Greenwashing risks in asset management

Fund/product lifecycle

Regulatory requirements/guidance

Actions for addressing key challenges

Pre-contractual stage

Financial Conduct Authority (FCA):

Requires that names, objectives, documented investment strategy and holdings be consistent; and

Requires comprehensive information on strategies and stewardship policies.

SFDR:

Requires disclosures on firm websites: sustainability due diligence, sustainability risk and remuneration policies; and

For Article 8 or 9 funds, the following disclosures are required on firm websites and pre-contractual documents: investment strategies, objectives, top holdings, due diligence, data sources and limitations to methodologies and data.

Obtain, analyze, and use sustainability data, which is often incomplete or infrequently available, to make investment decisions; and

Ensure that fund documentation and firm-wide policies provide clear and specific information in a non-technical way on the objectives and strategies of sustainable products, and whether there are data limitations and how they are being addressed.

Post-investment and ongoing-reporting stage

FCA:

Suggests providing ongoing performance reports on how well a fund meets its stated objectives and any relevant information used to facilitate investment decisions; and

The profile of a fund’s holdings should always be consistent with its disclosed objectives.

SFDR:

Requires periodic disclosures on how environmental and social characteristics have been promoted (for Article 8 funds) or how sustainable objectives were attained (for Article 9 funds); declarations that no significant harm has taken place towards certain sustainable objectives (Article 9); and the fund’s top holdings and actions taken to achieve its objectives.

Have a strategy to deal with unexpected new sustainability data on investee companies in funds from various sources, potentially affecting the fund’s objectives.

Complaints-handling stage

FCA’s dispute resolution: complaints sourcebook (DISP) rules require firms to:

• Assess the subject matter of complaints fairly, consistently, and promptly;

• Consider whether the complaint should be upheld, and whether and what redress should be provided;

• Observe a time limit for responses, which should be fair, clear, and not misleading; and

• Maintain complaints-handling policies.

• Have policies and procedures in place for compliance or other relevant functions to properly investigate complaints related to greenwashing. This includes assessments against the FCA’s complaints-handling rules and determining whether compensation is required.

The role of firm and fund boards

The role of portfolio managers

The role of compliance and risk

Pre-contractual stage:

1. Sustainability data

Set firm-wide sustainability data policies.

Enhance in-house capabilities to obtain, analyze and validate data;

Avoid relying on a single data provider and compare data from different sources to identify and resolve any discrepancies; and

Identify and disclose data limitations to control functions.

In conjunction with portfolio managers, undertake appropriate due diligence on third-party sustainability data and ratings providers;

Review sustainability data policies periodically and ensure data disclosures are up to date when data availability changes; and

Conduct periodic monitoring on fund documentation to assess whether data limitations have been made clear.

2. Clear communication

a.    Firm-wide information

Firm boards to sign off on firm-wide sustainability and engagement policies. This requires careful consideration of the tone used in such documents, the resources available for the sustainable fund offering, and the firm’s overall stance on sustainability.

b.    Fund-specific documents and disclosures

Fund boards need to ensure the fund strategies are aligned with firm-wide ones.

Ensure staff are trained on the prescribed technical thresholds under each of the FCA’s labels (when finalized);

Ensure sustainability-related disclosures can be easily understood by less sophisticated investors;

Ensure objectives and strategies are worded in an accessible way; and

Include data limitation disclaimers and issues that may hinder the fund from achieving the environmental impact promise.

Ensure documents are written in a non-technical manner and that there is sound evidence to support any claims regarding the fund’s non-financial objectives and associated financial returns;

Flag any risks of exaggerated language or not aligned with the firm’s overall tone or approach to sustainability; and

Perform a spot check that the information in prospectuses is consistent with that on the firm’s website and in firm-wide policies.

3. Investment strategy

Consider the firm-wide strategy for sustainable investing, which must be made clear in firm-wide policies; and

Ensure the firm-wide strategy is incorporated into the fund-specific strategies.

Exclusions/negative screening

Clarify whether exclusion is based solely on the company’s activities or includes other entities in its supply chain.

Best-in-class investing

Clarify the limitations of using ESG ratings for investment decision-making.

Thematic and impact investing

Specify funds’ objectives and time horizon to achieve these, and events that these are contingent upon.

Monitor whether holdings and allocation percentages in funds are compatible with the fund’s stated objectives; and

Monitor whether holdings and strategies are consistent with the firm-wide sustainable investment strategy set by boards.

4. Third-party distribution

Approve the overall strategy and parameters for how the firm works with third-party distributors; and

Set the firm’s overall risk appetite for engaging with third parties, e.g., the level of due diligence on third parties.

Provide additional training to the Independent Financial Advisors (IFAs), e.g., where new types of investment strategies are concerned or where there are uncertainties around non-financial performance and new sustainable investing terminology.

Review periodically whether up-to-date fund-specific documentation is made available to third parties.

Post-investment and ongoing-reporting stage:

1. Sustainability data

Consider whether to employ a strategy of third-party assurance on new sustainability data that emerges unexpectedly and could affect funds’ objectives.

Scan and identify information that emerges from a variety of different sources about the investee companies, and have the requisite relationships with data providers that can promptly update them; and

Assess proactively whether any divestment or engagement must take place if new sustainability data emerges that affects funds’ ability to perform on sustainable objectives.

Review communications to ensure investors are informed of any changes to holdings in a timely manner;

Check whether any decisions regarding changes in investments have been explained clearly and that no exaggerated claims have been made regarding these changes; and

Undertake due diligence on the sources where new data has been received.

2.  Ongoing reporting

Ensure a consistent strategy about which non-financial metrics must be used and how they must be displayed.

Determine the right metrics to measure non-financial performance and ensure the metrics are understandable;

Inform intermediaries and end-investors about changes in strategies and objectives in sustainable funds proactively; and

Explain why non-financial performance is falling short of expectations or certain sustainability objectives, and what is being done to improve it.

Conduct periodic formal reviews to assess whether ongoing reporting documents are reporting performance accurately;

Carry out spot checks on performance data included in ongoing reporting documents against internal performance data; and

Assess whether claims, strategies and ongoing reporting for funds are consistent.  

Complaints-handling stage:

Ensure the boards see management information (MI) on the number of greenwashing complaints being received; and

Undertake a root cause analysis and, if need be, review existing firm-wide policies on sustainable investing.

Consider whether the approach or investment strategies can be amended, or whether the expected time horizon for achieving certain sustainability objectives must be amended, to prevent further instances of greenwashing complaints.

Compliance, risk, or other relevant departments must ensure they are trained in sustainability investing, sustainability data and related terminology and analysis, so that they can determine whether greenwashing may have occurred;

Investigate whether communication in fund documentation and websites was clear, appropriate and not exaggerated, and whether the sustainability data on which investment decisions were based had serious deficiencies and whether they were disclosed;

Ensure there is a robust analysis of whether the situation is within the definition of an FCA complaint (i.e., financial loss, material distress or material inconvenience), on what grounds, and whether financial compensation is required; and

Handle deliberate greenwashing as any other instance of serious misconduct.