Building trust in sustainable investing in 2021

Investors’ growing awareness of issues such as climate change, along with a heightened focus on social responsibility accentuated by the pandemic, has led them to explore funds that benefit society in addition to generating returns.

Challenges for the ESG sector

However, in a report titled ‘Ten Key Regulatory Challenges of 2021’, KPMG notes that ESG investing has challenges as a sector, stemming from multiple standards and frameworks for measuring and reporting ESG risks. They are mostly voluntary and not directly comparable, which can make it difficult for stakeholders to objectively assess these risks.

Consequently, ESG investing continues to sit at the top of the regulator’s agenda and the pace of legislative and regulatory change, both inside and outside the EU, will continue into 2021.

In March, the EU is introducing landmark rules mandating greater transparency for ESG funds and the sustainable finance disclosure regulations require fund groups to provide information about the ESG risks in their portfolios for the first time. This new Sustainable Finance Disclosure Regulation (SFDR) – also known as the Disclosure Regulation, is essentially putting sustainability right at the heart of the investment process.

What are the UK’s plans in relation to sustainable investing?

Whilst the UK is no longer proposing to transpose this EU regulation directly into UK legislation, there are a number of steps the FCA is taking to improve the flow of data and information into the ESG investment process, as outlined in November by Richard Monks, its Director of Strategy*.

• The regulator consulted to require UK premium-listed companies to make better disclosures about how climate change affects their businesses and aims to publish a policy statement in the coming months. It is also looking at wider corporate reporting on sustainability, to form the basis for a common international non-financial corporate reporting standard.
• It wants to improve firms’ disclosures to clients and consumers on how they are managing sustainability factors. This is in both dedicated ESG-focused products, and across their wider investment activities.
• Some of the initiatives under the Sustainable Finance Action Plan will come into force after the Brexit implementation period. The FCA has welcomed the UK Government’s commitment in the Green Finance Strategy (a comprehensive approach to greening financial systems)  to ‘matching the ambition of objectives’ of the EU’s Plan. The FCA is therefore working closely with the Government and other regulators on how to implement the EU’s proposals in the UK.
• It is currently developing online consumer behaviour experiments to test consumers’ understanding and expectations of key ESG terms. It will also be testing how the presentation and content of product information might influence consumers’ decisions and will look to publish results in 2021, which will help inform whether additional guidance or rules are needed.
• An important defence against potential ‘greenwashing’ is to tackle misleading claims as applications for new products are submitted to the FCA for authorisation. This includes non-financial objectives that a product is seeking to achieve – such as reducing the fund’s carbon footprint. It will review the strategy, investor documentation and model portfolios of applications to ensure that they meet the rules and will require changes to the way information is presented to consumers if it isn’t convinced.
• The regulator is also considering whether it would be helpful to introduce a set of guiding principles to help firms with ESG product design and disclosure.

As Richard Monks summarised in his November speech “Looking ahead, sustainable investing is surely here to stay. This is a fast-moving, evolving and innovative space. But innovation can’t come at the expense of undermining trust in the sustainable finance market.”

With this backdrop, sustainable investing only looks set to grow and advisers need to increasingly be prepared to enter into ESG conversations with their clients in the year ahead.