Other Author Oliver Williams, Trainee Solictior
"Greenwashing" – which, as noted in the European Securities and Markets Authority's Sustainable Finance Roadmap 2022-2024, "intuitively refers to market practices, both intentional and unintentional, whereby the publicly disclosed sustainability profile of an issuer and the characteristics and / or objectives of a financial instrument or a financial product either by action or omission do not properly reflect the underlying sustainability risks and impacts associated to that issuer, financial instrument or financial product" – continues to be a major focus of public and investor scrutiny across all sectors. As discussed in our previous blog posts (which you can read here, here, here and here), regulators across the globe are responding to this increased scrutiny in a number of ways.
The UK's financial regulator – the Financial Conduct Authority ("FCA") – on 25 October 2022, published its "Sustainability Disclosure Requirements ("SDR") and investments labels" Consultation Paper (CP 22/20) (the "Consultation Paper").
This follows the FCA's July 2021 "Dear AFM Chair" letter regarding improving the quality and clarity of authorised ESG and sustainable investment funds and November 2021 "SDR and investment labels" Discussion Paper (DP 21/4), both of which indicated that the FCA intended to toughen its stance towards greenwashing against the backdrop of increasing concerns over investment funds making ESG-related claims that are exaggerated, misleading or unsubstantiated.
Whilst noting that "tackling greenwashing is a core regulatory priority for the FCA", the Consultation Paper proposes a set of new rules aimed at tackling greenwashing, including investment product sustainability labels and restrictions on how terms like "ESG", "green" and "sustainable" can be used.
What are the proposed new rules?
The Consultation Paper proposes a number of new rules primarily aimed at the asset management industry, which can be broadly categorised as follows:
1. Sustainable investment product labels
The FCA is proposing to introduce three categories of sustainable investment product labels. In particular, the product labels aim to distinguish between products according to whether they aim to invest:
- in assets that are environmentally and/or socially sustainable ("sustainable focus");
- to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm ("sustainable improvers"); and
- in solutions to environmental or social problems, to achieve positive, real-world impact ("sustainable impact").
The labels will be underpinned by a set of objective criteria that cover the specification of an objective, investment policy and strategy, key performance indicators, firm-level attributes (resourcing and governance of ESG), and investor stewardship.
2. Naming and marketing rules
The FCA intends to impose restrictions on how certain sustainability-related terms, such as "ESG", "green" and "sustainable", can be used in product names and marketing for products which do not qualify for the sustainable investment product labels. The FCA is also proposing a more general "anti-greenwashing rule" clarifying that sustainability-related claims must be clear, fair and not misleading. Combined, it is hoped that these restrictions will help avoid misleading marketing of products.
3. Consumer-facing product-level disclosures
To help consumers understand the key sustainability-related features of investment products, the Consultation Paper proposes that investment funds should be required to make several consumer-facing product-level disclosures, which include (but are not limited to) disclosing the investments that consumers may not expect to be held in the investment product.
4. Detailed disclosures
In addition, it proposes that investment funds should be required to make more granular disclosures at both a product and entity level that are suitable for a broad range of stakeholders, such as institutional and retail investors. It provides that such disclosures should take the form of:
- pre-contractual disclosures covering the sustainability-related features of investment products;
- ongoing sustainability-related performance information, in a 'sustainability product-level report'; and
- a sustainability entity report covering how firms are managing sustainability-related risks and opportunities at entity-level.
5. Requirements for distributors of products
Finally, the distributors of products, such as investment platforms, shall be required to ensure that the sustainable investment labels and consumer-facing disclosures are accessible and clear to consumers and investors
When drafting these rules, the FCA looked to regulatory regimes and proposals in the EU and US to, as far as possible, achieve international coherence with other greenwashing-related regimes. The FCA also sought contributions from other groups and organisations, such as the Disclosures and Labels Advisory Group, FCA-regulated firms, foreign regulators, NGOs and consumer groups.
Who will the proposed new rules cover?
Portfolio managers, managers of UK UCITSs (as defined in the FCA Handbook) and managers of Alternative Investment Funds ("AIFs") will be subject to the rules set out in paragraphs 1, 2, 3 and 4 above, whilst firms that distribute authorised funds and unauthorised AIFs to retail investors will be subject to the rules in paragraph 5 above. However, the FCA is proposing that all FCA-regulated firms will be subject to, at the bare minimum, the general "anti-greenwashing" rule referred to in paragraph 2 above.
Initially, the new rules will focus on UK-based products offered by the in-scope entities, with an intention to later expand the scope to overseas products offered by FCA-regulated firms.
When will the proposed new rules take effect?
The consultation is open until 25 January 2023 and the final rules are planned to be published by 30 June 2023.
Once the consultation is closed and the final rules are published, the Consultation Paper states that the general "anti-greenwashing rules" will take effect immediately, i.e. provisionally on 30 June 2023, whilst the rules for labelling, consumer-facing disclosures, pre-contractual disclosures and naming and marketing will apply from 30 June 2024.
The Consultation Paper also states that the requirement to disclose ongoing performance‑related information in an annually-published sustainability product report will apply from 30 June 2025 for the largest firms (i.e. asset managers with over £50 billion in AUM), and from 30 June 2026 for smaller firms (i.e. asset managers with over £5 billion in AUM).
In the Consultation Paper, the FCA states that it is also exploring other areas in its attempts to tackle greenwashing, which include extending the scope of the rules to cover overseas products, financial advisers and listed issuers, whilst also exploring the idea of introducing disclosure requirements in respect of transition plans, a potential UK taxonomy and sustainability-related metrics.
Although the timelines for the implementation of the new rules vary for FCA-regulated funds, portfolio managers and other stakeholders, in-scope entities are encouraged to undertake a holistic review and assessment of their "ESG", "green" and "sustainability"-related products and statements to ensure that they are prepared for the introduction of the rules.