UK FCA tackles ‘greenwashing’ fund mis-selling risks

The Financial Conduct Authority (FCA) recently published a summary of its findings from analysis of the effects of presenting funds as ‘sustainable’ on consumer investment decisions and the mis-selling risks related to this. Its findings will be helpful to firms challenging themselves to assess where regulatory systemic problems may exist within their operations.

As concerns about climate change continue to grow in public importance, so too has the proportion of consumers looking to invest in ‘green’ financial products which address sustainability and wider environmental, social and governance (ESG) issues. However, with an ever-increasing range of such products and services coming to the market, the risk of ‘greenwashing’ – the promotion of products which make misleading or erroneous claims as to their positive environmental impact – is a real one.

Green product mis-selling is likely to give rise to increasing regulatory scrutiny and consumer claims, whether by litigation or via the Financial Ombudsman Service (FOS). The FCA’s current regulatory framework – and proposed changes specifically aimed at ESG products – will play a fundamental role in this.

A change in regulatory approach

Against this backdrop, and to enhance its regulatory regime, the FCA has taken a more proactive stance towards climate-related disclosures in recent years. For example, recent rule change proposals aimed at asset managers, life insurers and FCA-regulated pension providers will, if adopted, require the disclosure of high-quality information on how climate-related risks and opportunities are being managed across the investment chain, including to consumers. The rules would be relevant to firms’ regulatory and customer action exposures. The FCA believes that better information will help clients and consumers make more informed decisions about their investments.

The FCA is also looking to implement a new ‘ESG Sourcebook’ which will expand over time to include new rules and guidance on climate-related and wider ESG topics. The new rules, if adopted, would be relevant to customer litigation against financial firms regarding ESG products, as well as an important part of the FCA’s supervisory and enforcement approach. Even without a new sourcebook, existing parts of the FCA Handbook are already relevant to such exposures.

The regulator has also highlighted the potential adverse knock-on effects to consumers where insufficient information from issuers on climate change may result in firms designing and structuring financial products which do not reliably disclose to consumers how their products are exposed to climate risks and opportunities. This, in turn, makes it difficult for consumers to assess which financial products meet their needs, leading to a higher risk that they purchase unsuitable products.

The FCA is also consulting on whether to require certain listed companies to include statements in their annual financial reports setting out whether they have made disclosures consistent with standards set by the Task Force on Climate-related Financial Disclosures.

It is not difficult to foresee a range of mis-selling type complaints and claims emerging in which consumers advance points which are variations on the greenwashing theme – for example, that the investment product’s ESG rating was not properly explained to them, or that they were misled as to the fund’s exposure to investments that have a positive or negative ESG impact. The FCA’s framework will play an important part in such exposures and, if the new sourcebook and rules are implemented, there will be additional ammunition for consumers to seek to rely on against firms.

How consumers are responding

The weight given by individual consumers to different types of disclosures may not always be that easy to predict, but the FCA’s recent analysis suggests that objective ESG gradings such as ‘medal’ ratings sway consumers’ decisions in respect of their choice of investment. Fund images, descriptions and strategies had no significant effect on the participants who did not see medals on their factsheets, according to the research. However, a salient and objective grading of a fund’s ESG and sustainable credentials would have a significant effect on which funds consumers decided to invest in.

Although the research did not test detailed comprehension of what the medals stood for – so consumers may have taken them as more of a sign of general quality, for example – it nevertheless points to the potential power of a rating or symbol in influencing a consumer’s decision-making. It follows that the risk of mis-sale may be significant where such a rating turns out to be unclear or misleading – and this may have wider implications. Where a firm publishes a misleading rating across a large swathe of promotional material, it could be faced with a serious systemic issue where it may be obliged to compensate a large cohort of consumers, or face FCA enforcement and FOS intervention.

Of course, much will depend on the nature, prominence and content of such ratings and other disclosures. The FCA acknowledges that the issue is complex. There may be legitimate causes for differences in assessments of sustainability of products – for example, sectoral or regional differences – and it can be difficult to determine the net impact of a financial product in supporting sustainability goals. The issue is further complicated by the current lack of harmonisation in climate reporting metrics and appropriate benchmarks. Asset managers will need to consider carefully, and have a defensible position on, the framework they have adopted and why it is appropriate for their product.

Where a customer makes a mis-selling allegation in this area, firms may still have defences around causation and loss depending on the facts of the individual case. Firms will want to ensure that the quality of ‘up-front’ climate-related disclosure is clear, fair and not misleading, so as to mitigate the risk of regulatory intervention and civil action in the first instance.

How firms should respond

It follows that firms will need to be rigorous in their assessment, collation and presentation of climate-related information which they include when marketing their green products. This will involve, amongst other things:

• having robust assessment processes in place which properly scrutinise information concerning a product’s green credentials and those of the underlying investments to which it is exposed;
• seeking objective validation of product sustainability assessments and impact assessments where possible; and
• ensuring that any medal-type ratings and similar grading systems have been carefully tested and calibrated, and can be backed up with clear and objective evidence where necessary, so as to mitigate potential challenges as to their veracity.

Of course, there can be no ‘one size fits all’ mitigant to potential regulatory action, mis-selling complaints and court action – but the more a firm can demonstrate that it has taken reasonable and proportionate steps to ensure the accuracy and credibility of its climate-related disclosures, the easier it is to reduce the risk of FCA and other regulatory intervention, as well as litigation.

Co-written by Anthony Harrison of Pinsent Masons.