On 19 July 2021 the Financial Conduct Authority (FCA) published a letter to the chairs of Authorised Fund Managers (AFMs) (the Dear Chair Letter) setting out the regulator's expectations that all funds marketed as environmental, social and governance (ESG) related should describe their investment strategies clearly and contain reasonable and substantiated objectives.
The Dear Chair Letter annexed a set of Guiding principles (the Principles), the purported aim of which is to assist AFMs to: "comply with existing requirements by ensuring that fund disclosures accurately reflect the nature of the fund’s responsible or sustainable investment strategy in both the pre-contractual documentation (for example, the prospectus) and on an ongoing basis".
Rationale
The Dear Chair Letter was published against a background of a rapidly growing demand for ESG and sustainable investment funds, now the fastest growing segment of the European funds market. Stressing its role to help build trust in the market, the FCA identifies the importance of transparent objectives, investment strategies and characteristics.
The Principles
The Principles represent a significant step in regulating the ESG market and are intended to apply to all funds which make ESG or sustainable related claims. While the Principles are not mandatory, they have been developed with reference to existing statutory requirements, Handbook rules and guidance. Under the Principles, fund managers offering ESG funds should consider how to disclose and reflect accurately the nature of the fund in line with the claims made about it mindful of the overriding imperative "to enable consumers to make an informed judgement about the merits of investing in a fund".
A snapshot of the Principles is set out below, but these can be read in full here
Overarching principle: Consistency
A fund’s focus on ESG/sustainability should be reflected consistently in its name, stated objectives, its documented investment policy and strategy, and its holdings.
Principle 1: The design of responsible or sustainable investment funds and disclosure of key design elements in fund documentation
A fund’s name, financial promotions or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund. Fund names should not be misleading. A fund prospectus should include its policy and objectives, in accordance with which the fund should be managed and voting rights should be consistent with the benefit of the fund and its investment objectives.
Principle 2: The delivery of ESG investment funds and ongoing monitoring of holdings
The resources that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way that a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives. Effective resources should be deployed to ensure that the fund's objectives are achievable and that appropriate due diligence has been carried out on the data relied upon. The fund manager should take into account whether a reasonable investor would consider that the fund’s holdings reflect any ESG/sustainability characteristics, themes or outcomes that have been disclosed or claims that have been made.
Principle 3: Pre-contractual and ongoing periodic disclosures on responsible or sustainable investment funds should be easily available to consumers and contain information that helps them make investment decisions
Consistent with one of the FCA's key objective of ensuring a high level of transparency, the Principles prescribe that a key investor information document should be easily available and clear, succinct and comprehensible, avoiding the use of jargon and technical terms where possible. Firms should issue ongoing performance reporting, with these periodic disclosures including evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of the fund’s stated aims.
Comment
The Dear Chair Letter is indicative of further intervention by the regulator in this space. Prompted by a frustration with poor-quality fund applications for ESG products and a concern about the potential for low quality ESG funds to damage consumer trust, the FCA seems to have identified regulation of ESG funds as a priority.
The Principles offer a clear framework setting out the FCA's expectations and how the rules apply in the context of the design, delivery and disclosure of responsible and sustainable investment funds. But they are not the final word on the matter.
The Dear Chair Letter alludes to the FCA's aim of introducing principles which are "compatible with prospective future disclosure rules for responsible and sustainable investment fund products", including Government plans for economy-wide Sustainability Disclosure Requirements and sustainable investment labels that allow consumers to compare the impacts and sustainability of their investments.
The regulated sector should expect to see further intervention and increasing requirements on the design and reporting obligations associated with ESG marketed products.
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