The Financial Conduct Authority (FCA) proposed a new set of rules on Tuesday that funds must adhere to in a crackdown on so-called greenwashing.
Funds without thorough environmental, social and governance (ESG) mandates have been able to label themselves as sustainable without clear regulations in place and the City watchdog has been under mounting pressure to act.
Sacha Sadan, director of ESG at the FCA, said: “Greenwashing misleads consumers and erodes trust in all ESG products. Consumers must be confident when products claim to be sustainable that they actually are.”
Indeed, AJ Bell head of investment analysis Laith Khalaf said that “the ESG bandwagon was getting suspiciously overcrowded” in recent years as some funds attempted to ride the popularity of sustainable investment without much oversight.
Three new fund labels have been proposed by the FCA to categorise funds by their investment objectives: sustainable focus, sustainable improvers and sustainable impact.
Khalaf said that most funds will likely land in the sustainable focus group, as its requirement that 70% of assets be invested according to ESG considerations provides managers with some flexibility. Funds in the category will invest predominantly in sustainable equities
Those labelled sustainable improvers will hold assets that are improving their ESG characteristics over time. This second group will be a good option for investors seeking a broader investment universe, according to Khalif.
He added that the third label – while sustainable impact funds, which hold companies having a positive effect on the world – may provide a niche for those wanting a specialist portfolio.
He said: “The greater regulatory hurdles to marketing a fund as sustainable should also force asset managers to start walking the walk or stop talking the talk.”
However, the new regulations are not without their faults. Ottilia Csoti, associate at Fladgate, was supportive of the FCA’s move towards tighter regulation but pointed out that loopholes will allow funds labelled ESG to invest in controversial sectors.
“The proposals allow for the inclusion of coal, gas and oil investments under certain conditions which, given the relatively long lead time for these measures and the scale of the climate crisis, likely means these measures will be of limited effect in urgently directing capital flows away from investments that further the consumption of fossil fuels,” he said.
Likewise, funds have a lot of work ahead of them in creating the necessary factsheets to meet the discourse the FCA are proposing, according to Myron Jobson, senior personal finance analyst at interactive investor.
“A principal challenge for asset managers will be to create effective and far-reaching market-based solutions to address a range of environmental problems, including climate change, deforestation, air quality issues and biodiversity loss,” he said.
“Effective cataloguing of such products, as well as greater availability of data to allow people to scrutinise green credentials, is a must.”
Even so, Jobson said that these more thorough disclosures still might not be enough for dedicated investors who will find “no substitute for doing the legwork themselves”.
Khalaf added that this could lead to a “slightly absurd situation that sustainability disclosures tell us more about investment processes than longstanding fund factsheets and Key Investor Information Documents.”
Nevertheless, the sustainable investment universe as whole has other challenges to face - ESG equity funds faced their first outflow in over three years last month as investors pulled £126m.
Although the FCA’s new rules are ultimately a step in the right direction, they could dissuade fund groups from pursuing new sustainable ventures.
Khalaf said: “This presents a more challenging environment for ESG fund sales, and combined with the increased regulatory hurdles being proposed, might lead to fewer fund launches. That may be no bad thing given the glut of offerings we have seen brought to the market in the last few years.”