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United Kingdom: FCA issues guiding principles for funds on compliance with ESG obligations

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In brief

The FCA has written a letter to the chairs of authorised fund managers on improving the quality and clarity of authorised ESG funds, setting out guiding principles on compliance with ESG obligations.

The guiding principles

The FCA’s letter is driven by concerns about the number of poor quality applications for funds marketed with a sustainability and ESG focus making claims that do not hold up under scrutiny. In the letter, the FCA criticises “the number of poor-quality [ESG/sustainable] fund applications we have seen and the impact this may have on consumers”, and requires material improvements to be made. The FCA is also concerned about the clarity and accuracy of ongoing disclosures to consumers, and whether they are effective at enabling consumers to make informed investment decisions.

Against these concerns, the letter sets out three “guiding principles” for fund managers (both pre and post-authorisation) to ensure that they comply with their ESG obligations. Importantly, the principles are targeted at funds that make specific ESG-related claims, but not those funds that integrate ESG considerations into mainstream investment processes.

The principles are rooted in various pre-existing parts of the FCA Handbook and focus on design, delivery and disclosure. Underpinning the principles is the overarching principle of consistency: a fund’s focus on ESG/sustainability should be reflected consistently in its name, objectives, investment policy and strategy, and holdings.

  • Principle 1 (design). The design of responsible or sustainable investment funds and disclosure of key design elements in fund documentation. Under this principle, references to ESG/sustainability and related terms in a fund’s name, financial promotions or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives, investment policy and strategy of the fund.
  • Principle 2 (delivery). The delivery of ESG investment funds and ongoing monitoring of holdings. This principle requires that the resources (including skills, experience, technology, research, data and analytical tools) that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way that a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives on an ongoing basis.
  • Principle 3 (disclosures). Pre-contractual and ongoing periodic disclosures on responsible or sustainable investment funds should be easily available to consumers and contain information that helps them make investment decisions. Under this principle, ESG/sustainability-related information in a key investor information document should be easily available and clear, succinct and comprehensible, avoiding the use of jargon and technical terms when everyday words can be used instead. Funds should disclose information to enable consumers to make an informed judgement about the merits of investing in a fund. Periodic fund disclosures should include evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of the fund’s stated aims. 

The letter breaks down the “key considerations” for each principle and provides some helpful practical examples of how each principle works in practice. Firms submitting fund applications or managing funds making ESG/sustainability claims should consider, in light of the guidance in the FCA’s letter, how those claims are reflected in the fund’s objectives, strategy and disclosures to enable consumers to make an informed judgment about the merits of investing. 

The wider context

The FCA’s letter sits within a wider body of ESG related regulatory initiatives, and the principles have been developed with the aim of being compatible with prospective future disclosure rules for responsible and sustainable investment fund products. These include, for example, the Treasury’s recently announced plans to introduce economy-wide Sustainability Disclosure Requirements and sustainable investment labels that allow consumers to compare the impacts and sustainability of their investments, and the FCA’s open consultation on the implementation of TCFD-aligned disclosure rules for asset managers (which include certain entity and product-level disclosure requirements). The FCA has also designed the principles to be complementary to obligations under the EU Sustainable Finance Disclosure Regulation (SFDR) for those UK firms complying in relation to their cross-border business in the EU; for our summary of the European Commission’s latest SFDR guidance, please see our briefing here. At the international level, the International Organization of Securities Commissions (IOSCO) launched a consultation at the end of June on sustainability-related regulatory and supervisory expectations in asset management. Given the proliferation of sustainability-related regulatory initiatives among the regulators and international standard setters, together with pressure from institutional investors to assign a higher standard of sustainability to financial products, firms should remain cautious and alert to potential conflicts when embedding compliance with regulatory expectations.

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Author

Caitlin McErlane is a partner in Baker McKenzie’s Financial Services & Regulatory Group in the London office. Caitlin's practice focuses on advising a range of global financial institutions on complex and high value regulatory matters. She advises banks, major corporates, payment institutions and asset managers on navigating UK and EU financial services regulation. She has particular experience in advising clients on regulatory implementation projects, day-to-day compliance issues, and regulatory issues arising in the context of large-scale transactions. She also expertise in the areas of banking and wholesale financial markets regulation, in particular in the FX and fixed income space, alongside experience advising market infrastructure providers, including major international exchanges, trading platforms, clearing systems and payment services providers, on a variety of compliance issues. Caitlin is also a member of the Baker's ESG and sustainability taskforce, and advises a range of clients on the drafting and implementation of ESG policies and the implications of becoming a signatory to the UNPRI and the Stewardship Code. Caitlin is an authority on regulatory reforms in the sustainability space and sits on a number of trade association working groups. She has recently been interviewed by Climate Action on her work and is a frequent speaker on the subject.

Author

Kimberly Everitt is Baker McKenzie's knowledge lawyer for Financial Services Regulation & Enforcement, covering the EMEA region, and brings over a decade of experience to the team in both knowledge and fee-earning roles. Prior to joining Baker McKenzie, Kim held roles specializing in contentious financial services regulation knowledge, and her fee-earning roles covered non-contentious regulation in the private equity and general financial services sectors.

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