UK regulator, representatives from investment industry defend SDR fund labels as GTAG publishes new taxonomy guidance.
The UK’s Financial Conduct Authority (FCA) was challenged during a parliamentary hearing on Wednesday, on the grounds that funds adhering to the regulator’s proposed rules for sustainability labels may be able to hold fossil fuel firms, some of which have recently rowed back on climate commitments.
The draft proposal was published last year as part of the UK’s Sustainability Disclosure Requirements (SDR) framework in a bid to crackdown on greenwashing, introducing three new labels: ‘sustainable focus’ (funds investing in sustainable assets), ‘sustainable improver’ (funds investing in assets undergoing a sustainable transition), and ‘sustainable impact’ (funds targeting sustainable solutions).
The FCA estimates that a third of funds currently claiming to be sustainable would fail to qualify for these new labels, but members of the Treasury Sub-Committee on Financial Services Regulations were concerned that there is no explicit mandate barring the likes of fossil fuel firms from inclusion.
Mark Manning, the FCA’s Technical Specialist for Sustainable Finance and Stewardship, pointed out to MPs that product providers including ‘unexpected investments’ within their sustainability-labelled funds would be expected to publish additional disclosures “that should draw attention to any investment [consumers or other investors] might reasonably baulk at”.
Providing oral evidence, Chris Cummings, CEO of the UK-based Investment Association (IA), said that less sustainable companies should be allowed to be included under the proposed labels, if they are transitioning to more sustainable practices.
“[Fund managers] could green their portfolios today, but we have got to have a regime that allows for all companies to transition towards a greener economy tomorrow,” he said.
In recent weeks, following controversy over huge profits, some of the world’s largest oil and gas majors have appeared to undermine their initial commitments to the climate transition, lowering their targets and dialling back on ambition.
BP recently announced that it will reduce its 2030 goal of cutting oil and gas production from 40% to 25%. Environmental law firm ClientEarth is taking Shell directors to court over their lack of climate ambition.
Angela Eagle, Labour MP for Wallasey and a member of the Treasury Sub-Committee, pointed out that Shell is featured in a number of existing funds that would qualify for an FCA label.
“If you want to actually drive investment into properly green, properly regulated funds that aren’t lying about their green credentials, surely you have to have standards that allow that to happen,” she said.
The proposed labels are expected to apply from 2024.
Credible transition plans
There isn’t yet a baseline standard for an acceptable climate transition plan, which would help identify truly credible ‘brown’ companies in transition, according to Kate Levick, Associate Director of Sustainable Finance at climate change think tank E3G. This is set to change.
Levick also gave oral evidence, noting her additional role as Co-Head of the UK’s Transition Plan Taskforce (TPT) Secretariat, a group launched by HM Treasury to develop a framework for companies to disclose their climate transition plans, which is expected to eventually be made mandatory by the UK government.
The TPT is currently consulting on its draft framework for disclosure, which is set to close at the end of this month.
Levick noted that E3G’s consultation response calls for the FCA to “mandate strict exclusion criteria for fossil fuel investments for any product receiving one of the three proposed labels”.
Speaking to ESG Investor after the hearing, Levick said: “The key reason for [E3G’s recommendation] is the credibility of the label itself. Retail investors who wish to invest in green or sustainable financial products are unlikely to want or expect these companies to be included.
“There is more scope for firms in the process of transition to be included in a ‘sustainable improvers’ product but, in E3G’s view, only if the firms being invested in have robust and credible transition plans which they are delivering on.”
She added that the work of the TPT will be “helpful” for firms interacting with the new labelling scheme, with the “publication and delivery of such plans likely to be an important data point for fund managers in deciding which companies to invest in”.
Pushing for interoperability
Although the FCA labels will help to set clear parameters for sustainable funds, the regulator’s proposed labelling scheme “does not define what is or is not a green investment”, Levick said.
“That role will be played by the UK taxonomy, and hopefully we will hear more about next steps for this in the upcoming Green Finance Strategy,” she added.
HM Treasury announced delays to the UK’s green taxonomy in December, noting that it is a “complex, technical exercise” to create a system for classifying whether an economic activity is sustainable. Other taxonomies are in the works across jurisdictions, including the EU, Russia, and China.
The Green Technical Advisory Group (GTAG), 18 industry figures providing advice on the design and implementation of the taxonomy, today published ‘Promoting the International Interoperability of a UK Green Taxonomy’, which outlines ten new recommendations for the UK government to ensure increased alignment with taxonomies across jurisdictions.
“Building on its strong track record in world-leading green finance policy, the UK is well placed to help address the challenge of global market fragmentation, while at the same time securing its leadership on green finance through a scientifically robust and usable taxonomy,” said Ingrid Holmes, Chair of GTAG and Executive Director of the Green Finance Institute.
GTAG’s recommendations include adopting the same “broad concepts, methodologies and metrics” as the EU taxonomy where possible, conducting a review every three years to assess the taxonomy against the evolving international taxonomy landscape to determine whether any adjustments need to be made, and producing guidance on how (if at all) relevant KPIs are applied to activities abroad under the UK’s reporting regime.
The IA’s Cummings also raised the importance of interoperability between the FCA’s fund-labelling proposal with other labelling requirements, most notably the EU’s Sustainable Finance Disclosure Regulation (SFDR).
He urged the FCA to consider bolstering “commonalities” to avoid any “market dislocation”.
Manning from the FCA said the regulator has considered the potential for market dislocation, but that “the risk is reduced by the fact we are not specifying what constitutes a sustainable activity, we’re allowing the firm themselves to determine what benchmark they are using for sustainability”.
He then referred to the FCA’s rule that fund managers should be “fair, clear and not misleading”.
“Now that we are able to establish some standards and some reference points for what that actually means in the context of sustainable investment, that gives the FCA a much stronger basis for its supervisory activities and to take enforcement action if we see egregiously bad behaviour.”