FCA Review of AFM Implementation of Guiding Principles for ESG and Sustainable Funds

On Thursday (16/11), the Financial Conduct Authority (FCA) published a report on how Authorised Fund Managers (AFMs) comply with existing regulatory requirements and expectations on the design, delivery and disclosure of Environmental, Social and Governance (ESG) and sustainable investment funds.

The review is a follow-up to the Dear Chair letter sent to AFMs in July 2021, which gave guidance on the FCA’s existing requirements through a set of guiding principles. The Financial Conduct Authority mapped their findings against their Guiding Principles outlined in their Dear Chair letter:

Principle 1: Design

Inconsistencies in approach were evident with some AFMs setting ESG investment policies and strategies despite not having ESG or sustainability objectives within their objectives or even fund names. The Financial Conduct Authority reiterated that AFMs should comply with COLL 4.2.5(3)(a)E regarding their ESG and sustainable funds, and with COBS 4.2.1R with any financial promotions or communications so that these are not misleading.

Principle 2: Delivery

There were instances of funds with net zero emission targets that had no Scope 3 emission targets or acknowledgement/explanation in fund literature, and holdings in oil, gas, mining and manufacturing sectors. The Financial Conduct Authority explained the importance of financial promotions and communications being clear and having supportive explanations where necessary to ensure compliance with COBS 4.2.1R. Ensuring consistency across fund strategies, objectives, and communications is necessary for this.

Principle 3: Disclosure

Various disclosures reviewed by the Financial Conduct Authority failed to explain vital ESG and sustainability-related features of funds, such as the decision to exclude Scope 3 emissions or explanations regarding changes to ongoing reporting metrices, such as carbon emissions. The Financial Conduct Authority acknowledged the challenges in accessing some of this data, particularly Scope 3 emissions, but remind AFMs of the importance in describing such limitations and explaining these where possible.

Governance

Alongside the three Guiding Principles, the review showed deficiencies in oversight and controls across AFMs. This resulted in complications and challenges when evidencing key decisions and their rationale. By enhancing these areas, risk management for harmful practices conflicting with the Guiding Principles will be easier and more effective. The Financial Conduct Authority recommend making adjustments where necessary here so that there is appropriate oversight and control frameworks for identifying and addressing such risks.

Consumer Duty

Finally, the Financial Conduct Authority explained the relevance of this review and its findings to the Consumer Duty, particularly the Consumer Understanding outcome. AFMs which ensure that they are adhering to the Guiding Principles and expectations will be better positioned for meeting the requirements of this outcome and evidencing this to the regulator if requested. AFMs should evaluate how their design, delivery, and disclosures for ESG and sustainable investment funds interact with the Consumer Duty outcomes on an ongoing basis to ensure they do not become misaligned.  

Next Steps 

Going forward, the FCA will continue their work alongside AFMs that were included in their review to help with addressing their findings and improve upon these areas. The FCA highlight how enhancements to these areas will help AFMs in their preparation for the proposed SDR and investment labels regime, as well as supporting Consumer Duty outcomes and requirements.