Watchdogs call for funds to come clean on green finance claims
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Financial regulators are toughening their stance against so-called ‘greenwashing’ to ensure climate-conscious investing delivers on its promises.
The energy crisis that has followed Russia’s invasion of Ukraine, and the growing threat of global recession, have not dented support for sustainable investing as feared.
Instead, investment has flowed into environmental, social and governance (ESG) funds every month this year, according to Bank of America figures up to August. Meanwhile, conventional funds have faced outflows in some months of this year, the bank said.
So, with the viability of sustainable investing seemingly secured, regulators are pushing to ensure the sector achieves its environmental ambitions.
In October, the UK’s Financial Conduct Authority proposed rule changes to tackle greenwashing and rein in the use of terms such as “green” and “ESG” in investment fund marketing. It has recommended establishing three categories of “green” funds and putting a greater burden on asset managers to validate any sustainability claims their funds make in marketing materials.
But the FCA and its overseas counterparts face a challenge in combining their anti-greenwashing rules into an effective global effort to promote environmentally friendly investment products, says Richard Weighell, partner at accounting firm BDO.
“These new rules will need to align closely with other developing international standards,” Weighell says. “If there is too great a divergence, this could prove a big regulatory headache for financial services firms operating internationally.”
The EU has led the way in writing rules for this sector. Its Sustainable Finance Disclosure Regulation (SFDR) now categorises investment funds into three categories: conventional; green; and pure green.
Funds in the conventional category do not consider any ESG criteria. Green funds can take a middle-of-the-road approach by considering ESG concerns in their investment strategies. But pure green funds must incorporate sustainable investing into their overall strategies. Half of all assets in European funds are now held in the green and greenest fund categories, according to Morningstar, the investment research group.
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Building on the EU’s initial SFDR rules, European asset managers will next year also have to disclose certain greenhouse gas emissions and carbon footprints that come from their investments. The aim is to prevent funds from marketing themselves misleadingly as green without changing underlying investment strategies.
In the US, Democrats are fighting to push through ESG rules and climate disclosures under the administration of President Joe Biden. The Securities and Exchange Commission has at least three proposals in the works that would result in significant changes for leading companies and asset managers. Earlier this year, the agency put forward changes that would require Scope 3 emissions — which come from a company’s suppliers and customers — to be revealed and would require certain emissions disclosures to be audited.
But the disclosure proposals are opposed by some companies that argue they would drive up costs and expose them to litigation risks. The SEC seems determined to finalise the rules, though — possibly before the end of the year.
“We are going to wind up with a climate disclosure rule for public companies,” predicts George Raine, partner at law firm Ropes & Gray. “But that rule will get challenged in court. What we have been advising companies is that you have to have a game plan.”
Separately, the SEC has proposed rules determining how asset managers can add ESG and other green terms to their fund names. The agency has also recommended ESG disclosure rules for investment advisers.
Raine fears differing transatlantic ESG disclosure rules could have “enough similarities to be confusing and enough differences to be tricky”. Common rules accepted across major jurisdictions would help. But “there is not much of an expectation that the regulators are going to get together and align their frameworks,” he warns.
There is one plan for harmonisation, however. The International Financial Reporting Standards Foundation — the global standards-setter for accounting — has set up an independent unit to focus on climate disclosures.
Called the International Sustainability Standards Board, it was launched in 2021 to draw up standards for ESG reporting and is chaired by former Danone chief executive Emmanuel Faber. The body is now designing rules to set a baseline for sustainability disclosures, globally. In October, it announced Scope 3 emissions would be required as part of its disclosures.
But Lauren Anderson, a senior vice-president at the Bank Policy Institute, a US lobbying group, says the proposed Scope 3 requirements will “create an overly aggressive international baseline that many nations would unlikely follow, leading to less convergence”.