Ahead of the new AGR coming into force on 31 May 2024, this article will discuss the new requirements, existing regulatory protections, the sustainability disclosure regime, and greenwashing in the context of the FCA non-handbook guidance. We set out below some of the key scoping considerations.
The pressure on banks and other financial institutions to assume responsibility for environmental issues is growing with the FCA’s new AGR coming into force on 31 May 2024.
The AGR was included in a broader package of measures (the FCA’s Sustainability Disclosure Requirements, “SDR”) that mainly are restricted to fund managers and distributors. So, firms in other sectors such as banking or insurance may have inadvertently overlooked the AGR. However, if you are in that position, it is not too late to get ready and protect yourself against claims of having inadvertently engaged in greenwashing.
What is the FCA’s new anti-greenwashing rule?
The FCA’s new anti-greenwashing rule, ESG 4.3.1R, is contained in the Environmental, Social and Governance Sourcebook. The rule sits alongside the FCA’s finalised non‑handbook guidance, which is set-out in Chapter 2 of FG24/3 . Together, the new rule and guidance (collectively the AGR) come into force on 31 May 2024 [1].
From 31 May 2024 a firm must ensure that any reference to the sustainability characteristics of a product or service is:
- consistent with the sustainability characteristics of the product or service; and
- fair, clear and not misleading.
The first point to note is that the AGR has a broader reach than what is traditionally understood to encompass greenwashing. The AGR applies to any firm that references “sustainability characteristics” in relation to its services or products. A “sustainability characteristic” is defined as “environmental or social characteristics”. So, firms need to be mindful of this rule when referring to not just the “E” of ESG, but also the “S”. Statements referring to a firm’s DEI initiatives or approach to tackling modern slavery risks within its supply chain could also be caught by the AGR.
When considering which materials should be reviewed for compliance with the AGR, firms should also note that the rule will apply to a wide range of materials. Sustainability references can be present in, but are not limited to, statements, assertions, strategies, targets, policies, information, and images. Furthermore, it can cover statements made about the firm itself and not just the specific products, notwithstanding how the rule is written. For example, if a firm includes a statement about its approach to climate change and an investor could consider this to be relevant to their investment decision, this could be in scope for the AGR notwithstanding that it does not relate to a specific product or service line. It should be noted that the AGR will also extend to overseas originated products being marketed in the UK.
The rule applies to all client types. Communications aimed at professional clients, and not just those for retail clients, are in scope. The FCA is also clear that the AGR will apply to all firms, regardless of whether they are subject to the Consumer Duty.
It is therefore important that companies and financial institutions check whether they are in scope as the rules go beyond what initially meets the eye.
Do the new rules extend Existing regulatory protections?
There is an argument that the AGR does little more than rephrase existing obligations. For example, many of the materials to be covered by the AGR are likely to constitute a financial promotion which must be clear, fair, and not misleading. Over the past few years, the FCA has taken a much stricter stance on financial promotions. The financial promotion gateway is likely to be used as a means of further tightening up on the supervision of misleading communications and become a tool for enforcing the AGR. Firms that approve greenwashing promotions may see their access to the financial promotion gateway being removed by the regulator.
Firms subject to the Consumer Duty should already have revisited their promotional materials as part of their implementation plan. With the first anniversary of the Consumer Duty fast approaching, firms should be looking back at their implementation plans and checking that they do not need to be further refined. This would be a good opportunity to build in additional tests to ensure compliance with the new AGR.
Arguably, therefore, the FCA has a sufficient toolkit to deal with greenwashing already without adding a dedicated AGR. In trumpeting new green rules that have little new substance or powers to back them up, an uncharitable view may be that the FCA is itself engaging in greenwashing.
How do the new rules interact with the wider Sustainability disclosure regime?
