The CFA Institute’s new voluntary global fund labelling guidelines put the focus on greenwash.
The issue of investors having resources to protect themselves from greenwashing and fund mislabelling has challenged the asset management industry for several years due to broad definitions around ESG products.
Launched earlier this month, the CFA Institute’s Global ESG Disclosure Standards for Investment Products were designed to ease the concern for investors and their advisors, and to better distinguish between fund products that are at risk of greenwashing, mis-selling, and mis-labelling.
“Although there are differing regulations in markets to address transparency for investors on ESG matters, it is critically important that a harmonised approach exists to enable investor protection,” said Paul Andrews, Managing Director for Research, Advocacy, and Standards at CFA Institute, the global association for investment professionals, unveiling the framework.
“Such regulation does not always comprehensively cover all market participants. The Standards fill these market needs on a global scale, facilitating disclosures that will drive communication between the buyers of investment products and an industry marketing increasing numbers of funds and strategies that offer an ESG-centric approach.”
Their release followed consultation on creating non-binding standards that were based on “the principles of fair representation and full disclosure of ESG issues within the objectives, investment process, and stewardship activities of investment products,” according to the CFA Institute.
A crowded market
Although the initiative has been broadly welcomed, some market participants flagged concerns over scope during the consultation process, questioning the need for further voluntary guidelines at a time of rapid regulatory change in the sustainable investing space.
The EU is furthest ahead with its rules around asset managers’ disclosures already in motion; the UK has made progress on corporate and financial institution disclosures on climate risks, and recently outlined plans for investment product disclosures.
In its recently published Roadmap to Sustainable Investing, the UK announced plans for investment product disclosure, requiring managers to report on products’ sustainability impact and relevant financial risks and opportunities. A discussion paper is expected to be published later this year.
But the most obvious comparison with the CFA Institute’s new guidelines is the Sustainable Finance Disclosure Regulation (SFDR), introduced by the European Commission alongside the Taxonomy Regulation and the Low Carbon Benchmarks.
The SFDR necessitates mandatory ESG disclosure obligations for asset managers, requiring them to sort their investment products into progressively ‘greener’ categories. Regulatory technical standards will require asset managers to augment existing Level One product categorisations with more detailed underlying data across a series of social and environmental factors.
The US is further behind, but catching up. Earlier this year, the Securities and Exchange Commission (SEC) proposed its Annual Regulatory Agenda, which recommended requiring corporate ESG disclosures and “initiatives to proactively identify ESG-related misconduct”. Separately, the SEC is also planning to launch a climate-related disclosure framework for US publicly-listed companies in the coming weeks, which aims to ensure companies are disclosing the financially material information that investors need.
“We already see a lot of disclosure practices in place in various jurisdictions,” says Annette Capretta, Associate General Counsel at the Investment Company Institute (ICI), a US-based trade association which represents fund providers globally.
“Our perspective on the CFA’s work was that we urged them to wait until the dust has settled,” she adds, noting that more US government regulations are due to be released.
Separately, the International Organisation of Securities Commissions (IOSCO) published its own set of recommendations about sustainability-related practices, policies, procedures and disclosures in the asset management industry, earlier this month.
IOSCO’s recommendations aim to address several challenges associated with the growth of ESG investing and sustainability-related fund products, including the need for consistent, comparable, and decision-useful information and the need to mitigate risks posed by greenwashing.
Explaining the standards
According to the CFA Institute, the standards give firm-level ESG disclosure guidance on the labelling or rating of investment products or the content of investment products’ periodic reports with an exception related to stewardship activities. By recommending disclosure guidelines in key categories, the goal is to make it much easier for investors – retail or institutional – to compare ESG credentials when comparing the claims of one or more fund products.
The standards follow three areas: compliance, disclosures, and the development of concrete ESG terminology. The guidelines are split into two categories, those that are ‘required’ and those that are ‘non-required’ but recommended.
Compliance covers ten required fundamentals. For example, investment managers must comply recommendations on maintaining documentation. Non-required recommendations for compliance include investment managers obtaining independent assurance on ESG disclosure statements.
For disclosure, there are five requirements, which offer more detailed synopses. “If the investment product’s investment process, stewardship activities, or objectives systematically address one or more specific ESG issues, then the investment manager must disclose a summary description of those specific ESG issues,” the guidance says. There are a further 14 sub-clauses covering various addendums.
Terminology has eight clauses, which aim at offering succinct definitions. “Terminology is often a barrier to investors’ understanding of the ESG approaches used in an investment product,” the standards say. “Sometimes, investment managers use technical terms that are understood within the industry but are unfamiliar to the average investor. Other times, investment managers use words that have a commonly understood meaning but carry a special meaning when used in the context of ESG investing,” it explains.
