City watchdog says sustainable funds ‘not meeting expectations’

The Financial Conduct Authority (FCA) has said that sustainable funds are not meeting its guiding principles on holdings and stewardship.

The FCA, in reviewing 12 fund firms’ sustainable and ESG approaches, found room for improvement in the disclosure of how certain stocks meet a sustainability objective.

It questioned whether fund firms are doing enough to explain why they hold certain stocks in sustainable or environmental, social and governance (ESG) funds.

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On stewardship – how fund managers engage with the companies they invest in and retail investors – the FCA said the design of stewardship approaches “generally did not meet our expectations”.

It added: “It was often difficult to identify the nature of stewardship activities from fund literature alone and identify clear examples of progress from engagement.”

The City watchdog said that some fund firms “failed to explain information about the key ESG and sustainability-related features of their funds”.

As an example, the FCA noted that some groups “often chose to disclose carbon footprint data and carbon emissions metrics but omitted to explain that they excluded Scope 3 emissions, even though these are often the majority of a fund’s carbon footprint”. 

It added: “We also saw examples of ongoing reporting on carbon emissions metrics that showed the emissions of ESG and sustainable investment funds were higher than non-ESG or sustainable funds, without any explanation given.”  

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The FCA also found that “it was common for the fund prospectus to have little detail on ESG and sustainability policy goals and instead investors were referred to firm-level policies that gave greater detail”.

In addition, the FCA was critical that despite some funds having a reference to ESG or sustainability in their name, some did not have an explicit ESG or sustainability objective. However, it noted that ESG and sustainability outcomes were typically reflected in the investment policy and/or strategy.

It also said that “in a number of cases, key ESG and sustainability information was not clearly presented and made accessible”.

The FCA said it expects fund firms to review their ESG and sustainable fund ranges and assess whether their disclosure material meets their rules.

Over the past four years or so, assets under management for sustainable and ESG funds have snowballed. There are various factors behind this trend, with one of the main drivers simply being that more investors are looking to ensure their money is invested in businesses “doing good” in some form or other.

This trend, of course, has not escaped the attention of fund management companies’ marketing teams, resulting in scores of new sustainable fund launches. In addition, there’s been various re-brandings of existing funds to put sustainability in the shop window.

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While a greater choice of funds is to be welcomed, investors need to be wary of “greenwashing”. This is when asset managers push themselves or their funds as “green” through marketing, rather than fully integrating ESG and sustainability into their investment processes.

Greenwashing has been on the FCA’s radar for a number of years. It is hoped that by pushing fund firms to be more transparent about how they invest sustainably, investors can avoid potential greenwashing.