As mentioned above, the AGR sits within a wider package of new measures that crystallised late last year with publication of the FCA’s Policy Statement 23/16. The majority of the other measures only apply at present to fund managers (full-scope UK AIFM (Alternative Investment Fund Manager or a small authorised UK AIFM, although not small registered property AIFs (Alternative Investment Funds), and managers of UK authorised funds such as OEICs (Open-Ended Investment Companies), AUTs (Authorised Unit Trusts), and authorised contractual schemes. A recent FCA consultation (CP24/8) is looking to expand this out to discretionary portfolio managers and some private equity firms as well.
Whilst these other SDR measures have a relatively restricted application, it is worth considering them briefly as they provide an insight into how the FCA is approaching ESG regulation more generally. It also demonstrates how UK regulation is starting to diverge from European regulation in a post-Brexit world.
A. Sustainability labels
The first area to look at is the introduction of sustainability labels. Four labels have been introduced, which firms will be allowed to start adopting from 31 July 2024. The labels are:
- Sustainability Improvers
- Sustainability Focus
- Sustainability Impact
- Sustainability Mixed Goal
Frustratingly, these four labels do not match up neatly to the three labels under the EU SFDR regime. This is likely to cause difficulties for firms who seek to promote structures across both the EEA and the UK. Firms that wish to make use of these new labels face prescriptive rules, such as having at least 70% of the assets in the portfolio meeting the criteria for the label and setting KPIs.
Echoing the AGR, managers who adopt a label must not do so in a way that is misleading.
B. Disclosures
Accompanying the new labels are rules around disclosures which build on the recommendations of the Task Force on Climate-Related Financial Disclosures. These apply at various different levels, including at entity level and for pre-contractual information.
C. Naming and marketing
There are then additional rules around the naming of funds. These rules are directed at funds that do not adopt one of the four labels described earlier. These rules only apply to managers engaging in retail business, so are more restrictive than the general AGR. Nonetheless, it seeks to achieve the same objective.
There is a list of terms (such as ESG, green, transition and net zero) that can only be used in the name of, or literature for, in-scope products if they meet the criteria set out in the ESG Sourcebook. For firms that adopt one of the four labels, they must comply with these naming rules from the date they first use the label; for other managers, they only need to comply from 2 December 2024.
It should be noted that the distribution rules apply to advisers and platforms, as well as the managers themselves. This imposes rules on distributors of products that use these terms. Where they distribute overseas products that use similar terms but do not comply with the UK FCA SDR rules, they must include a set warning.
What is the significance of the FCA’s non-handbook guidance?
To underpin understanding of, and compliance with, the core anti-greenwashing rule, the FCA has recently issued its finalised non-handbook guidance (FG24/3). This is compulsory reading for any firm that wishes to reference environmental or social matters in its marketing materials or broader communications. The guidance provides colour on how the FCA interprets its new rules.
To comply with the non-handbook guidance, firms should ensure that sustainability references are:
- Correct and capable of being substantiated.
- Clear and presented in a way that can be understood.
- Complete (i.e., not omit or hide important information and consider full product lifecycle).
- Comparisons to other products or services are fair and meaningful.
Helpfully, the guidance provides non-exhaustive examples of good and bad practice to help firms understand what the core principles mean in practice.
Are there related UK Litigation Risks?
In addition to the regulatory risks, which ultimately include FCA enforcement actions, firms should be alive to the increasing litigation risks in the ESG space. ESG litigation risks are driven not just by increasing regulation, but also come from investors, customers, and suppliers. Whilst the risk of litigation is sector agnostic, we are seeing a particular increase in claims against financial institutions arising out of:
- misleading financial products;
- the way that suppliers describe their activities;
- customers providing data; and
- corporate disclosures being made.
Increasingly, investors and customers are holding their business partners and service providers to account. It is therefore important for firms to understand regulators’ expectations to minimise the risk of finding themselves exposed to both regulatory enforcement actions and/or in a courtroom defending litigation.
[1] Note that this is earlier than many of the other rules in SDR, or example the restrictions on labelling will not apply to many until December 2024.
