FCA sends market clear signal of interventionist approach to ‘greenwashing’

It also sets out a detailed labelling, disclosure and naming and marketing regime regarding sustainability-related products in financial markets for asset managers and investment distributors.

The consultation paper (179 pages / 1.97MB) makes clear that the FCA’s current attitude towards environmental, social, governance (ESG) and sustainability-related claims firms make is relevant to all regulated firms – not just those directly impacted by the proposed new rules. Crucially, the proposals will be accompanied by the FCA "stepping up its supervisory engagement on sustainable finance and enhancing its enforcement strategy.” Here are some of the key areas of future, and current, regulatory risk that arise from the FCA’s consultation paper.

The general anti-greenwashing rule

The FCA's view is that the proposed new general 'anti-greenwashing' rule merely reiterates regulated firms' obligations - to ensure communications are clear, fair and not misleading - which already apply in respect of sustainability claims under the FCA's ‘Principle 7’ and section 4.2.1 of its conduct of business sourcebook (COBS).

Nevertheless, among the FCA's reasons for this new rule, which is intended to apply from 30 June 2023 to all regulated firms, is the intention to ensure the FCA has "an explicit rule on which to challenge firms that we consider to be potentially greenwashing their products or services, and take enforcement action against them as appropriate".

Regulated firms should therefore expect that the FCA may not wait until 30 June 2023 to review or take enforcement action against suspected greenwashing. After all, the FCA has taken an increasingly interventionist approach towards dealing with potential misconduct within financial markets in recent years.

Rules for asset managers and investment distributors

The bulk of the FCA's consultation paper relates to detailed rules relating to sustainability disclosure requirements and investment labels. These are due to be finalised with any amendments arising from the FCA's consultation by 30 June 2023. The rules will be implemented to various groups of firms in stages.

According to the consultation paper ‘in-scope firms' are those based in the UK that carry out portfolio management services, UCITS managers and full-scope and small authorised alternative investment fund managers (AIFMs). 'In-scope products' are UK-based authorised funds, unauthorised Alternative Investment Funds (AIFs) including investment trusts and portfolio management services. 'Distributors' are defined by the FCA as firms that are distributors of in-scope products to retail investors, including platforms and advisers.

Implementation

The FCA plans to implement the proposed new regime in four stages, although the deadline for each one remains provisional. As each implementation milestone passes for UK asset managers and distributors, their exposure to regulatory risk – such as FCA scrutiny and potential enforcement action - will increase.

Stage one

By 30 June 2024 all in-scope firms, except portfolio managers, will be required to adhere to rules on sustainable investment labels; naming and marketing rules where labels are not used; consumer-facing disclosures and pre-contractual disclosures.

Portfolio managers will have to implement elements of the rules on consumer-facing and pre-contractual disclosures by the same date. Distributors will have to abide by distributor-specific rules on the display and provision of access to investment labels and sustainability disclosures.

Stage two

By 30 December 2024, portfolio managers are to implement rules on sustainable investment labels – where 90% or more of the value of constituent products qualify for any label. They must also adhere to naming and marketing rules, unless 90% or more of the value of constituent products qualify for any label.

Stage three

By 30 June 2025, all in-scope firms including portfolio managers must implement rules on ongoing sustainability-related performance information. All in-scope firms with £50 billion or more of assets under management (AUM) will also have to adhere to rules on entity-level disclosures.

Stage four

By 30 June 2026 all other in-scope firms with £5 billion or more of AUM must implement rules on entity-level disclosures.

Risks arising from current industry practices

The FCA's consultation paper also suggests that certain current practices within the asset management and investment distribution sectors already fall outside of its expectations for compliance with the existing regime.

According to the FCA, while many products “currently promote themselves as ‘ESG-integrated’ and many employ strategies such as ‘exclusion/negative screening’ or basic ‘ESG tilts’” it does “not consider these attributes alone to be sufficient to meet the requirements for a sustainable label.” The regulator added: “If such products were to continue to name and market themselves as being ‘ESG’ or ‘sustainable’ in this way, despite not qualifying for a sustainable label, consumers could be misled.”

ESG integration

Regarding ‘ESG integration’ strategies, the FCA notes that it understands this strategy to be “the consideration of ESG risks, opportunities and impacts that may be material to the future financial performance of the product’s assets.” It also notes that ESG integration “is increasingly considered to be integral to a firm’s acting in accordance with its fiduciary duty and risk management.” Despite this, the FCA said that ESG integration “would not be regarded as a sustainable investment strategy in its own right.”

