FCA finds further work required to fully embed ‘Guiding Principles’ for ESG and sustainable investment funds

The Financial Conduct Authority, FCA, has published a press release to inform that it has concluded its review of the application of the FCA’s so-called guiding principles which were issued in July 2021 and which are expected to assist authorized fund managers (AFMs) in the design, delivery, disclosures, and governance of investment funds with an ESG (sustainability) focus (please see EventID 11795 for more information in this context). A detailed description of the findings may be found here, a brief summary is provided below.
During the review, the FCA examined the disclosures of 12 authorized retail funds of various sizes that had terms related to ESG or sustainability in their names such as ‚responsible‘, ‚ethical‘, ‚climate‘, or ’social‘. The FCA also conducted an on-site visit to discuss funds‘ ESG (investment) strategies. The key findings are as follows:
#### Design
Generally speaking, the review showed the need for clearer and consistent alignment between fund objectives, ESG claims, and disclosures, as well as more transparent communication regarding stewardship activities‘ impact on achieving fund-level ESG objectives. In detail, the FCA found that some funds lacked ESG objectives altogether or were inconsistently aligned with stated ESG goals in their documentation. Others closely described their ESG objectives and investment policies, but did not commit themselves to such.
As far as ESG funds‘ stewardship approach is concerned, the FCA was highly dissatisfied. Many funds did not provide the needed clarity about their approach. They lacked information as to how their approach delivers on the funds‘ objectives or how the outcomes of stewardship engagements are measured. Others, on the other hand, described the objectives of their stewardship approach, but failed to demonstrate any results from their engagements. Furthermore, the FCA found that sometimes information on funds‘ stewardship approach wasn’t easily accessible or that information contained wording and formulations to satisfy regulatory obligations, but not necessarily the information needs of investors.
#### Delivery
In the context of delivery (the holding of appropriate assets aligned with a fund’s objective), the review revealed similar findings. In fact, the FCA found that some funds had investments that were inconsistent with the stated ESG or sustainability objectives. Others had holding, particularly in the oil, gas, mining, and manufacturing sectors, where the investee companies did not provide sufficient information to qualify them as being in the transition to net zero carbon emission by 2050. In this context, the FCA emphasizes that it is the obligation of firms to disclose such discrepancies to investors and explain why a particular holding may not align with disclosed ESG objectives. This obligation is even more so important since the introduction of the new Consumer Duty which requires firms to act in the best interest of investors and ensure good outcomes for investors, including clear, transparent, and fair communications.
#### Disclosures
As far as the disclosures of ESG funds were are concerned, the FCA found various alarming practices:
– in many circumstances, there were discrepancies between firm-level and fund-level disclosures;
– often, prospectuses of ESG funds referred investors to firm-level policies for detailed ESG information on the fund;
– individual fund contributions to firm-wide ESG goals were unclear or omitted altogether, leading to ambiguity in fund-level alignment with firms‘ overall ESG policies;
– key ESG and sustainability information was often not explained, put into context in disclosures, or „scattered“ among various disclosed documents;
– fund fact sheets were often intransparent with missing links to relevant information and unclear structures and formats;
– AFMs failed to offer continuous non-financial reporting or a means to monitor their funds‘ sustainability performance over time.
To conclude the issue of disclosures, the FCA notes that it expects AFMs to review their disclosures in view of provided cross-references, ensure accessibility of their disclosures, and present information in a clear, concise, and understandable manner.
#### Governance
Generally speaking, the FCA found that ESG funds managers need to enhance their governance principles and procedures. Many AFMs lacked governance records and management information to evidence decision making or evidence the rationale for decisions as far as ESG policies and procedures, investment objectives, or engagements are concerned. This particularly held true for „older“ ESG funds established prior to the issuance of the guiding principles. Therefore, the FCA expects funds to review their governance principles and align them with those outlined in the guiding principles.
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In view of the upcoming sustainability disclosure requirements, the FCA expects all ESG fund managers to carefully consider the guiding principles and assess firms‘ alignment with those principles. They should also „identify and address any shortcomings in the design, delivery and disclosure of their funds, and ensure they are not conducting their operations in a way that causes harm to consumers“.