However, the proliferation of 'greenwashing,' or misleading claims of environmental responsibility, has left consumers sceptical and markets muddled. Enter the Financial Conduct Authority’s (FCA) Sustainability Disclosure Requirements and Investment Labels Regime (Regime), a streamlined approach which aims to improve transparency and foster trust in investment funds that are designed to deliver sustainability objectives .
Main features of the Regime
The regime has four main parts. First, a system of four labels has been introduced, that reflect different approaches to sustainability. To allocate a label to a fund a firm needs to meet the FCA’s required definition of the label (including having clearly defined objectives). It is thought this will enable investors to align their sustainability appetite or objectives with the relevant funds. This is further bolstered by requirements to have accessible information, ensuring that consumers can easily understand the key sustainability features of a product.
Second, the naming and marketing rules for investment products are being revamped to ensure the precise use of sustainability-related terms.
Third, recognising the varying needs of institutional investors and consumers seeking in-depth information, the regime includes detailed disclosures at pre-contractual, ongoing product-level, and entity-level stages. This requirement aims to provide a nuanced understanding of sustainability attributes tailored to different audiences.
Finally and crucially, the FCA will hold distributors accountable by imposing requirements to ensure that product-level information, including the newly introduced labels, is readily available to consumers.
Benefits of the Regime
The primary purpose of this regime is to combat greenwashing, by providing greater certainty that the labels used to describe funds are truly reflective of the “green credentials” of the underlying investments and objectives of the funds. A key part of the new regime is that funds that do not meet the FCA’s label definitions cannot misrepresent themselves as sustainable or green.
By introducing four simple investment labels, the framework caters for the average consumer and retail investor that does not have the time or ability to undertake their own due diligence to ensure that the funds they invest in have the “green characteristics” that they are looking for.
With greater trust in the market, the regime aims to encourage higher capital allocation into green funds. It is hoped that this will lead to a surge in investments envisioned to support the transition to a net-zero economy, incentivise firms to actively engage in sustainability initiatives, and deepen markets for sustainable goals.
The regime's principles-based approach requires firms to define their sustainable goals, objectives, and Key Performance Indicators (KPIs), providing for some flexibility within the sector. Simultaneously, it sets clear boundaries for instances where sustainable claims clearly fall short.
Things to Look Out For
Despite the merits of the regime, there are concerns that the FCA’s definitions are potentially too loose and subjective. Part of the challenge lies in the absence of a clear steer on what the UK as a country aims to define as sustainable, and the absence of a UK green taxonomy. The ambiguity this creates may open the door to varied interpretations, potentially leading to looser definitions or subjective perspectives in defining sustainability goals .
While a fund may initially qualify for one of the four labels, it remains to be seen how good firms’ internal review processes will be at identifying when a fund ceases to meet the FCA’s definitions, and how firms will react.
For example, will they voluntarily de-label in situations of underperformance or when asset composition falls below set sustainability standards? How quickly will they react? What happens when this is in breach of any agreed upon client mandates to allocate into sustainable assets? Will we see forced redemptions and at what cost if these are done at times when funds are underperforming? If firms continue to accept new investors when a fund no longer meets a definition, they open themselves up to mis-selling.
The absence of third party verification or assurance requirements that a fund’s label is appropriate (and continues to be appropriate) may be an impediment to promoting trust in the regime, as investors may otherwise lack confidence that a firm’s internal controls and corporate governance are adequate to deliver objectivity in the labelling process.
The role of the FCA in policing the regime will therefore be critical to the success of the regime. Without third-party assurance, the FCA must devise supervisory strategies to identify and rectify instances of greenwashing, ensuring the credibility of labelled funds on an ongoing basis.
The regime’s requirements may add a further layer of complexity to the assessments that firms are required to undertake under the recently implemented Consumer Duty with its fair value outcome.
The regime's interaction with proposals to supervise ratings agencies adds another layer of complexity, requiring a delicate balance between fostering credibility and avoiding excessive regulatory burdens.
One notable aspect is the mostly unrelated nature of the four investment labels. Unlike food labelling, which often relies on a traffic light system to provide a sense of potential dietary benefit or harm, the investment labels lack a progressive structure. This raises a question: is there a missed opportunity to provide consumers with a sense of progression regarding how green a fund or asset's credentials are?
The counter to this is that unlike food labelling, the parameters around sustainability objectives are far reaching and cannot be confined to a handful of indicators. Therefore, establishing a spectrum of labels from light green to dark green would be nigh impossible.
Conclusion
As the Sustainability Disclosure Requirements and Investment Labels Regime goes live for existing funds on 31 July 2024, its success hinges on balancing flexibility with accountability. Striking this delicate equilibrium will not only nurture trust in sustainable funds but also contribute to a more sustainable and responsible financial landscape. While challenges persist, the regime offers a promising stride toward a greener and more transparent investment future.
