FCA accused of inaction on “greenwashing”

The FCA has been urged by a prominent wealth manager to launch an urgent review of the UK ethical investment sector as high-profile managers’ socially responsible investment (SRI) products focussed on environmental, social, and governance issues (ESG) are revealed to have notable exposure to sectors like alcohol, tobacco, gambling, and defence.

Greenwashing – a regulatory issue?

There is currently considerable uncertainty and subjectivity surrounding both the criteria by which funds, and the companies they invest in, are considered socially responsible or ethical and how those criteria are translated into investment decisions.

Wealth manager SCM Direct has published a report partly laying blame at the FCA’s door, arguing that the regulator has “been slow to provide a definition or methodology of what constitutes responsible investing, leaving it to investment managers and data providers to self-identify.” However, the appropriateness of further national regulation when there is a considerable raft of pan-European sustainable financing regulation on the horizon is debatable. See our Sustainable Financing and ESG Investment microsite for more information.

The FCA has stated previously that there are currently no “universally agreed common minimum standards and guiding principles for measuring the performance and impact of green finance products” and that the data used for these products “may be causing confusion or even distorting markets” (DP18/8). In October 2019, it released Feedback Statement FS19/6 in which it promised to monitor SRI products and “challenge firms where [it sees] potential greenwashing and take action to prevent consumers being misled”.

Industry response

Recent media reports have highlighted how investment manager Fidelity discovered that third-party data it was provided that sought to identify funds with “socially responsible” investment policies did not meet its criteria for such a description. To improve its transparency with investors, Fidelity has now launched an investigation into the filter on its website which allowed users to browse only those funds that avoided companies involved in the tobacco, alcohol, gambling or defence industries.

Other asset managers have responded to SCM’s report, with some preferring to maintain a seat at the table of companies that do not score well on ESG metrics. Investing in poor ESG performers and using the engagement power of shareholder votes and access to senior management can be an effective strategy used by fund managers to help companies improve their ESG performance and generate value for investors, an area of particular focus in the recently published Stewardship Code which takes effect on 1 January 2020. However, if a fund is adopting this approach, the manager should disclose this strategy to investors clearly and ensure that the fund is marketed appropriately.

Conclusion

The considerable subjectivity around ethical and ESG issues combined with the difficulties created by inconsistent data means that, even when acting in good faith, managers may be exposed to claims for mis-selling and breach of investment mandate, and potential FCA enforcement action.

Fund managers should therefore be reviewing not only prospectuses and marketing materials of funds with ethical or responsible investment objectives or labels, but also carefully considering the investment processes and portfolios of such funds for consistency with their stated objectives.