Will the FCA’s greenwashing crackdown really assist buyers?

Friday marks the conclusion of the COP 29 climate summit, which for many years has marked an important date in the diary of global finance leaders. 

But almost two weeks of global warming pontification in Baku appears to be just that for many bosses: hot air. 

The chief executives of major financial institutions, including BlackRock, Standard Chartered and Deutsche Bank, have reportedly skipped this year’s event, highlighting its diminished significance in the eyes of investors. 

COP 29 chief executive Elnur Soltanov may not have helped a perception of growing irrelevance when he was covertly filmed agreeing to facilitate oil and gas contracts at the climate event.

Green investors are likely to feel somewhat disappointed by this. 

It follows a growing spotlight on so-called greenwashing, which has driven many investors away from ESG investing after a multi-year boom, 

Less than half of DIY investors are now considering ESG impact when making investment decisions.

However, for many investors, including some of those who say they no longer use ESG to direct their decisions, the environment is still a major concern.

Given the option, investors would choose to put their money somewhere they feel is benefitting the environment.

Almost two thirds of DIY investors have some form of environmental focus, data from wealth manager Charles Stanley shows. 

The problem, however, is that greenwashing has made it increasingly difficult to discern firms making a legitimate environmental impact from those misleading investors to make themselves appear more sustainable than they actually are.

Just half of investors think they can spot greenwashing, with a similar amount looking to environmental certifications to direct their investing decisions.

But these certifications and regulations are generally reactive rather than proactive. 

So can investors now be confident in ESG investments, or is there still some way to go?

How has greenwashing impacted investing?

Investment giants including asset manager DWS, HSBC and Goldman Sachs all have been penalised for various instances of misleading the public over their environmental credentials. 

It has become increasingly difficult for investors to trust claims made by firms.

Growing distrust, lagging performance and a political backlash in the US saw investors withdraw a net $40billion from ESG equity funds last year, according to Barclays. 

But there is still considerable appetite for environmentally conscious investing. 

Morgan Stanley data shows that ESG appetite has increased over the past two years and 54 per cent of investors expect to increase their sustainable investment allocations over the next 12 months.

Bloomberg Intelligence predicts global ESG assets to reach $40trillion (£31.6trillion) by 2030.

The story is likely the same among DIY investors.

Rob Morgan, chief investment analyst at Charles Stanley Direct, said: ‘Being a self-directed investor gives you the opportunity to put your money into what you believe in.

‘Increasingly people want their investments to do more than make money, with investors clearly seeking investments that have a greener, more ethical or social impact on society.’

The future of ESG investing in the UK comes down to changes in regulation, particularly the imposition of Sustainability Disclosure Requirements.

What regulation is in place?

Earlier this year, the Financial Conduct Authority (FCA) brought in new anti-greenwashing rules, seeking to ensure that firms back up the claim they make about their ESG credentials.

Under the regulation, known as Sustainability Disclosure Requirements, some 50,000 firms will be required to comply.

Funds are now classed as sustainability labelled, non-labelled ESG or non-ESG funds.

The regulation applies to UK investment funds, FCA-authorised firms offering sustainability-linked products or services and UK firms that distribute investment products.

Seb Beloe, partner and head of research at WHEB Asset Management, said: ‘Before SDR there was very little control over how firms could use terms like sustainability, low carbon or environmental. SDR has now set a high standard for funds that want to use these terms.’

The new rules mean that funds with more than 70 per cent of their portfolio invested into sustainable assets can be labelled ‘sustainability focus’, while those with 70 per cent of assets potentially improving environmental or social sustainability can adopt a ‘sustainability improvers’ label.

Funds can also qualify for a ‘sustainability impact’ label if they aim to achieve a measurable positive impact, and those with a combination of the three can qualify for a ‘sustainability mixed goals’ label.

Will these rules work, and what do they mean for investors?

With new regulation in place, it should become easier for investors to make sense of the products available and understand whether they really fall under the ESG bracket.

Beloe said: ‘Only funds that have an explicit sustainability objective that relates to a real-world outcome and have an investment process and methodology for measuring performance against this objective can use these terms.

‘This means that investors can be confident that funds that get an SDR label will be supporting positive real world sustainability outcomes.’

On the face of it, SDR does look likely to reduce greenwashing. 

Bianca McMillan, associate director at Gravis Capital, told This is Money: ‘The regulation will prevent those investment companies that are not sustainably focused from using certain names and language.

‘So, from that point of view, I think it will reduce greenwashing. It is certainly making investment companies think about how they describe their investments and communicate and report on objectives to investors.’

But some investment funds – such as venture capital trusts, for example – aren’t affected by the labelling rules as most are not specialist sustainability funds. 

Henry Philipson, director of marketing and communications at ProVen VCT manager Beringea, said VCT managers ‘have been putting substantial efforts into building robust approaches to ESG, ensuring that commitments to sustainability are translated into frameworks that underpin investment strategies and processes’.

However, Gravis’ McMillan also points out that SDR could make it more difficult for investors to navigate the fund space, with the metrics used to prove sustainably not set out definitively in the regulation.

She said: ‘The way the regulation has been drafted means there is scope for investment companies to set far-ranging definitions of sustainability. For example, there is flexibility around setting your sustainable objective, with the ability to apply proprietary methodology to measure your objective.’

Many fund managers have also chosen to hold off from adopting the voluntary SDR labels in order to see how the regulation develops.

What this means for investors is that a number of funds that may be able to qualify for ESG labels have designated themselves as such.

Although many are holding off from adopting these labels, Beloe expects this to change and he is optimistic that more funds will begin using the labels.

He said: ‘Many fund managers have said that they won’t try and meet this standard because it is too difficult and expensive.

‘The FCA has said explicitly that they are trying to design a labelling regime that will work for the market over many years and not just for today. This means that they have set a demanding standard for funds to meet.’

Beloe added: ‘The danger is that it takes much longer for funds to use the labels and this leads to a decline in the amount of available product that undermines the market for investors. 

‘Even in this scenario, we think that the market would recover, but it might take a few years.’