Banking

FCA and EU greenwashing regulations: Key differences

Last month the FCA proposed a new set of rules to clamp down on greenwashing by UK-based funds and portfolio managers.

Receiving close attention from the investment community, the proposal imposes sustainable investment labels, disclosures and related requirements.

It builds on the FCA’s existing rules for climate-related disclosures by investment managers, which were finalised in December 2021.

Ultimately, many of the challenges surrounding this latest proposal will stem from its divergence from EU requirements currently in force. 

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The FCA proposal stands to present meaningful time and expense for firms that do business across both Europe and the UK.

The proposal is open for comment by interested parties until 25 January 2023, after which final rules and guidance are expected to be published by the FCA by the end of the first half of 2023.

In the longer term, observers should take note that the proposed regime is but “a starting point” according to the FCA, which expects eventually to introduce further regimes including for overseas and pension products.

How it compares

The FCA’s proposal distinguishes between funds with a ‘sustainable focus’, those that are ‘sustainable improvers’ and those with a ‘sustainable impact’. 

The first has sustainability as the main objective, the second looks to improve sustainability in otherwise non-sustainable activities (for example, through corporate stewardship), and the third seeks to achieve a more narrow, measurable sustainable impact. 

While calling its framework essentially a labelling regime, the FCA acknowledges that the so-called ‘Article 8’ and ‘Article 9’ categories for EU-marketed funds under SFDR have also become de-facto labels.

Unlike the EU regime however, the FCA’s categories are not a hierarchy of ESG-ness, but rather three different approaches to sustainable investing.

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They should prove useful for investors, who after all have different views on how they want to contribute to sustainability. 

For investment managers tasked with complying with the UK and EU frameworks, the categories will not be easily comparable. A UK fund qualifying as sustainable focus, for example, may not necessarily qualify as an EU ‘sustainable objective’ (Article 9) fund. And vice versa. 

The only clear relationship seen is that an ‘Article 6’ fund in the EU – one that does not consider ESG – would not merit any of the three sustainability labels in the UK.

The UK regime sets itself apart in a variety of ways.

To assess the sustainability of investments, for example, the EU requires that particular key performance indicators (KPIs) be relied upon (based on turnover, capital expenditure, and/or operational expenditure).

The FCA proposes more flexibility in letting investment managers decide which KPIs to use. 

Additionally, the concept of “do no significant harm” – a requirement for sustainability in EU fund disclosures – is not found in the UK proposal. 

Disclosure statements would differ as well: while the EU requires sustainability information in annual reports, prospectuses and on websites, the FCA is looking to fund managers for a “sustainability product report”, a consumer-facing summary, and a “sustainability entity report” as well as relevant prospectuses.

In short, when complying with the FCA’s regime, UK firms are likely to find that gains in efficiency from being able to leverage their EU compliance processes should be relatively limited. 

This could eventually improve somewhat, with the development of ISSB sustainability reporting standards currently under way (which are expected to inform KPIs used by firms in their disclosures).

But generally speaking, prudent compliance and operations departments will maintain protocols and systems prepared to treat their UK-marketed funds and EU-marketed funds differently.

What to expect

Against what is being proposed for UK-based funds, EU funds calling themselves sustainable are likely to offer more convergence and comparability.

The EU Taxonomy – a well-established and lengthy list of commercial activities qualifying as environmentally sustainable – helps provide that assurance. 

Meanwhile in the UK a green taxonomy is yet to be published, and the FCA is not committing to rely on it even when it is released, noting that “other standards may emerge”. 

Yet the flexibility within the FCA’s proposal has its benefits.

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As notions of sustainability evolve, and as the concept of ESG becomes increasingly fragmented in the face of geopolitics and economic realities, the EU’s precise technical standards may begin to feel like an albatross around the neck of its regulators tasked with keeping them current.

In that respect, the FCA’s new proposal may be better suited to evolve with the times. 

Agencies around the world will absorb important lessons, one hopes, as these two contrasting regulatory approaches play out.

Greg Hotaling is regulatory content manager at Confluence

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