Greenwashing and informational asymmetries: The FCA's direction of travel
The below is written by Samir Manek, Associate at Mishcon de Reya
What could be more important than working to save the planet that sustains us?
There are clearly strong movements in this direction: the Government made a commitment in 2019 to a net zero economy by 2050; consumers are increasingly voting on this imperative with their money; and, in response to growing customer demand, firms are providing an increasingly diverse range of products that target various ESG related objectives. Indeed, The Investment Association found that funds under management for responsible investment products contributed £11.7 billion to net retail sales in 2020.
However, 'greenwashing' – when misleading or unsubstantiated claims about environmental performance are made by businesses or investment funds about their products or activities – is a fundamental problem. It is a fundamental problem because it prevents a well-functioning ESG and sustainable investment market. It does this by misallocating capital in pursuit of a net zero economy.
Nikhil Rathi, the FCA's CEO, in his speech at COP26 on 3 November 2021, highlighted the importance of "setting appropriate guard-rails to make relevant market functions well". He said the FCA are "targeting potential harms to market integrity and consumers as companies and firms adapt to the unfolding ESG landscape."
This article will address:
the FCA's expectations;
the warning shots that have been fired; and
points for reflection.
The FCA's expectations
The FCA 2021 Business Plan states: "we will increase our supervisory focus on whether asset managers present the ESG properties of funds in terms that are fair, clear and not misleading". Indeed, the FCA recognise that they "need to ensure that ESG claims and credentials stand up to scrutiny, that consumers' interests are protected, and that competition remains effective in the interests of consumers."
Two of the FCA's six target outcomes in this space are:
High-quality climate and wider sustainability-related disclosures to support accurate market pricing, helping consumers choose sustainable investments and drive fair value.
Trust and consumer protection from mis-leading marketing and disclosure around ESG-related products.
Building on these target outcomes, the FCA published a Discussion Paper titled 'Sustainable Disclosure Requirements (SDR) and investment labels' in November 2021. Its purpose is to seek views on sustainable disclosure requirements for asset managers and certain FCA-regulated asset owners as well as the sustainable investment labelling system. Without common standards, clear terminology and accessible product classification and labelling, there is the potential for harm and for the misallocation of capital in pursuit of a net zero economy.
The FCA's initial views to correct the market failures are:
Product labels: Classifying and labelling investment products according to objective criteria and using common terminology to help combat greenwashing and enhance trust.
Consumer-facing disclosures: The most salient sustainability-related information for consumers so that they can make considered choices about their investments.
Detailed disclosures: Building on the consumer-facing disclosure, more granular information for professional investors. This could include methodologies used to calculate metrics.
Quite apart from any moral imperative to do so, firms ought to be prioritising the FCA's views in this space given the sombre mood music and the financial, reputational and regulatory implications of not doing so.
The Warning Shots
Plenty of public warning shots have been fired.
In addition to the speeches and publications in this space, the most striking example is the FCA's 'Dear Chair' letter to authorised fund manager chairs in July 2021. This highlighted the risk of misleading ESG-related claims by products and providers. The FCA state in the letter that they have seen "numerous applications for authorisations of investment funds with an ESG or sustainability focus", which "often contains claims that do not bear scrutiny". Further, they expect "firms to communicate clearly and avoid making misleading claims".
It is not necessary to look far to see regulatory action in this space. DWS Group, a German asset manager, who has approximately $1 trillion under management, is being investigated by German and US financial regulators. The investigation relates to allegations that it mislead clients about its sustainable investing efforts. It is not difficult to imagine regulatory action abroad being a precursor to Enforcement action by the FCA.
Points of reflection
Readers may wish to reflect on the following:
Regulatory action: The FCA's Authorisations and Supervision divisions are taking action. The Enforcement division will want to show that there are real and meaningful consequences for firms and individuals who don't follow the rules, like their international counterparts are doing.
Financial, reputational and regulatory risk: The news about the investigation into DWS significantly hit its share price. Firms ought to be thinking about the financial, reputational and regulatory risks of being implicated in or associated with greenwashing. Further, the threat of litigation and activist investor involvement will likely be substantial.
Conduct and culture: Is misconduct in this space evidence of a poor culture? Is the firm sufficiently diverse and inclusive as a way mitigate the risk of misconduct? How might this impact the FCA's view of the firm? See my article which builds on this important FCA thinking: FCA Reflection: Diversity and Inclusion – A Regulatory Matter.
Informational asymmetries: Correcting informational asymmetries and setting clearly defined common standards is something the FCA is doing and must do. One would expect the FCA to closely follow the EU's Sustainable Finance Disclosure Regulation where possible to avoid making the complex more complicated.
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