ESG funds falling short: FCA gives an early Christmas gift in the form of homework for AFMs
In anticipation of the long-awaited Sustainability Disclosure Regulation (SDR) final rules, the FCA have delivered a warning shot to Authorised Fund Manager’s (AFMs) on their oversight of funds with an environmental, social and governance (ESG) or sustainability focus.
The FCA published their Dear Chair letter to AFMs in July 2021, outlining their expectations on the design, delivery and disclosure of ESG and sustainability funds. In the letter they noted an increase in the number of authorisation applications for these types of funds, a number of which they found to be poorly drafted and below the standards expected.
From the latest review published today, it looks like concerns remain and more work is required to ensure there is adequate oversight of ESG and sustainability funds and that firms are being clear in their communications on them, to avoid further eroding trust and consumer confidence in ESG and sustainability products. This should focus minds, particularly in light of the greenwashing rule due to be effective as soon as the SDR is published in the coming weeks.
To get a head start on SDR and ensure you are aligned with FCA expectations we’d recommend challenging yourself on the below:
Design
If your fund has ESG-related terminology in its name, such as “climate”, “sustainable” or “impact”, is there a clear link through to the fund’s objective, policy and strategy, and is this adequately captured in the fund documentation?
Have you considered how ESG characteristics of such funds are described in the various fund documentation, including whether they are in line with Consumer Duty expectations on Consumer Understanding?
If you state that stewardship activities such as voting and engagement are a key part of the ESG strategy, are you being clear on how these support delivery of the investment objective, with progress and impact of these activities on the holdings being measured and reported?
Delivery
Is there a documented rationale for all holdings within your ESG and sustainable funds on how they are contributing to the fund’s objective?
Where there may be ‘unexpected’ holdings, are you providing additional information on these to help investors understand the rationale for having them in the fund?
Are you comfortable that the data relied on to support investment rationales is robust and adequate due diligence has been applied to e.g. ESG data and rating providers?
Disclosure
Have you tested your client facing documentation on your ESG and sustainable funds to ensure they are clear, fair and not misleading, and investors are able to make sense of what can often be complex information – such as emissions data?
Have you checked that firm-level policies made available on your website and referenced in any fund documentation, such as voting policies or minimum ESG criteria, are up to date and truly reflective of the current process?
Have you disclosed all relevant limitations, such as data availability, quality and consistency and their potential impact on the fund?
Governance
Are ESG and sustainability specific considerations included in your product governance processes?
Are those involved adequately skilled to appropriately challenge on ESG characteristics?
Is there sufficient reporting on adherence to investment objectives, policies and strategies being provided to the AFM Board to allow them to provide adequate oversight?
We are expecting another early Christmas present in the form of the SDR final rules any day soon; so if you want help unwrapping them, or perhaps an end of year health check on any of the above areas to ensure you’re on the FCA’s ‘nice’ list then get in touch at contact@avyse.co.uk and we’d love to help.