ESG tilts

In respect of exclusion/negative screening strategies or basic ESG tilts, the FCA states that: “Where such strategies align with their objectives, it is important that consumers are able to identify, access and gather reliable information about these products.” It said, however, that: “such strategies, alone, would not plausibly contribute to positive sustainability outcomes,” adding that “it is also important that consumers can reliably distinguish them from genuinely sustainable investment products.”

The FCA concluded that exclusion/negative screening strategies or basic ESG tilts would not qualify for a sustainable investment label alone. However, they may “if combined with other strategies and if the full criteria were met – including that the product had a sustainability objective.”

Potential breach of existing rules

The FCA’s comments on the potential for such strategies to be misleading to customers should be considered in light of its view that the general ‘anti-greenwashing’ rule is, in fact, nothing more than a reiteration of existing obligations on firms. Taken together, it is logical to conclude the FCA may seek to argue that the consultation paper merely clarifies that firms’ ESG-related claims, when justified solely by such strategies, may have been misleading to customers in breach of regulatory obligations prior to 25 October 2022 - the date that the consultation paper was published.

The FCA might also argue that the consultation paper clarifies regulatory expectations of ESG-related claims which may be misleading, and firms which continue to make such claims after 25 October 2022 potentially do so in breach of their regulatory obligations. There is, therefore, a clear risk here that the FCA already considers – or might come to conclude upon a future review – that certain asset managers are already in breach of existing rules, or shortly will be without prompt review and remediation.

Distributors

The FCA has stated that distributors must display labels prominently on a relevant digital medium and provide access to the accompanying consumer-facing disclosures. According to the consultation paper, they must not use a sustainable investment label for a product other than the label that has been assigned by the firm. The FCA proposes that distributors must keep the relevant digital medium and marketing communications updated with any changes a firm makes to the label and disclosures. For products that do not use a label, the paper sets out how distributors “will nevertheless be required to provide retail investors with access to the consumer-facing disclosure.”

It added that: “These proposals are consistent with current expectations on distributors in making information available to investors. So, we remind distributors that they must comply with existing requirements for the distribution of financial products in the PROD Sourcebook and under the new Consumer Duty.” As with asset managers, there is a clear risk that the FCA considers, or would come to conclude, that certain distributors are already in breach of existing rules on displaying and providing access to ESG-related claims relating to financial products, or shortly will be without prompt review and remediation.

Implications

UK asset managers and investment distributors should therefore promptly review whether existing practices may fall within the FCA’s examples of potentially non-compliant practices and identify whether remedial steps may be required. The longer potentially non-compliant practices continue after publication of the consultation paper, the greater chance the FCA may intervene – including by bringing enforcement action.

Wider risks

At this stage, certain wider commercial and regulatory considerations also arise from the FCA’s approach to tackling greenwashing. For example, it is possible to imagine that a fund manager facing difficult market conditions may be faced with the choice of either meeting their ESG targets or their financial targets. In either case this may impact the degree to which representations to customers at the point of sale have been met, the ESG labelling of investments, and/or the customer disclosures required.

Clearly, it would bring significant regulatory risk if a firm was revealed to have systemically mislabelled, mis-sold, or misrepresented the sustainability or ESG credentials of products. It also brings risk of ESG-related customer complaints and disputes between commercial parties arising from ESG-related issues. It is therefore likely that courts will increasingly be asked to consider the question of how losses can be quantified where ESG targets have been missed. Courts will be asked to do so in cases where no financial loss has been incurred, or where financial gain has been received, at the cost of meeting ESG targets.

A clear signal to the market

The FCA's consultation sends a clear signal to the market of its intention to prevent greenwashing and, significantly, to take enforcement action where it considers regulated firms are engaging in the practice. Authorised fund managers should take particular note that the FCA will be carrying out a multi-firm review as to “how firms have responded to the expectations set out in the Dear Chair letter (9-page / 284KB PDF) to authorised fund managers in July 2021”. These will, therefore, be naturally more exposed to regulatory risks identified above.

However, all regulated firms are impacted by the approach set out in the FCA’s consultation paper. While the consultation paper focuses primarily on asset managers and investment distributors, the general anti-greenwashing rule impacts all regulated firms. The FCA explicitly states that these proposals are “a starting point” for its wider plans to tackle greenwashing in the market.

It has announced that it will be pursuing further consultations aimed at expanding these requirements to overseas investment products; pension products and other investment products marketed to retail investors such as insurance-based investment products (IBIPs). The FCA also plans to expand the regime further including to financial advisers, listed issuers, disclosure of transition plans, taxonomy-related disclosure requirements, mandatory sustainability-related metrics on all products and further enhancements to entity-level disclosures.

This is a high priority area for an increasingly interventionist FCA, which will likely look to make an example of firms it identifies as falling outside its expectations. Firms should therefore promptly take steps to review, and if necessary, remediate their approach to sustainability-related products.