FCA’s new “anti-greenwashing rule” - “clear, fair and not misleading” is complicated when it comes to sustainability-related claims

At a glance

• This blog explores the challenges around communicating sustainability-related claims in a “clear, fair and not misleading” manner, gives examples of areas of particular challenge faced by different sectors, and provides insight on how firms could begin strengthening their processes and controls to address these challenges.
• The FCA’s Sustainability Disclosure Requirements (SDR) proposes an “anti-greenwashing” rule, applicable to all FCA-regulated firms, which will require all sustainability-related claims to be clear, fair, and not misleading i.e., proportionate and not exaggerated. The rule is due to come into effect from Q4 2023.
• The “clear, fair and not misleading” requirement already features in various FCA rules. Firms, however, will likely need to enhance their existing controls to meet the requirement in the context of sustainability.
• Where sustainability-related information is concerned, conveying information in a way that is clear, fair and not misleading is made more complicated by the broad, technical and largely undefined sustainability lexicon, and (typically) by firms lacking consistent in-house definitions of sustainability‑related terms. Lack of staff training on sustainability‑related terms and concepts, and low consumer education, further increase the difficulty, and in turn the risk of greenwashing and associated consumer detriment.
• Any unclear or overly technical sustainability‑related language will also be under the regulatory lens as part of the “Customer Understanding” Consumer Duty Outcome introduced by the FCA.
• Firms should consider setting up internal taxonomies with consistent definitions, invest in training staff and ensure that their culture is conducive to members of staff being careful about the terminology they use in external‑facing discussions and communications.

Target audience: CROs, CCOs, Chief Sustainability Officers, Heads of Non-Financial Risk, Heads of Product, and others in charge of ensuring mitigation of greenwashing risk and compliance with the SDR’s anti-greenwashing rule.

The term “greenwashing” is now common parlance in the financial services industry. Regulators in a number of jurisdictions are concerned about the risk of sustainable finance products being marketed in an exaggerated or misleading way. The FCA shares these concerns and is due to publish final rules under its Sustainable Disclosure Requirements (SDR) for investment products – consisting of disclosure and labelling requirements – in Q4 2023. The rules are expected to take effect in a phased manner from 12 to 24 months after publication.

In addition, if the FCA follows its consultation proposal, the SDR will also introduce a standalone anti-greenwashing rule that will take immediate effect in Q4 2023. The FCA proposed that the anti-greenwashing rule will apply to all FCA regulated firms and require that a firm (whether it is undertaking in-scope sustainability business or not, including firms that approve financial promotions for unauthorised persons) must ensure that any reference to the sustainability characteristics of a product or service is (i) consistent with the sustainability profile of the product or service; and (ii) clear, fair and not misleading. The FCA further provides that this also means sustainability‑related claims should be “proportionate and not exaggerated”.

Assuming that the rule is introduced later this year or early next, firms should already be considering which of their communications make reference to sustainability characteristics of products and services. Firms will also need to consider carefully what enhancements are required for existing controls for ensuring communications are “clear, fair and not misleading”.

This blog sets out our view on how the scope of the rule might be interpreted, why being clear, fair and not misleading is complicated in the context of sustainability‑related claims and how firms can begin to tackle the implementation process.

“Clear, fair and not misleading” – more of the same?

What constitutes a “reference to the sustainability characteristics of a product or service” is not defined by the FCA. In our view, it is prudent for firms to proceed on the basis that it is intended to cover the full range of sustainability‑related references, including phone and in-person conversations with consumers, interviews with journalists and any statements made in roadshows, webinars and other external facing events – well beyond sustainability information in product documents. Firm level disclosures, such as net zero statements, that are necessarily linked (directly or indirectly) to the sustainability characteristics of the firm’s products or services are also likely to be covered. If the FCA intends a narrower scope, we would expect this to be made clear in the final rule and any associated guidance.

The SDR does not provide specific examples of what “clear, fair and not misleading” means in the context of sustainability. However, the concept is already reflected in various existing FCA rules and principles including PRIN 2.1, COBS 4.2, Principle for Businesses 7 and CONC 3.3.

For example, rules under CONC 3.3 provide that communications should be legible, accurate, balanced (not emphasising benefits without giving a fair indication of risks) and presented in a way that is likely to be understood by the intended audience.

Applying the clear, fair and not misleading principle in the context of sustainability is not likely to be straightforward. The broad, unfamiliar and largely undefined sustainability lexicon combined with the wide applicability of the anti-greenwashing rule raises specific considerations that might make implementation more complex in practice. In particular:

• it may be difficult for firms to explain technical terms and KPIs in a way that is readily comprehensible to consumers;
• different firms may use the same terms e.g., “social” to mean different things; and
• members of staff within firms may use distinct terms interchangeably e.g., “nature”, “environment” and “climate”.

These factors, individually or in combination, could result in consumers and other external stakeholders misunderstanding the objective, terms or performance KPIs of sustainable products, in turn exposing consumers to detriment and firms to greenwashing claims.

