Tightening product disclosure rules leave fund managers vulnerable to regulatory risks.
Asset managers should expect and prepare to be challenged on the sustainability credentials of their ESG-labelled funds as financial markets watchdogs clamp down on greenwashing, according to regulatory experts.
“[Fund managers] being precise in their claims and having the right disclosures is paramount to the transparency demanded by the market and, frankly, by investors who are seeking to contribute to making the world a more sustainable place,” said Patricia Pina, Head of Product Research and Innovation at sustainability software company Clarity AI.
Asoka Woehrmann, DWS’ Group CEO, resigned last week following a raid by German police in connection with accusations of fraud relating to its ESG funds. Last year, the US Securities and Exchange Commission and Germany’s BaFin launched separate investigations following greenwashing allegations that the German asset manager made misleading statements in its 2020 annual report by claiming more than half of the firm’s assets were invested using ESG criteria.
The SEC has also recently fined BNY Mellon Investment Adviser US$1.5 million due to misstating ESG investment policies for some mutual funds it managed.
Growing concerns over greenwashing and mislabelling were highlighted in a 2021 report published by think tank InfluenceMap.
It analysed 723 listed-equity funds with a collective US$330 billion in AUM which used one of 30 descriptions under two categories: broad ESG and climate-themed. Of the 130 climate-themed funds, 55% were not aligned with the goals of the Paris Agreement, the report noted.
Some argue that inaccurate descriptions are an inevitable part of the growing pains of ESG investing.
“Greenwashing is not always malicious,” said Arthur Carabia, ESG Policy Research Director at ratings and data company Sustainalytics. Inconsistencies are partly down to “misconceptions” about the “inherent complexity of sustainability investing,” he added.
To ensure increased cohesion in the development and marketing of ESG-labelled funds, regulators have been introducing – and increasingly now enforcing – new rules.
“Regulators have made the fight against greenwashing a top priority. This is warranted given both the growth of sustainable investment funds and their objective to shift towards more sustainable economies. So far, they are addressing it by requiring new transparency requirements for asset managers and issuers, which is the right approach,” said Carabia.
As greenwashing regulations are finetuned, fund managers must exercise caution and continually review the content of their ESG-labelled funds, experts told ESG Investor.
Paving the way
Efforts to ensure ‘green’ funds and investment products are marketed accurately are most advanced in Europe.
The EU’s Sustainable Finance Disclosure Regulation (SFDR) has introduced a reporting framework to ensure that asset managers’ with EU-domiciled ESG-labelled funds are providing a minimum level of transparency about their holdings and investment activities. The complexity of SFDR has caused some teething issues, forcing regulators to attempt to clarify the rules – with mixed success.
Managers have had to categorise funds, as a requirement of the first part of SFDR, since March 2021. From next January, managers must justify these categorisations through a series of environmental and social principal adverse impact (PAI) disclosures.
“We expect next year’s SFDR disclosures on PAIs to further help combat greenwashing, as the increased quant disclosures start to substantiate products’ stated objectives,” said Carabia. Managers will likely face issues as the PAI definitions continue to be “ironed out”, as well as potential problems around the usability and comparability for end-users without ESG expertise.
Recent European Commission attempts to clarify disclosure rules under have been branded “painful”, with some experts arguing late-in-the-day explanations can be unhelpful.
Separately, the European Securities and Markets Authority (ESMA) has been working on a legal definition of greenwashing to underpin enforcement action, and recently issued guidance on how national competent authorities (NCAs) can limit greenwashing.
NCAs should “raise questions and challenge” the use of ESG-related terms, further investigating and rejecting the use of any terms they perceive to be misleading, ESMA noted. The guidance added that the use of terms, such as ‘ESG’, ‘green’, and ‘impact’, should be used only when “supported in a material way by evidence of sustainability characteristics, themes or objectives that are reflected fairly and consistently in the fund’s investment objectives and policy and its strategy as described in the relevant fund documentation”.
Following the Commission’s Q&A document, the European Supervisory Authorities have also published a statement providing further clarifications, including on the use of sustainability indicators, PAI disclosures, and taxonomy-related financial product disclosures.
In the UK and US, plans for regulated disclosures and fund-labelling are being finalised.
First mentioned by Chancellor of the Exchequer Rishi Sunak last summer, the UK’s Sustainability Disclosure Requirements (SDRs) are expected to closely model the EU’s SFDR, introducing rules that will require asset managers with ESG-labelled funds to disclose the environmental impact of the activities financed and to justify all sustainability claims.
The timeline for the primary legislation will be subject to the parliamentary timetable, but it is hoped a consultation on the final rules will be published by the end of this year.
Late last month, the SEC proposed two rule changes to prevent the greenwashing of US funds.
The first proposal recommends amendments to the US ‘Names Rule’ to ensure that a wider variety of funds are required to hold at least 80% of the type of investment outlined in the product name – for example, a fund labelled ‘fossil fuel free’ should hold at least 80% fossil fuel free investments. The second proposal aims to increase reporting requirements around funds’ and advisers’ incorporation of ESG factors in their marketing material.
Daan Van Acker, Programme Manager at InfluenceMap, said fund managers would need to pay close attention to differences between proposed regimes.
“There will then be the question of how products offered across more than one of these markets will be expected to comply with each standard,” he said.
Ahead of the finalisation of these regulations, asset managers need to dedicate resources to limiting any potential greenwashing in their investment products, according to Raza Naeem, Partner at law firm Linklaters.
“Asset managers need to continually look at their product ranges and ensure they are good enough from an ESG perspective, as the goalposts keep moving and what was previously deemed good enough may not now be the case,” he said.
“Fund managers need to continue devoting resources and time to continuously checking and continuously reviewing and updating their ESG product ranges based on new standards as they come in.”