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In October, ahead of COP26, the government published its ‘Greening Finance’ roadmap.
The report sets out the steps it intends to take to help ensure the financial services industry is geared up to support initiatives such as the UK’s 2050 Net Zero strategy and to ensure that growing investor interest in ESG matters is backed up by credible, transparent and verifiable data. This follows the publication of the FCA’s ESG regulatory principles in July, in which the expectation was made clear that a reasonable investor should easily be able to assess the extent to which the underlying portfolio of a fund matches up to the strategy as set out in the prospectus and marketing material. The strategy is a major step in demonstrating how this will work in practice and we believe that it is critical part of efforts to ensure that this fast-growing market embeds high standards of investor protection.
Two key initiatives in particular stand out from the report: the UK ‘Green Taxonomy’, and the Sustainability Disclosure Requirements. The government has also indicated that there will be future developments in terms of regulation and authorisation of ESG data providers.
The taxonomy will be consulted upon in Q1 2022, and is similar to, but not equivalent to, the EU’s Taxonomy Regulation. The aim is to ensure consistency of terminology across the industry, so that all participants – from regulators to fund managers to end investors – have a common understanding of the different definitions used in relation to green finance. This will enhance transparency and help to protect investors from ‘greenwashing’, whereby ‘green’ terminology is misapplied in order to wrongly persuade investors of the sustainability attributes of a product.
More immediately on the radar is the SDR; a discussion paper is open for responses at time of writing, which also encompasses a new proposed approach to the ‘labelling’ of sustainable funds.
The discussion paper proposes that new labels and disclosures be introduced on an entity level and on a product level so that retail investors and professional investors can objectively understand the credentials of ESG funds. The aim is for this information to be presented in a standardised and accessible way, which is fair, clear and not misleading. The FCA is proposing a product label which would classify a fund in terms of its sustainability characteristics (e.g. ‘not sustainable’, ‘responsible’, ‘transitioning’, ‘aligned’, ‘impact’), as well as well as consumer-facing disclosures so that retail investors better understand how a product measures up to its aims.
The FCA is also proposing detailed disclosures for institutional and professional investors. The SDR will operate in a similar way to Taskforce on Climate-related Financial Disclosures (TCFD) reporting, which will be mandatory for asset managers in the UK from 2023. Where TCFD looks at the impact of climate change on a firm and on its products, the SDR will look at the impact of firms and products on climate change: a subtle but significant distinction.
Assurance and verification
As part of its discussion paper, the FCA notes that the underlying data for these disclosures and labels may benefit from third party oversight and verification. The FCA say they “want to explore whether there are market-led mechanisms that might support the establishment and verification of a robust system”, and to understand whether “independent third-party verification of product-level disclosures could help instil additional confidence in investors and investment managers, and improve the quality of sustainability-related information given to consumers.” This is a new approach which may mean firms will need to seek out an independent third party to attest to the validity of the data underpinning any disclosures, further enhancing their credibility. We support this proposal as transparency and assurance are key aspects of ensuring investor protection.
The discussion paper closes on 07 January. It comprises 20 questions. A full consultation paper will be issued in Q2 2022. No date has so far been provided for implementation, either of the SDR, labelling or the taxonomy, at this stage.
We are beginning to see specific examples of how the government and regulators are putting ESG-related aspirations into practice. For firms, this means a greater duty in terms of assurance of ESG claims and data, enhanced reporting, and more probing by the FCA to ensure claims made are justified. This suite of regulatory reforms, while increasing the compliance load on firms, will ultimately drive a more transparent and competitive market for sustainable funds with investor protection at its heart, which is to be welcomed as this market shows every sign of continuing to gather momentum, and inflows.