FCA targets potential ESG 'harms' caused by UK asset management firms
Published on 7th Mar 2023
ESG investment products and strategies can pose risks to consumers and markets if not carefully labelled and described
The Financial Conduct Authority (FCA) has published its first "Dear CEO" letter since the launch of its new "integrated regulatory structure", which has meant that asset management is now supervised by the UK financial regulator's Buy-Side Directorate.
The letter published on 3 February, which supersedes the FCA's previous strategy letter of January 2020, outlines the harms to consumers or markets that the FCA thinks are most likely to arise from "asset manager" business models and sets out how it intends to supervise this sector in order to address these potential harms.
Environmental, social and governance (ESG) and sustainable investing is one of five risks of harm the FCA focuses on in its letter. The letter encourages CEOs to consider whether the risks identified are present in their firms and recommends that firms adopt strategies to address them. It also provides welcome developments to the ESG requirements and guidelines for asset management companies as set out in its "Dear AFM Chair" letter from 19 July 2021, which set out expectations on the design, delivery and disclosure of ESG and sustainable investment funds.
The "Dear CEO" letter comes as part of a prolonged and enhanced focus on ESG and "greenwashing" – that is, making misleading or exaggerated "green" claims – which has seen many regulators including the FCA, the Advertising Standards Authority (ASA) and the Competition and Markets Authority (CMA) push for stronger regulatory oversight.
The FCA has signalled its commitment to supporting the financial sector in enabling an economy-wide transition to net zero and to a sustainable future more broadly with a raft of new proposals and legislation, which are set to come into force this year. The FCA has specifically said to firms that they will employ these new sources of information and applicable rules when considering the conduct of firms in relation to ESG.
The FCA is introducing a new ESG sourcebook containing rules and guidance. Those firms in scope will be required to make their first disclosures in the first half of 2023, consistent with the recommendations of the Taskforce on Climate-related Financial Disclosures.
On 25 January 2023, the FCA's long-awaited consultation focused on "clamping down on greenwashing", the Sustainable Disclosure Requirements and investment labels (CP22/20), closed. The FCA is aiming to publish its final decision on the proposals and will set out their rules for product disclosure and labelling.
The FCA published its discussion paper "Finance for positive sustainable change" (DP23/1), on 10 February 2023, through which it encourages an industry-wide dialogue on firms' sustainability-related governance, incentives and competencies.
The "Dear CEO" letter was accompanied by a separate letter addressed to CEOs and directors of a number of categories of firm, including asset managers. This additional letter serves as a timely reminder that the proposed new "consumer duty" will apply to a firm's retail market business; that is, where a firm is in a distribution chain involves retail customers and not just where there is a direct customer relationship. The duty requires firms to act to deliver good outcomes for retail customers. This requirement will need to be front of mind for asset management firms as they continue to develop their ESG strategies.
Taken together, the upcoming regulations suggest a serious crackdown to come on firms particularly those with known issues, or where the FCA identify outliers in the risk categories outlined in their letter, which would include those deemed to have shirked their responsibilities with regards to ESG-related factors.
Enforcement in the meantime
The number of recent ESG-related statements from the FCA show how seriously it is taking this matter and suggests it will not be sitting on its hands until applicable regulations are in force. It already has a broad range of powers by which it is able to hold asset managers accountable if it considers their ESG communications to be misleading.
For example, the FCA could enforce against the making of misleading or exaggerated sustainability-related claims in relation to financial products under principle 7 of its "Principles for Businesses", which requires authorised firms to ensure that communications must be clear, fair and not misleading.
As set out in its Dear CEO letter, the FCA will consider whether governing bodies and senior managers with accountabilities have taken appropriate actions to ensure that consumers and markets are adequately protected from harm. The FCA have said it will focus on assessing the effectiveness of firms' governance and will take relevant action if necessary.
If the FCA does find fault, the repercussions could cause significant damage by way of fines and disruption to firms and their customers – or even reputational damage from the fallout.
ASA and CMA regulatory oversight
The FCA is not the only authority keeping its eye on the potential for consumer harm arising from the making of environmental claims. The ASA and the CMA have also both been very active.
The requirement to ensure that environmental statements about a product, service or a brand are not misleading is not new. The UK advertising codes, enforced by the ASA, have contained a section on making compliant environmental claims for a number of years now. Similarly, the Green Claims Code launched by the CMA in September 2021, was intended to provide brands with guidance to ensure their environmental claims are compliant with existing consumer protection – notably the Consumer Protection from Unfair Trading Regulations 2008 – so as not to be misleading and cause consumers to make transactional decisions they would not otherwise have made. Again, this is not new law.
What is new, however, is the focus environmental claims are now receiving from regulators, especially the ASA and CMA, and the impact this has on a range of corporate communications. For instance, the ASA's remit covers more than just paid-for adverting space in print and TV media but a range of environmental claims made on a brand's own websites and social media channels amongst other things. The risk associated with a brand making these kind of claims has increased in the last couple of years in particular.
CMA enforcement action
The CMA recently launched its second market investigation into greenwashing claims, looking specifically at the environmental claims made in respect of "consumer goods". This forms part of the CMA's ongoing work into reducing misleading green claims, with its first (and still ongoing) sector investigation considering the green claims made by fast fashion retail.
The CMA has indicated it has ongoing concerns as to the way products are being marketed to customers with particular concern around sweeping environmental credentials such as "environmentally friendly" and "sustainable". The CMA also has concerns about whether environmental claims are supported by sufficient evidence as across the relevant brand, service or product's total life cycle. The outcome of both those investigations could impact how all brands, whatever their sector, craft, substantiate and promote their green credentials.
ASA activity ramps up
In parallel, the ASA is also continuing active enforcement in this area. In 2022, it undertook consumer research into waste, carbon neutral and net-zero claims, as well as scrutinising claims made about the electric vehicle market. It is being proactive in its enforcement – including using online bots to scour the internet for environmental claims being used – there has been an increase in the number of green-related adjudications published on its website over the last year.
One of the most recent examples of the ASA's enforcement in this area concerned a leading international bank which had displayed posters in which it claimed that it aimed to provide significant financing and investment globally to assist its clients transition to net zero. The ASA held these posters to be misleading. When upholding the complaints received against the claims, the ASA explained that it viewed the claims as misleading as information regarding the bank's investments into companies that contributed to carbon dioxide and greenhouse gas emissions should also have been provided – to enable consumers to understand the overall message of the adverts and view the claims in proportion. Without this balanced information, the ASA was of the opinion that the claims made were misleading as to the nature of investments made.
Osborne Clarke comment
Asset managers and others who will be making their first climate-related financial disclosures in 2023, in line with the FCA's ESG sourcebook, should not consider themselves exempt from scrutiny while the market and regulations catch up; instead, they should take great care in ensuring their disclosures and any green-related statements are fully compliant from the outset and are representative of and proportionate to their overall environmental impact.
The green credentials of a firm, a product, a service or brand should not be exaggerated and should be proportionate to the activities of the business as a whole. Indeed, organisations should be run in a way that is within the spirit of the industry's wider objectives.
At a time when new guidance is being created at pace, with further developments on the horizon for 2023, it's important to keep an eye on such change and keep all forms of ESG disclosures and statements under careful review and scrutiny.