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The UK pursues a home-grown ESG regime

Investor appetite for ESG (environment, social, governance)-focussed and sustainable funds is reaching new heights, fuelled by the sector’s perceived performance benefits; regulatory intervention; and growing fears about stranded asset risk. According to Morningstar data, ESG funds accumulated $139.2 billion in net inflows during the second quarter of 2021, bringing total AuM (assets under management) to $2.3 trillion. [1] Amid the asset class’ strong growth, regulators – particularly in the UK- are keen to ensure standards remain high – following growing concerns about potential greenwashing.

Improving clarity around ESG funds

In a letter to AFMs – published in July 2021 – the UK’s Financial Conduct Authority [FCA] noted that it had seen a notable increase in ESG/sustainable funds applying for authorisation, before adding that a number of these applications “have been poorly drafted and have fallen below our [FCA] expectations.” In its letter, the FCA continued that many of the ESG claims in these applications do not bear scrutiny, and stressed they should have been addressed during the fund product design process. Among some of the more egregious examples of product mis-labelling cited by the FCA included a proposed passive fund with an ESG-related name which was looking to track an index that was not ESG-focused. In another case,the FCA criticised  a sustainable investment fund  for having two high carbon emitting energy companies in its portfolio holdings without “providing obvious context or rationale behind it – e.g. a stewardship approach that supports companies moving towards an orderly transaction to net zero.” Such behaviour risks undermining consumer confidence in ESG funds.

In response, the FCA has outlined a set of guiding principles on the design, delivery and disclosure of ESG and sustainable funds. These requirements are entirely sensible and proportionate, and have not elicited criticism from the Independent Investment Management Initiative [IIMI]. For example, the FCA urges that references to ESG in a fund’s name, financial promotions or any other documentation should reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund. For example, the FCA highlights managers should not use terms such as ‘ESG’, ‘ethical’ or ‘green’ in their fund name unless they are directly adopting such strategies. The second principle states that the resources used by a firm to pursue its ESG objectives be appropriate, and the manner in which an investment strategy is implemented be consistent with its disclosed objectives. And finally, the third principle advises that pre-contractual and ongoing periodic disclosure by sustainable investment funds be available to consumers and must contain information to help them make investment decisions. The latter requirement will be vital in ensuring trust among retail clients.

Enhancing ESG reporting in the UK

Having announced in November 2020 that it would introduce climate-related disclosure obligations for asset managers, life insurers and pension providers, the FCA has since published a consultation – CP21/17 – outlining its requirements. Under the FCA’s proposals, in-scope investment firms [i.e. UK AIFMs; UK UCITS] will need to produce disclosures which are based on the Financial Stability Board’s [FSB] recommendations  in the Task Force on Climate-related Financial Disclosures [TCFD]. The FCA has said the new reporting requirements will take effect from January 1, 2022 for the largest investment managers, namely firms with more than £50 billion.  As of January 1, 2023, the rules will apply to all other fund managers running at least £5 billion in AuM. Although the proposals only cover UK managers, an article by international law firm Sidley Austin warns that non-UK managers could also be indirectly impacted. “The FCA’s proposals could result in in-scope UK asset managers and asset owners requesting that a non-UK asset manager provide certain product-level information – in order to discharge the in-scope UK asset managers’/asset owners’ own disclosure obligations,” it continues.[2]

In terms of the specific reporting obligations, the FCA has told managers to report information at both an entity and product/portfolio level. In the case of entity level disclosures, “these would be made with reference to activities over the previous 12 months using the most up to date information available. We {FCA] are proposing to give firms the flexibility to select the 12-month reporting period for their first entity level TCFD report provided that the period begins no earlier than January 1, 2022 and that the first disclosures are published on their website by June 30, 2023.”[3] On product and portfolio level disclosures, the FCA said “firms required to make public disclosures would be required to publish them on their websites by June 30 of each calendar year. These disclosures would be made using the most up-to-date data available at the time of reporting. The data must be calculated within the 12 month reporting period covered by the TCFD entity report. Firms would be required to publish disclosures on their website by June 30. This includes [or cross-reference to] the website disclosures in the appropriate client communication which follows most closely after the reporting deadline. In the case of on demand disclosures to institutional clients, firms must provide the requested information from July 1, 2023.” Although it is clear the UK needs to demonstrate its ESG credentials – particularly following Brexit – there are concerns among managers about the risk of duplication of ESG regulations.

ESG reporting could pose challenges

In isolation, the UK’s climate reporting regime appears sensible, not least because it adopts a widely used international standard [TCFD] as its template. Nonetheless, the UK’s approach does create its own problems, especially for firms who are also caught out by the EU’s SFDR (Sustainable Finance Disclosure Regulation). With more regulators across the globe now contemplating their own bespoke ESG reporting regimes (i.e. the US and certain APAC markets), there is a risk that the entire process could become increasingly complicated and costly. This comes at a time when boutique investment managers are already grappling with rising regulatory costs and operational overheads – the latter a direct consequence of the pandemic. While the IIMI fully supports a comprehensive and meaningful ESG reporting regime, it has growing concerns that too many regulators are introducing their own rules in silos leading to duplication and arbitrage. Moreover, the multitude of different reporting templates and approaches that are likely to emerge is going to be confusing for investors, particularly retail.  In order to mitigate this risk, it is vital  regulators engage and collaborate with each other when developing their ESG reporting regimes , so that there is a degree of standardisation and consistency.  


[1] Reuters (July 27, 2021) Global sustainable fund assets hit record $2.3 trillion in Q2, says Morningstar

[2] Sidley Austin

[3] FCA