ESG News


FCA’S GREENWASHING RULES: LESSONS FROM THE SFDR BOOMERANG


Critics claim that the regulator’s proposed rules to tackle greenwashing lack teeth, but if SFDR is anything to go by, asset managers could be facing greater scrutiny.


Asset managers making unvalidated ESG claims could face harsher consequences, if proposed rules aimed at tackling greenwashing are implemented. Under the rules proposed by the Financial Conduct Authority (FCA), sustainable funds will be ranked in three categories. In the first category are assets that are environmentally and/or socially sustainable, so called “sustainable focus” investments. The second category includes investments aimed at improving the social sustainability of assets over time, through stewardship, for example, to be listed as sustainable improvers. The third category covers investment strategies aimed at offering dedicated so- lutions to environmental and social prob- lems, so called sustainable impact funds. The FCA’s rules also foresee more strin- gent naming and marketing rules around sustainability claims and more detailed disclosure standards for institu- tional investors and retail investors look- ing for more information.


In the footsteps of SFDR The new Sustainability Disclosure Requirements (SDR) step in the footsteps of the EU’s Sustainable Finance Disclosure Reg- ulations, which came into force in 2022 and distinguish between Articles 6, 8 and 9 funds. While Article 6 funds have no ESG credentials, those labelled Article 8 are promoted on an ESG basis and require companies to follow at least good governance standards. Meanwhile, Article 9 covers funds that have sustainable investment as an objective and offer a desig- nated benchmark index.


While the UK is no longer required to implement EU regula- tions, British regulators were nevertheless responding to the challenge that most fund providers would de facto be market- ing their products in the UK and EU. So a close overlap between UK and EU rules was seen as desirable by both sides. While EU funds have an implicit ranking, with Article 9 funds being seen as greener, the FCA is keen to stress that there is no hierarchy between its sustainability categories. Evidence from the SFDR rollout shows that the categorisation of funds is likely to have a far reaching impact as asset managers scram- bled to brand their funds as Article 9.


Voting with their feet


In the third quarter of 2022 alone, Article 8 funds reported outflows of €28.7bn (£23.7bn) while Article 9 funds recorded more than €12bn (£9.9bn) in inflows. Meanwhile, Article 6 assets dropped by nearly 10%, according to Morningstar. More than 380 funds changed their SFDR status in the third quarter, according to Morningstar, with most upgrading to Article 9 status. But the data provider warns that many of these supposedly upgraded funds fall short of the EU’s new report- ing rules. Less than half have disclosed a minimum percentage of sustainable investments.


Enforcement


While enforcement of SFDR rules is lagging behind, the European Commission has significantly raised the bar for Article 9 funds in a guidance published in July. It now says that all issuers in Article 9 funds must be considered sustainable.


This does not bode well for the flurry of branded Article 9 funds. According to Morningstar, less than 5% are targeting a sustainable investment exposure between 90% and 100%.


As a result, asset managers are facing pressure to review their green creden- tials. By the end of November, some of the largest asset managers, including


Blackrock, Amundi, Axa, Invesco and NN Investment Part- ners, confirmed that they had to downgrade some of their Arti- cle 9 funds.


FCA rules state that any firm labelling a product remain responsible to ensure the classification is appropriate. This approach has come under criticism. Mick McAteer, co-director of the Financial Inclusion Centre, warns that the FCA’s propos- als will not work. “Firms marking own homework won’t pre- vent greenwashing. So, we’ll be campaigning to get the FCA to significantly toughen up their proposals,” he says.


A warning


The FCA proposals are at the consultation stage, with com- ments being received until the end of January. The regula- tor intends to publish the final version of the rules at the end of June.


It remains to be seen whether the FCA will intervene to chal- lenge asset managers on their greenwashing claims. If the evi- dence of the SFDR rollout is anything to go by, asset managers could indeed be tempted to mark their own homework more favourably. But it also heeds a warning that the eventual climb- down could be embarrassing.


Issue 119 | December-January 2023 | portfolio institutional | 31


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