Issues with the Financial Conduct Authority’s (“FCA’s”) proposed new rules to tackle greenwashing (FCA Consultation Paper 22/20) were highlighted during their scrutiny by the Treasury Select Committee on 22 February 2023. Firms that will be affected need to understand these issues urgently because the first greenwashing rule could come into force as early as 30 June 2023. It would also be prudent to consider the FCA’s proposals alongside implementation of the new Consumer Duty. In this article we discuss the main issues raised.
The core proposals
An overview of the FCA’s anti-greenwashing proposals can be found in our previous article here.
At the core of the FCA’s proposals are sustainable investment labels, classifying investment products into three different types – “sustainable focus”, “sustainable impact” and “sustainable improvers” according to “intentionality” and the channels by which the product/its manager can plausibly contribute to positive sustainability outcomes. According to the FCA’s Consultation Paper “The labels will be underpinned by a set of clear, objective criteria that set a high bar for quality and integrity. These criteria cover specification of an objective, investment policy and strategy, key performance indicators, firm-level attributes (resourcing and governance of ESG), and investor stewardship”. Any in-scope investment products aimed at retail investors that do not apply such a label will have to comply with the FCA’s naming and marketing rules, which as currently drafted prohibit the use of a number of widely used sustainability related terms including ESG, climate, impact, transition, net zero, responsible, green and “any other term which implies that a sustainability product has sustainability characteristics”. This ban on the use of specific terms is in addition to the proposed general “anti-greenwashing” rule providing that “A firm must ensure that any reference to sustainability characteristics of a product or service is consistent with the sustainability profile of the product or service and clear, fair and not misleading”.
The FCA is scheduled to publish its Policy Statement including final rules by 30 June 2023 with funds then being given 12 months to implement the labelling rules and portfolio managers being given 18 months. On current proposals the general anti-greenwashing rule could come into force immediately on publication of the Policy Statement.
The issues
Some providers of purportedly sustainability-orientated investment products may have significantly overstated their investment approaches and what these can realistically achieve. It is right that bad actors of this sort are purged. Many regulators around the globe are looking at or already have rules in this area, such as the EU Sustainable Finance Disclosure Regulation The FCA has been criticised both for being late to the party and for deliberately taking a different approach from the EU despite the fact that a significant portion of UK investors’ fund investments are in non-UK UCITS funds.
On the FCA’s own assessment and according to the UK Investment Association, only a third of existing funds that have been marketed as having sustainable elements would qualify for a label. It is perhaps problematic that the FCA finds it acceptable to design a labelling regime that will exclude two thirds of existing products. Of course, the introduction of new FCA rules does not mean that the two thirds of existing products have been mis-sold (though some of them may have been) and the FCA has accepted this. However, retail investors may well feel that there is something wrong with an existing investment that they thought was green but which does not qualify for a label. The Investment Association warns that the new rules could result in significant market dislocation as a result. There is a risk of mass disinvestment from unlabelled funds unless they go through major and expensive reengineering that in itself could be damaging for investors and investees. To mitigate this risk, the FCA needs to communicate very clearly to retail investors in existing “sustainable” funds what the new rules mean for them. For this reason it is far from ideal that the general anti-greenwashing rule could come into force as early as June 2023, twelve months ahead of the implementation date for the labelling rules for funds.
One reason that so many existing funds marketed with sustainability elements will not qualify or will not apply for the FCA’s proposed labels, is the artificial straitjacket the proposed rules impose. For example, if a fund invested all of its capital in a combination of sustainable improvers, sustainable impact and sustainable focus investments it could not qualify for a sustainable label. Funds can qualify for a label only if they stick to just one of these investment approaches. To date asset managers have taken a more flexible approach to investment selection and stewardship. Further, the FCA’s proposals, in particular the naming and marketing restrictions, do not cater for retail investors who want just a little exposure to “green”. In this way the impact of the FCA’s proposals risks resulting in a green investment landscape that looks more like a golf course than a wildflower meadow.
There will always be the fundamental problem for asset managers of how to judge whether a particular investment can be regarded as sustainable or promoting sustainability. To an extent “green” is in the eye of the beholder. Put another way, one person’s green may be another person’s poison. For example, it is commonly thought that investing in renewable energy providers such as wind and solar is a good thing to combat climate change but that does not necessarily take into account the significant carbon footprint that these providers may have. The major oil companies are some of the biggest investors in carbon capture technology (necessity being the mother and father of invention), something that if developed appropriately and deployed widely across other industries could help save the planet, yet many sustainability-oriented retail investors do not feel comfortable having an oil major in their portfolio. So sustainable investing involves nuanced decisions and there are many competing viewpoints on the correct approach. Further, corporate sustainability reporting does not yet have a robust internationally agreed approach - instead there are fragmented approaches around the world - so the information available to asset managers about how their investments are performing is imperfect.
With that backdrop, the FCA’s proposed new rules to tackle greenwashing in its Consultation paper CP 22/20, though well meaning, may be a step too far. The FCA cannot know whether its approach to sustainability labelling is an optimal one for driving real world outcomes, like slowing climate change. Yet it will have the effect of driving UK retail investors’ capital towards only these labelled approaches to sustainability investment. The FCA can point to the extensive work it has done with the Disclosures and Labels Advisory Group and the testing of 7000 consumers in developing its proposals. However, customer understanding, though very important, is only part of the story. An approach that is easy for retail investors to understand does not necessarily align with the optimal mix of investment and stewardship approaches to deliver material sustainability outcomes. This is something that the industry is still experimenting with and learning about. It would be preferable, therefore, if the FCA could as a minimum scrap the marketing rules, so that a wider, more flexible range of investment approaches is available, which the FCA can then police using the general greenwashing rule.
At the scrutiny session on 22 February 2023, the Chair of the Treasury sub-committee appropriately asked a number of pointed questions of the FCA and the experts called to give evidence, including:
- “[ Is it] …. a good outcome that two-thirds of firms that currently claim to be sustainable will not be able to obtain one of these sustainable labels?”
- “The industry is basically flying blind into whether or not these three categories are something they can achieve based upon the data available?”
- “You are going to have a lot of consumers who thought they were invested in something that was green and they are going to be told that, as a result of these changes, that is not the case any more. In fact, you estimate 70% of the market is going to be told that. What are going to be the costs to those investors? Presumably, since they have gone to the effort of investing in what they thought was green, they are going to probably have to now switch into something else?”
- “You have not done any estimate of what the costs are going to be to consumers here?”
The session concluded with the Chair expressing to the FCA “shock that you had not thought about the cost, either for the industry or for the consumer, in terms of any of the communication, and also some of these important questions around enforcement and a clear answer on international standards.”
The scrutiny session had been preceded by an exchange of correspondence between the FCA and the Treasury Select Committee in which the FCA acknowledged that it is still capacity building amongst its staff for specialist ESG knowledge.
Meanwhile on 16 February 2023 ClientEarth announced that it has filed a judicial review action against the FCA alleging it acted unlawfully by approving the prospectus of UK oil and gas company Ithaca Energy plc in autumn 2022 despite the company’s disclosures allegedly failing adequately to describe the climate-related risks faced by the company, therefore breaching the prospectus requirements and depriving investors of key information. Naturally we do not prejudge the outcome of that case but perhaps the FCA’s Listing arm could do with some ESG capacity building too, to ensure that all parts of the FCA are aligned in its sustainability efforts?
If you would like to know more about the issues raised in this note or to discuss the implications for your business with our regulatory experts, please contact Angela, Charlotte or Mathew whose details are given below.
