The UK financial regulator has flagged a crackdown on environmental, social and governance (ESG) benchmarks after finding many were riddled with flaws.
In a letter to industry leaders earlier this month, the Financial Conduct Authority (FCA) director of infrastructure and exchanges, Edwin Schooling Latter, says some ESG index providers have “not accurately described the economic reality that their benchmarks measure”.
“We have observed occurrences of poor data quality and controls (eg, calculation errors and poor validation of data inputs) and are concerned these may impact the reliability and representativeness of benchmarks,” Schooling Latter says.
“We will provide specific feedback to firms on our findings and assess the effectiveness of firms’ actions to address these.”
As in many jurisdictions, including NZ, the UK market has seen an influx of money into ESG products of late, prompting regulatory concerns of ‘greenwashing’.
While Europe and the UK are both developing ESG product disclosure regulations the sector remains ill-defined with managers often leaning on third-party data and index providers to validate claims.
“We believe that the subjective nature of ESG factors, and how ESG data and ratings are incorporated into benchmark methodologies, give rise to an increased risk of poor disclosures in ESG benchmark statements,” Schooling Latter says.
“… Poor design, description and naming of benchmarks, including ESG benchmarks, could create a trust deficit in the market for passively-managed sustainable investment products.”
UK financial advisers will also soon have to take sustainability factors into consideration when giving investment advice under new regulations currently in development.
Meanwhile, the peak global body for financial regulators, the International Organization of Securities Commissions (IOSCO), is also on the case, calling for a co-ordinated approach to ESG education for retail investors and advisers.
In a paper published at the end of August, IOSCO says regulators should help retail investors source and understand ESG-related product information.
As well, the report titled ‘Retail Investor Education in the Context of Sustainable Finance Markets and Products’ says financial regulators should support: “… initiatives of market participants to help retail investors understand ESG certifications, labels and scores regarding the financial products offered to individuals and encouraging and/or facilitating training that helps financial advisors better understand greenwashing and how to protect investors against unsubstantiated or misleading sustainability claims”.
However, the IOSCO paper acknowledges that any regulatory anti-greenwashing or ESG education campaign faces considerable challenges – not the least a confusion of labels and lack of broad agreement on principles or practice across the industry.
“… it should be noted that there is no common or generally accepted definition of sustainable finance or ESG, and not even a single definition or characterization of ‘environmental’, ‘social’, or ‘governance’ factors,” the IOSCO report says.
“Likewise, and depending on the emphasis in a particular aspect, ESG or sustainable investments could be referred to as ‘community investing,’ ‘ethical investing’, ‘green investing’, ‘impact investing’, ‘mission-related investing’, ‘responsible investing’, ‘socially responsible investing’, among many other terms.