FCA warns fund firms on ‘poor quality’ ESG fund launch applications

The FCA has created ‘guiding principles’ for fund managers looking to launch and run ESG funds.

Ethical and sustainable fund applications often “fall below expectation” and “contain claims that do not bear scrutiny,” according to the Financial Conduct Authority (FCA), in a letter to the chairmen of authorised fund managers.

In recent years there has been increased appetite for environmental, social and governance (ESG) funds, with many fund houses rushing to launch new products. However, according to the City watchdog: “Against this backdrop, we are concerned by the number of poor-quality fund applications we have seen and the impact this may have on consumers. This must improve.”

• Three ESG fund winners and three spinners
• Three reasons why ESG fund sales are booming

According to the regulator, many ESG fund applications do not contain sufficient and clear information that explains their chosen strategy and how this relates to the assets selected for the fund.

The FCA gives several examples of sub-standard ESG fund applications: “A proposed passive fund had an ESG-related name that we found misleading as it was looking to track an index that did not hold itself out to be ESG-focused. It also had very limited exclusions from the index, based on high-level ESG criteria.

“A fund application claimed to have a strategy to invest in companies contributing to ‘positive environmental impact’. The fund intended to invest predominantly in companies that, while reporting low carbon emissions, would not obviously contribute to the net-zero transition. We had expected to see a measurable non-financial objective alongside the financial objective or strategy with information on how that impact would be measured and monitored.

“Instances where it was challenging to reconcile the fund’s proposed holdings with statements made setting expectations for consumers [included] one example [of] a sustainable investment fund containing two ‘high-carbon emissions’ energy companies in its top 10 holdings, without providing obvious context or rationale behind it (eg, a stewardship approach that supports companies moving towards an orderly transition to net zero).”

• Want to invest ethically? ii’s ACE 40 list of ethical investments can help
• The ii Ethical Growth Portfolio: a ready-made diversified ethical portfolio, selected and managed by our experts

To address these concerns the FCA has created “guiding principles” for fund managers looking to launch and run ESG funds.

Included in these principles is the fund name and the proper outlining of the fund’s strategy and objectives. The FCA notes that fund names are subject to regulation. Therefore, a fund using ‘ESG’, ‘green’, ‘sustainable,’ ‘responsible,’ ‘ethical’, ‘impact’, or related terms in its name must have a suitable investment objective.

The principle also calls for more performance reporting. The FCA argues that funds should take “appropriate steps to make information on how well a fund is meeting its stated objectives (i.e. intended ESG/sustainability characteristics, themes or outcomes) available to consumers on an ongoing basis.”