Elizabeth Lance, Assistant Chief Counsel at ICI Global, supports the need for consistent terminology to describe sustainable investments. “Consistent terminology is going to go a long way in providing clarity for practitioners and it’s a rapidly changing area,” she says. “But we don’t know what every jurisdiction is going to do, and we don’t know how they’ll work on this and tackle greenwashing.”
Greenwashing is a growing concern, with a rising number of funds making claims to address climate change. An InfluenceMap report from August showed that the majority of climate-themed investment funds do not live up to the claims and called for increased regulatory oversight.
InfluenceMap identified 593 equity funds with over US$265 billion in total net assets of which 71%, had a negative Portfolio Paris Alignment score.
Of the 130 climate-themed funds, with titles such as ‘low carbon’, ‘fossil fuel free’ and ‘green energy’, and over US$67 billion in total net assets, 55% had a negative Paris Agreement alignment score.
The CFA Institute says it is responding to requests from members to provide more guidance on identifying greenwashing.
“The CFA set out to achieve more transparency around investment products that consider ESG issues in their investments,” Chris Fidler, Senior Director of Product Management at CFA Institute, tells ESG Investor.
“The problem is that the state of the market means investors don’t get the full picture. Disclosures are often incomplete or difficult to find,” he adds.
When asked if the current information currently available to protect investors from greenwashing simply wasn’t good enough, Fidler says that this depends on which sector of the investment community is being looked at.
“Different sectors have different needs, and you have to take that on board,” he says. Fidler adds that retail investors had asked for more information and more prescriptive guidance to save them from mistakes.
Fidler says the CFA’s research showed the level of need depends on the audience. The retail market was often helped by simple labels. “Our standards don’t set out specifications, but rather they set out ingredients. We set out to give information to investors. ESG can be built into investment products in different ways.”
Victoria Hickman, Senior Associate for the Regulatory Financial Group at law firm Linklaters, says she agrees with the CFA’s approach, as it means the institute is not impinging on areas where their guidelines could clash with mandatory regulations.
“Given the mandatory disclosure rules developing in this space and the need for consistency, the industry has been critical of moves to develop additional frameworks. That these are quite limited is preferable and they don’t really go off-piste in terms of what they’re asking,” she says.
“They are limited to an investment product disclosure, which is helpful in limiting their impact and balancing the fact that they represent another set of guidelines in an already busy space. They do not make recommendations for entity level disclosure, just product level, so do not add to the volume of corporate disclosure obligations.”
Points of difference
As voluntary guidelines, says Hickman, the CFA Framework will inevitably take second place in jurisdictions which have compulsory disclosure frameworks.
“If they are only voluntary – if they are limited – and if they are going to be overshadowed by compulsory heavy-hitting sets of disclosure requirements, then if there were any discrepancy, the compulsory rules win,” she says.
The CFA Institute’s Fidler acknowledges comparisons with Europe’s SFDR, but stresses where the two differentiate, with the latter generally being more prescriptive. “[SFDR] has a firm-level of disclosure; our guidelines don’t,” he notes.
Other differences include that SFDR has periodic reporting, whereas the CFA Institute’s guidelines do not. The CFA Institute offers a full rundown of the differences between the two systems. “We cross-referenced Level 1 requirements and regulations to provisions in the standards,” Fidler adds.
Another area of distinction concerns sustainability risk policies. Under SFDR requirements, “financial market participants shall publish on their websites information about their policies on the integration of sustainability risks in their investment decision‐making process”.
The CFA standards do not have a provision for this, and the institute explains, for example, how equivalence or comparison of entity-level disclosures are outside the scope of the current edition of its standards. Similarly, there are specific stipulations in SFDR on how market information shall be presented, whereas CFA standards do not require a specific format or order. “However, an optional template for ESG Disclosure Statements will be developed at a future date,” it adds.
Ultimately, Fidler explains, the CFA Institute guidelines were designed to provide a broader framework for narrower sections of the market – e.g. retail investors in a particular region – which are not fully protected by existing regulations.
But questions remain about the role of voluntary guidelines at a time when many jurisdictions are developing mandatory rules.
“It’s unclear how voluntary guidelines such as CFA’s sits in the ecosystem,” ICI’s Lance says. “We do appreciate their effort in this arena.”
Linklaters’ Hickman added that the product-level disclosures only represent part of the compliance picture. “If you put a statement in your disclosures to say that you have complied with the CFA principles, that’s very helpful,” she says. “But if you haven’t actually complied in reality, or if you haven’t complied with your compulsory regulatory obligations, then it doesn’t work as a get out of jail card. A robust governance framework backing it up will be key.”