiality of ESG considerations in the management of the fund.
Overall, the principles indicate that there will be much greater FCA scrutiny of UK authorised funds making ESG-related claims, both in the pre- and post-authorisation phases. The FCA has also given practical examples in the letter of funds that fell below its expectations on this topic. In the FCA’s view, applications for the authorisation of ESG-focused funds “often contain claims that do not bear scrutiny…we expect to see material improvements in future applications”.
The FCA letter also suggests an overall policy direction that aims to match the green ambitions of the EU (although using a more principles-based framework for now).
What products do the principles apply to?
The principles are expressed as applying to FCA authorised UK funds only, and so do not apply to unauthorised UK AIFs or overseas funds that are marketed into the UK (including those that are marketed under the FCA’s temporary marketing permissions regime).
Although there is no specific commentary to this effect, in practice the principles may become best practice for all funds / fund managers to consider (noting that they build on certain FCA rules, such as the fair, clear and not misleading rule, that apply to a much broader population of funds and fund managers than UK AFMs and authorised funds) and are likely to form the basis of the FCA’s version of the SFDR in due course.
No implementation date is specified and so the principles take effect from publication (i.e. as of 19 July 2021).
The guiding principles are underpinned by an overarching FCA principle that:
“A fund’s ESG/sustainability focus should be reflected consistently in its design, delivery and disclosure. A fund’s focus on ESG/sustainability should be reflected consistently in its name, stated objectives, its documented investment policy and strategy, and its holdings.”
This overarching principle is supplemented by 3 supporting principles: (i) design; (ii) delivery; and (iii) disclosure - with further guidance provided on each supporting principle. See table below for more details.
Further guidance / expectations
The design of responsible or sustainable investment funds, and disclosure of key design elements in fund documentation, should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.
- Fund names must not be misleading:
- terms such as "ESG2, "green", "sustainable", "responsible", "ethical", "impact", or related terms should not be used unless the fund pursues ESG/sustainability outcomes in a way that is substantive and material (compared to a fund that does not take such considerations into account);
- for example, an index-tracking fund that excludes a small number of securities, or where the holdings are not materially different from a similar non-ESG index should not use these terms in its name;
- “impact” or “impact investing” should only be used in the fund name if the fund is seeking a non-financial (real world) impact, and if that impact is being measured and monitored.
- Investment objectives / policy: where a fund claims to pursue ESG characteristics, themes or outcomes, these should be appropriately reflected in its objectives and/or policy, with specific and clear disclosures:
- funds that aim to generate a measurable, beneficial ESG/sustainability impact alongside a financial return should clearly state the intended ‘real-world’ outcome;
- where third-party data providers or indices are exclusively or largely relied on to meet the ESG aims, this should be disclosed in the prospectus;
- where a fund might hold securities that an investor might not expect, given the ESG/sustainability focus of the fund, this should be made clear in the prospectus, including the circumstances and the purposes for which these securities would be held.
- Investment strategy:
- key elements of the ESG strategy should be disclosed – e.g. the investible universe, any screening criteria (positive or negative), specific E, S or G characteristics/themes or ‘real world’ (non-financial) impacts pursued, application of benchmarks/indices, and the stewardship approach of the fund;
- where a fund just integrates ESG into the investment process, and there is no material ESG orientation in the fund design/strategy – there shouldn’t be any prominent ESG claims in the fund’s name or documentation and ESG shouldn't be positioned as a key part of that fund’s offering; and
- the disclosures should give sufficient information to enable investors to understand and compare the ESG strategy pursued by the fund (e.g. negative screens, ESG tilts or positive impact objectives).
- Stewardship approach: where stewardship is part of the active investment strategy of the fund, it should be clear how monitoring, engagement and voting activity in respect of ESG/sustainability matters are integrated with investment decisions, and how escalation and divestment decisions are made.
The delivery of ESG commitments / aims should be supported by appropriate resources, the fund’s investment strategy should be implemented consistently with stated ESG objectives and should be monitored.
- Resources: appropriate resources must be in place and deployed to support the delivery of the fund’s ESG aims – including in relation to skills (e.g. investment professionals), experience, technology, research, data and analytical tools.
- Oversight and due diligence of data inputs: appropriate resources should be in place to oversee internal and third-party research/tools and firms are expected to consider whether they should due diligence data providers. Appropriate steps should be taken to monitor, assure and understand quality of data, data inputs and any gaps.
- Holdings and the reasonable investor test: AFMs should consider whether a reasonable investor would consider that the fund’s holdings reflect the ESG commitments/promises made by the fund. Where holdings might appear contradictory to an ESG investment strategy, the AFM should consider explaining this apparent inconsistency to end investors.
Pre-contractual and ongoing periodic disclosures should be easily available to consumers, be clear, succinct and comprehensive and contain information that helps consumers make investment decisions.
- Easy availability: AFMs should take appropriate steps to ensure consumers can access relevant ESG/sustainability-related information to support their investment decisions and monitor outcomes (including information on third-party data tools, their methodologies and limitations) – including, to the extent possible, where a fund is marketed via a distribution platform.
- Pre-contractual disclosures: similar to the EU SFDR rules, these should be included in relevant regulatory documents and reflected in accompanying marketing materials in a clear, fair and not misleading way. The information should be presented in an accessible way that is clear, succinct and comprehensible, and that forms a sufficient basis to support consumers in making informed investment decisions.
- Ongoing performance reporting: AFMs should take appropriate steps to make information on how well a fund is meeting its stated ESG objectives/aims available to consumers on an ongoing basis (for example in annual and half-yearly reports). This should include (as appropriate) reporting on KPIs, non-financial (real world) outcomes and actions taken in that regard and on stewardship efforts.