ESG & Sustainable Funds: More Work Required

ESG investing has been the subject of considerable attention in recent years. There has been a growth in consumer demand and an increasing number of funds are being marketed as having ‘ESG’ or ‘sustainable’ credentials.

In 2021 the FCA published ‘guiding principles’ to Authorised Fund Managers (AFMs) regarding its expectations in this area. This aimed to drive consistency in how ESG funds are designed, run and marketed. A review has now been published of how well AFMs have been applying these principles. It finds that while progress has been made, further work is required by many firms, particularly in relation to product disclosures.

The Guiding Principles

AFM’s who promote funds that claim to have sustainable or ESG characteristics are expected to follow the following principles:

1. Design - There should be clear disclosure of the key ESG design elements.
2. Delivery - A fund’s investment strategy and the profile of its holding should be consistent with its ESG objectives.
3. Disclosure - The information provided to investors should be easily available and help them make informed decisions.

There is an overarching principle of consistency. All elements of design, delivery and disclosure should reflect consistent application and delivery of a fund’s ESG/sustainability factors.

Review Findings

In presenting its review findings, the FCA note the importance of meeting Consumer Duty requirements to deliver good outcomes for customers. Of particular relevance is the consumer understanding outcome. Customers should have the information they need, at the right time, to enable them to pursue their objectives.

Further improvements were found to be required as follows:

• The name of some funds included reference to ESG or sustainability issues but with no corresponding explicit ESG or sustainability objective.
• The design of stewardship objectives generally did not meet expectations.
• AFMs should improve their disclosures to explain their stewardship approach, how it delivers the fund’s objectives and how effectiveness is measured.
• Examples were identified where underlying fund holdings appeared to be inconsistent with the fund’s ESG objectives. This included oil, gas, mining and manufacturing companies where the AFMs could not explain why they were consistent with the purpose of the fund. Where holdings might appear contradictory to a fund’s ESG aims, this should be explained to investors.
• Some disclosures did not adequately explain key information about the ESG/sustainability approach. For example, carbon emissions metrics were found to be higher for some ESG funds than non-ESG funds with no commentary as to why.
• Examples were seen of disconnects between firm level and fund level disclosures. For example, a fund’s prospectus might refer to firm wide ESG goals but give little detail on how the fund aligned with those.
• Key ESG information was sometimes not presented in an accessible way. This means consumers have to navigate and cross refer between several documents to find the information they need.
• Governance arrangements need to be refined to ensure firms have adequate systems and controls. More effective oversight of the risks of harm from the practices identified is required to ensure good outcomes are delivered for consumers.

Next Steps

AFMs are expected to act on the review’s findings, and in doing so take account of forthcoming changes. The FCA will shortly publish final rules following its consultation on Sustainability Disclosure Requirements (SDR) and investment labels (CP22/20). This proposes to introduce a general anti-greenwashing requirement for all firms, and specific labelling criteria for investment funds that aim to deliver sustainability outcomes. The measures are designed to embed greater consistency and transparency, as well as enable consumers to better navigate the ESG investment market.