Any unclear or overly technical sustainability-related language will also come under regulatory scrutiny as part of the “Customer Understanding” Outcome of the Consumer Duty, which requires all firms in scope to ensure that communications are “likely to be understood by retail customers” and “equip [retail customers] to make decisions that are effective, timely and properly informed”.(See our blog on leveraging Consumer Duty implementation to mitigate greenwashing here.)

How can firms enhance their controls to comply with the new anti-greenwashing rule?

As a starting point, firms could create a taxonomy of the sustainability-related terms used for their product and service offerings, net zero statements and firm‑level sustainability ethos. The Consumer Duty rules, which are geared towards delivering good outcomes, encourage firms to test their communications for comprehensibility. Firms could test with various cohorts of consumers whether certain sustainability-related terms carry certain biases or are confusing, and use the results to inform their taxonomy, and also marketing and performance documents.

A strong “sustainability-positive” culture is also important for encouraging staff to use terminology accurately when communicating about sustainability. Training can help ensure staff are aware of the risks of greenwashing and understand the firm’s expectations of staff conduct. Surveys are one tool that can be used to gauge staff understanding and buy-in. Firms’ ability to embed a sustainability-positive ethos in culture can also have far reaching implications for the effectiveness of their sustainability strategy and risk appetite. See our blog on the wider role of culture and governance in sustainability here and the FCA’s view on the subject here.

The requirement for communications to be “consistent” with the sustainability profile of products and services will also require pro-active controls to be put in place. The FCA has previously emphasized this concept in its Dear AFM Chair letter from July 2021, where it stated the “sustainability focus of a fund should be reflected consistently in its design, delivery and disclosure”. In our view this requirement is likely to be met if consumers are able to follow a single, accurate narrative smoothly from the pre-contractual sales or terms documents through to any performance reporting documents. Compliance departments could do “end‑to‑end” checks for consistency before documents are finalised for products, and also conduct periodic compliance monitoring to check that performance reporting matches the initial claims, both in terms of terminology and substance. Firms could also consider consumer testing to determine whether external stakeholders are able to follow a consistent narrative from pre-contractual marketing materials to on-going performance documents.

Firms will also benefit from staying fully abreast of industry developments on sustainability‑related terminology – the financial services industry as a whole, including regulators and trade bodies, is continuing to discuss the definition of and distinction between various terms that might appear to mean the same thing e.g. “climate”, “nature” and “environment”. Individual firms need to ensure that they are aware of the current common understanding of sustainability‑related terms.The UK Taxonomy (consultation expected before end of 2023) may provide official definitions for certain terms, but this will depend on its final shape.

Lastly, firms should consider the interoperability between the anti-greenwashing rule and other sustainability‑related regulations. The anti-greenwashing rule applies to sustainability-related references relating to products and services, which in our view should be interpreted widely to include sustainability‑related regulatory disclosures such as the SFDR, TCFD and SDR. Firms should assume that the clear, fair and not misleading rule applies to information provided in any sustainability‑related disclosure, not just in marketing documents. As an example, the pre-contractual and on-going sustainability performance disclosures for products that use sustainable investment labels would be significantly exposed due to the amount of sustainability‑related information they are intended to carry.

What might unclear and misleading references look like in practice?

Examples provided by the European Supervisory Authorities in their progress reports on greenwashing in investment management, banking and insurance illustrate where firms might face challenges:

1. Investment Management: ESMA reported that some of the most frequent misleading claims it identified related to exaggeration based on an unproven causal link between an ESG metric and real-world impact. ESMA also found frequent cases of lack of clarity around where exactly the impact of a fund is achieved i.e. it was not clear to which part of the investment strategy (e.g. security selection, portfolio construction or stewardship) any impact was attributable.
2. Insurance: EIOPA reported various examples including insurers misleading consumers by declaring that they plant trees for every life insurance policy sold but not following through; insurers misleadingly claiming to be transitioning their underwriting activities to net zero by 2050 without any credible plans to do so; and insurance products being portrayed as benefitting sustainability factors solely because of good “ESG ratings” in instances where the ESG rating did not actually consider positive impacts on sustainability factors and only considered financial risks.
3. Banking: The EBA reported that the main types of misleading claims (including errors and omissions) that it identified are misleading claims on the current approach to integrating sustainability, misleading claims on the sustainability results and real-world impact, and misleading claims on future commitments relying on medium- or long-term plans. Separate to the EBA report, the FCA has raised concerns about the greenwashing risks inherent in the market for green mortgages. Green mortgages are not the only products exposed to potential greenwashing – the FCA also published a letter setting out its greenwashing related concerns in relation to Sustainability Linked Loans – see our blog here.

Conclusion

Firms should consider fully how the principle of “clear, fair and not misleading” needs to be embedded across their business and processes in the context of sustainability. In order to be best prepared for the introduction of this rule, firms will need to take a rounded view of all their sustainability‑related communications and consider how to ensure consistency across the board. Adopting an internal taxonomy, supportive culture, periodic risk and compliance checks, and staying abreast of industry developments on sustainability‑related terms are all steps in the right direction.