Will the FCA’s greenwashing crackdown actually help investors?

Friday marks the conclusion of the COP 29 climate summit, which has marked an important date in the agenda of global financial leaders for years.

But almost two weeks of pontificating about global warming in Baku seems to be just that for many bosses: hot air.

The CEOs of major financial institutions including BlackRock, Standard Chartered and Deutsche Bank have reportedly skipped this year’s event, underscoring its diminished significance in the eyes of investors.

COP 29 chief Elnur Soltanov may not have contributed to the perception of growing irrelevance when he was covertly filmed agreeing to facilitate oil and gas contracts during the climate event.

Green investors will probably feel somewhat disappointed by this.

It follows increasing attention to so-called greenwashing, which has driven many investors away from ESG investing after a years-long boom.

Less than half of DIY investors now consider ESG impacts when making investment decisions.

However, for many investors, including some who say they no longer use ESG to guide their decisions, the environment is still a major concern.

Given the option, investors would choose to invest their money somewhere they believe will benefit the environment.

Nearly two-thirds of DIY investors have some form of concern for the environment, according to data from asset manager Charles Stanley.

The problem, however, is that greenwashing has made it increasingly difficult to distinguish companies that have a legitimate impact on the environment from those that mislead investors to make themselves appear more sustainable than they actually are.

Only half of investors think they can spot greenwashing, while a similar number look for environmental certifications to guide their investment decisions.

But these certifications and regulations are generally reactive rather than proactive.

Can investors now have confidence in ESG investing, or is there still a way to go?

How does greenwashing affect investing?

Investment giants including asset manager DWS, HSBC and Goldman Sachs have all been punished for several cases of misleading the public about their environmental credentials.

It has become increasingly difficult for investors to trust claims made by companies.

Growing distrust, underperformance and a political backlash in the US led investors to pull a net $40 billion from ESG equity funds last year, according to Barclays.

But there is still a lot of demand for environmentally conscious investing.

Data from Morgan Stanley shows that ESG appetite has increased over the past two years, and 54 percent of investors expect to increase their sustainable investments over the next twelve months.

Bloomberg Intelligence predicts that global ESG assets will reach $40 trillion (£31.6 trillion) by 2030.

The story is likely the same among DIY investors.

Rob Morgan, chief investment analyst at Charles Stanley Direct, said: ‘As a self-directed investor you have the opportunity to put your money where you believe.

‘Increasingly, people want their investments to deliver more than just make money, with investors clearly looking for investments that have a greener, more ethical or social impact on society.’

The future of ESG investing in the UK comes down to regulatory changes, particularly the imposition of sustainability requirements.

What regulations are there?

Earlier this year, the Financial Conduct Authority (FCA) introduced new anti-greenwashing rules to ensure companies back up their claims about their ESG credentials.

Under the regulations, known as Sustainability Disclosure Requirements, approximately 50,000 companies will have to comply.

Funds are now classified as sustainability-labelled, non-labelled ESG or non-ESG funds.

The regulation applies to UK investment funds, FCA authorized companies offering sustainability-related products or services and UK companies distributing investment products.

Seb Beloe, partner and head of research at WHEB Asset Management, said: ‘Before SDR, there was very little control over how companies could use terms such as sustainability, low carbon or environment. SDR has now set a high standard for funds that want to use these terms.’

The new rules mean that funds with more than 70 percent of their portfolio invested in sustainable assets can be labeled ‘sustainability focus’, while funds with 70 percent of assets potentially improving environmental or social sustainability can be labeled ‘sustainability improvers’ .

Funds can also qualify for the ‘sustainability impact’ label if they aim to have a measurable positive impact, and funds with a combination of the three can qualify for the ‘sustainability mixed objectives’ label.

Will these rules work and what do they mean for investors?

With new regulations in place, it should become easier for investors to understand the products available and whether they truly fall into the ESG category.

Beloe said: ‘Only funds that have an explicit sustainability objective that relates to a real-world outcome and that have an investment process and methodology to measure performance against this objective can use these terms.

“This means investors can be confident that funds that receive an SDR label will support positive sustainability outcomes in the real world.”

At first glance, it seems likely that SDR will reduce greenwashing.

Bianca McMillan, associate director at Gravis Capital, told This is Money: ‘The regulations will prevent investment companies that do not have a sustainable focus from using certain names and language.

“So from that point of view, I think it will reduce greenwashing. It certainly makes investment companies think about how they describe their investments and how they communicate and report on the objectives to investors.’

But some investment funds – such as venture capital funds for example – are not covered by the labeling rules, as most are not specialist sustainability funds.

Henry Philipson, director of marketing and communications at ProVen VCT manager Beringea, said VCT managers have made “substantial efforts in building robust approaches to ESG, ensuring sustainability commitments are translated into frameworks that inform investment strategies.” and support processes’.

However, Gravis’ McMillan also points out that SDR could make it more difficult for investors to navigate the fund space, as the metrics used to prove sustainable are not definitively set out in the regulation.

She said: ‘The way the regulation is drafted means there is scope for investment companies to adopt far-reaching definitions of sustainability. For example, there is flexibility in determining your sustainable objective, with the option to apply your own methodology to measure your objective.’

Many fund managers have also chosen not to adopt the voluntary SDR labels, to see how the regulations evolve.

For investors, this means that a number of funds that may qualify for ESG labels have designated themselves as such.

While many are reluctant to adopt these labels, Beloe expects this to change and is optimistic that more funds will adopt the labels.

He said: ‘Many fund managers have said they will not try to meet this standard because it is too difficult and too expensive.

‘The FCA have explicitly said that they are trying to design a labeling regime that will work for the market for years to come and not just for today. This means that they have set a high standard that the funds must meet.’

Beloe added: ‘The danger is that it will take much longer for funds to use the labels and this will lead to a reduction in the amount of products available, undermining the market for investors.

“Even in this scenario, we think the market will recover, but that could take a few years.”