Will the FCA’s greenwashing crackdown really help investors?

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

But nearly two weeks of pontification about global warming in Baku appears to be just that to many bosses: all talk.

CEOs of major financial institutions including BlackRock, Standard Chartered and Deutsche Bank have reportedly skipped this year’s event, highlighting its lesser importance in the eyes of investors.

COP 29 chief executive Elnur Soltanov may not have helped create a perception of growing irrelevance when he was secretly filmed agreeing to facilitate oil and gas contracts at the climate event.

Green investors are likely to be somewhat disappointed by this.

This follows growing attention on so-called greenwashing, which has turned many investors away from ESG investing after a multi-year boom.

Less than half of DIY investors currently consider ESG impact when making investment decisions.

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

If given the choice, investors would choose to put their money somewhere they consider beneficial to the environment.

Nearly two-thirds of DIY investors have some form of environmental focus, data from wealth manager Charles Stanley shows.

The problem, however, is that greenwashing has made it increasingly difficult to distinguish between companies that have a legitimate environmental impact and those that mislead investors into appearing more sustainable than they really are.

Only half of investors believe they can detect greenwashing, and a similar number look to environmental certifications to guide their investment decisions.

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

So can investors now rely on ESG investing or is there still a way to go?

How has greenwashing impacted investing?

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

Investors are finding it increasingly difficult to trust companies’ claims.

According to Barclays, growing distrust, lagging performance and a political backlash in the United States caused investors to withdraw a net $40 billion from ESG stock funds last year.

But there is still considerable appetite for environmentally conscious investments.

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 investing allocations over the next 12 months.

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

The story is likely to be the same among DIY investors.

Rob Morgan, chief investment analyst at Charles Stanley Direct, said: “Being a self-directed investor gives you the opportunity to invest your money in what you believe in.

“More and more people want their investments to do more than just make money, and investors are 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 changes in regulation, particularly the imposition of sustainability disclosure requirements.

What regulation exists?

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

According to the regulation, known as Sustainability Disclosure Requirements, some 50,000 companies must comply.

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

The regulation applies to UK investment funds, FCA authorized firms that offer sustainability-related products or services, and UK firms that distribute 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. The SDRs have 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 as “sustainability focused”, while those with 70 percent of assets potentially improving environmental or social sustainability can adopt a “sustainability enhancers” label.

Funds may also qualify for a “sustainability impact” label if their goal is to achieve a measurable positive impact, and those with a combination of all three may qualify for a “mixed sustainability objectives” label.

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

With the new regulation in place, it should be easier for investors to understand the products available and whether they truly fall under the ESG umbrella.

Beloe said: ‘Only funds that have an explicit sustainability objective that relates to a real-world outcome and 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 earn a SDR label will support positive real-world sustainability outcomes.”

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

Bianca McMillan, associate director at Gravis Capital, told This is Money: ‘Regulation will prevent those investment firms that are not focused on sustainability from using certain names and language.

‘So from that point of view, I think it will reduce greenwashing. It is certainly making investment firms think about how they describe their investments and how they communicate and report objectives to investors.’

But some investment funds, such as venture capital funds, are not affected by the labeling rules, since most are not funds specialized in sustainability.

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

However, Gravis’ McMillan also notes that SDRs could make it difficult for investors to navigate the funds space, as the metrics used to prove they are sustainable are not definitively set out in regulation.

He said: ‘The way the regulation has been drafted means there is scope for investment firms to set wide-ranging definitions of sustainability. For example, there is flexibility to set your sustainable goal, with the ability to apply a proprietary methodology to measure your goal.’

Many fund managers have also chosen to postpone adopting voluntary SDR labels to see how regulation develops.

What this means for investors is that several funds that could qualify for ESG labels have been designated as such.

Although many are holding back from adopting these labels, Beloe hopes this will change and is optimistic that more funds will begin to use them.

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

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

Beloe added: ‘The danger is that it will take much longer for funds to use the labels and this will lead to a decrease in the amount of product available which undermines the market for investors.

“Even in this scenario, we believe the market would recover, but it could take a few years.”