FCA Seeks to Improve Quality of ESG Fund Disclosures

Latham & Watkins LLPFCA has published guiding principles on the design, delivery, and disclosure of ESG and sustainable investment funds.

On 19 July 2021, the FCA published a letter sent to chairs of authorised fund managers, which sets out the regulator’s expectations regarding disclosures by funds that make ESG-related claims. The FCA aims to ensure that any ESG-related claims are clear and not misleading, both when a fund is applying for authorisation and on an ongoing basis.

The FCA has published these principles in response to the significant increase in funds applying for authorisation that have an ESG or sustainability focus. The FCA notes that applications are often poor quality and fall below its expectations, and many make claims that cannot be substantiated. The FCA observes that, in general, fund applications in this area often do not contain sufficient, clear information explaining their chosen strategy and how this relates to the assets selected for the fund.

Whilst the principles are directed at authorised funds, they provide important guidance to the market on the lens that the FCA applies in assessing the integrity of financial products with ESG labels and should be considered more broadly as part of prudent disclosure risk management.

Guiding Principles

The FCA’s guiding principles include an overarching principle and three supporting principles that focus on design, delivery, and disclosure:

  • Overarching principle: A fund’s ESG/sustainability focus should be reflected consistently in its design, delivery, and disclosure. A fund’s focus on ESG/sustainability should be reflected consistently in its name, stated objectives, its documented investment policy and strategy, and its holdings.
  • Design: References to ESG (or related terms) in a fund’s name, financial promotions, or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.
  • Delivery: The resources (including skills, experience, technology, research, data and analytical tools) that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way in which a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives on an ongoing basis.
  • Disclosure: ESG/sustainability-related information in a key investor information document should be easily available and clear, succinct, and comprehensible, avoiding the use of jargon and technical terms when everyday words can be used instead. Funds should disclose information to enable consumers to make an informed judgement about the merits of investing in a fund. Periodic fund disclosures should include evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of a fund’s stated aims.

Each principle is accompanied by a set of key considerations and practical examples, to explain how the FCA expects fund managers to apply them. The guidance is extremely helpful for fund managers, as it gives clear examples of how they can meet the regulator’s expectations.

The guiding principles do not introduce new rules, but rather clarify how fund managers are expected to comply with existing rules. The FCA emphasises that the principles are intended to compliment new initiatives, including plans to introduce UK sustainability disclosure requirements and sustainable investment labels (so-called UK SFDR), and the new climate-related disclosure requirements for asset managers that the FCA is currently consulting on.

Interaction with SFDR

The FCA is conscious that, although the EU Sustainable Finance Disclosure Regulation (SFDR) does not apply in the UK, many UK fund managers will comply with the SFDR requirements. The FCA’s guidance only applies to FCA authorised investment funds, however, managers of funds that market into the UK may consider whether they should comply with the FCA’s guidance as a matter of best practice. Therefore, as many fund managers will aim to apply both the EU and UK regimes, they will want to understand how the regimes fit together.

The FCA emphasises that its guidance is intended to be complimentary to the SFDR. While the SFDR requires both entity-level and product-level disclosures, the FCA’s guidance is driven at the product level. The FCA guidance is particularly useful, as while the SFDR presents a fairly rigid framework (and lacks detail, as the Level 2 measures are still pending), the FCA guidance is more outcome-focused. Therefore, the FCA guidance will help fund managers to evaluate whether they are meeting the spirit of the requirements.

Helpfully, the FCA’s guidance broadly maps to the SFDR Article 6, 8, and 9 categories. However, one key difference is that, while Article 6 SFDR funds (funds without a specific ESG or sustainable investing objective) still make some disclosures as to how they incorporate sustainability, the FCA’s guiding principles target only funds that make specific ESG-related claims, not those that integrate ESG considerations into mainstream investment processes. The FCA states that it does not expect to see prominent ESG claims in such a fund’s name or documentation, or ESG positioned as a key part of that fund’s offering. Therefore, funds making Article 6 disclosures may want to clearly delineate them as SFDR disclosures to avoid falling foul of the FCA’s expectations.

The FCA does not set higher standards than the SFDR, and so fund managers that are fully compliant with the SFDR need not be concerned that the FCA is adding new requirements. However, the nature of the FCA guidance differs in that it is principles-based, and so may help fund managers to better understand their disclosure obligations.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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