The FCA’s review of its ESG 'Guiding Principles’

November 2023

In its February 2023 portfolio letter, the FCA indicated that it was reviewing fund managers' compliance with its guiding principles for authorised funds. It has now published the findings of the review — noting that although fund managers have made efforts to comply with the principles, a range of improvements are still needed.

The findings illustrate the importance of clear disclosures that can be understood by consumers, effective and measurable stewardship, robust governance, and the importance of ensuring all aspects of a fund are consistent with its name and any sustainability claims.

Given the close links to the FCA's Consumer Duty, and the anticipated publication of its Sustainability Disclosure Requirements (SDR) imminently (which will codify aspect of the principles), this is a timely publication. Fund managers should act quickly on the findings to inform their Consumer Duty 'Day 2' activities (see relevant article here) and to support preparations to implement the SDR (see an implementation guide here).

Context

The guiding principles were originally communicated in a 'Dear Chair' letter (PDF 283KB) to Authorised Fund Managers (AFMs) in July 2021, targeting funds with an ESG/sustainable investment strategy or those that claim to have ESG characteristics, themes or outcomes.

Absent implementation of the EU SFDR, and prior to the implementation of TCFD disclosures for UK asset managers, the FCA seized the opportunity to lay down a marker with its expectations for UK firms managing retail funds. The principles consist of an overarching principle on consistency, and three specific principles (design, delivery and disclosure).

Summary of the FCA's findings

Having reviewed authorised funds with a reference to ESG and/or sustainability terms in their name across 12 AFMs, the FCA found some evidence of good practice but noted that the principles had not been fully embedded. The key findings for ESG and sustainable funds are as follows: 

Crucially, there are Consumer Duty implications across all the findings. The FCA notes that the 'consumer understanding' outcome is particularly relevant (especially around testing whether communications meet the needs of retail customers). AFMs should also revisit the robustness of their product governance arrangements, and ensure relevant MI and data is captured in reporting to committees and the board (see a guide to the Consumer Duty board report here).

Next steps for Authorised Fund Managers

AFMs should act quickly to review their arrangements and assess them against the FCA's findings. Specifically, this should include reviewing their:

1. Governance structures and oversight arrangements: with a focus on the prevention of greenwashing. 
2. Stewardship operating model: including arrangements for setting the stewardship programme, the involvement of relevant functions including portfolio management and research, and tools for recording, tracking and monitoring engagement activity (see a broader summary of considerations for firms here). Firms with a centralised stewardship function will need to address specific challenges when responding to the FCA's comments. 
3. Sustainable product framework: focusing on whether it sets clear minimum standards aligned to the guiding principles and is appropriately linked to the firm's broader ESG strategy. 
4. Approach to product-level sustainability disclosures: with an emphasis on whether disclosures for ESG products are consistent and easy to find and navigate.
5. Sustainable investment framework: to ensure there is a robust approach to assessing the eligibility of investee companies as investments in ESG funds, including assessing transition investments. 

The outcome of these reviews should be documented and approved by the AFM's relevant committee(s), and ultimately the board.

Taking these steps should support firms' alignment with the Consumer Duty, but importantly should also assist preparations to implement the SDR regime. Given the SDR policy statement is due imminently, any work undertaken in the short term should also support compliance with the FCA's anti-greenwashing rule that takes effect on publication of the policy statement.