UK's financial watchdog proposes rules to stop greenwashing

It plans to implement 'sustainability labels' for investment products and restrictions on how terms like ESG, green and sustainable can be used

Britain’s financial watchdog has proposed new rules to prevent funds from misleading consumers by ‘greenwashing’ or exaggerating their environmental, social and governance (ESG) credentials.

The Financial Conduct Authority (FCA) intends to implement new sustainability labels for investment products and restrictions on how terms like ESG, green and sustainable can be used.

Three main categories aim is to keep things relatively simple for investors:A 'sustainable focus' label for funds investing at a high threshold of at least 70% in environmentally or socially sustainable assets,
The 'sustainable improvers' label would be for funds aiming to improve the environmental or social sustainability of their assets over time,
While 'sustainable impact' is for funds investing in solutions to environmental or social problems to achieve a positive, measurable real-world impact.

Restrictions will also be made on whether fund managers can use sustainability-related terms such as ‘ESG’, ‘green’ or ‘sustainable’ in product names and marketing for products that don’t qualify for the sustainable investment labels.

The FCA is also proposing a "more general anti-greenwashing rule" covering all regulated financial firms. This will help avoid misleading marketing of products.

It said the reason for its new rules was sparked by the fast growth in recent years of the number of investment products marketed as ‘green’ or making wider sustainability claims, with "exaggerated, misleading or unsubstantiated claims about ESG credentials" often damaging confidence in legitimate products.

Independent research, for example, recently found that hundreds of supposed ESG funds potentially had not invested in anywhere near enough sustainable investments to qualify for their label.

"The FCA wants to ensure that consumers and firms can trust that products have the sustainability characteristics they claim to have," the regulator said in a statement.

Becky O'Connor, author of the ESG Investing Handbook and Interactive Investor's head of pensions and savings, said: "Investors who want to make their money make a difference need to be able to trust that the investment they are buying actually does what it says on the tin.”

But it also marks a major shift from incentivising the transfer of money towards sustainable investments to now minimising the risk of greenwashing, said Lorraine Johnston, a financial lawyer at Ashurst.

"The new proposals place further burdens on fund managers who are trying to do the right thing but who now face a hodgepodge of international disclosure requirements," she said, though each company will be responsible for how to apply the rules in classifying a product, with the FCA only challenging categorisation rather than constantly vetting all firms.

Products are expected to have more detailed disclosures to aid consumers in understanding key sustainability features.

The FCA's rules will be finalised by mid-2023 but will not come into effect until at least 2024.

Critics of the current system say that the lack of common reporting standards, clear terminology and easy-to-understand classification and labelling make it impossible for consumers to compare and accurately access and identify the products that align with their moral values.

The European Union and the US are already in the process of finalising a package and writing rules to combat greenwashing.

Richard Stone, chief executive of the Association of Investment Companies (AIC), said more robust rules were needed as greenwashing was "increasingly undermining consumers’ confidence in ESG claims", with recent AIC research showing that 58% of investors surveyed are not convinced by ESG claims from funds, up from 48% last year.

He also applaud the FCA’s decision to include investment companies in the proposed sustainable investment labels, which he said, "creates a level playing field for all funds which is vital for consumers who need to be confident that they are comparing like with like when choosing a sustainable fund".