How investment managers can leverage Consumer Duty implementation programmes to mitigate greenwashing risk

At a glance

• This blog identifies how investment management firms can leverage their work on implementing the Consumer Duty (‘the Duty’) to mitigate therisks of greenwashing or a perception of greenwashing occurring.
• Investment managers will need to grapple with fast approaching deadlines under the Duty at a similar time as they prepare to address the FCA’s concerns about greenwashing.
• We see the involvement of Boards and senior management, specifying target markets, fund design, conveying sustainability-related information to end investors, value assessments and ongoing customer support as being critical to successful implementation of the Duty as well as providing opportunities to address greenwashing risks.

Relevant to: Boards and senior management teams, product teams and those working on Duty implementation at investment managers, including asset and wealth managers.

Introduction

The Consumer Duty intends to create a paradigm shift in good outcomes for retail customers. Under the rules, financial services firms will need to avoid foreseeable harm to retail customers and meet the requirements across four Duty outcomes: (i) products and services; (ii) price and value; (ii) consumer understanding; and (iv) consumer support.

With the deadlines fast approaching, investment managers (‘firms’) have their work cut out. By 30 April, firms need to have completed the reviews necessary to meet the Duty outcomes ahead of the implementation deadline of 31 July.

At the same time, firms need to consider their obligations to identify and address greenwashing risk, as they tackle an increasing range of sustainability-related regulations. The FCA’s proposed Sustainability Disclosure Requirements (‘SDR’) set out disclosure and labelling proposals applicable to investment managers with the main aim of preventing greenwashing. These include an anti-greenwashing rule which we expect to be effective from Q3 2023 and will apply to all regulated firms.

The FCA expects firms to manage and mitigate the risk of greenwashing, which is consistent with the Duty’s expectations that firms should avoid ‘foreseeable harm’. Given that the Duty’s Outcomes apply widely across firms’ operations and the fact that greenwashing can occur in various stages of the customer journey, firms can address the risk of greenwashing as part of implementing the Duty.

Given the outcomes-based nature of the Duty, firms should review the FCA’s non-handbook guidance and consider what good or bad outcomes may look like in the context of greenwashing. An example of a good outcome might be if a manufacturer identifies that a certain sustainable investment strategy is complicated and should only be sold with advice, or after the investor has watched a mandatory video. An example of a poor outcome may be where a fund exaggerates potential sustainable performance and downplays the associated trade off in investment performance with the result that investors forgo significant investment performance without the benefit of the expected sustainable performance. How a firm defines good outcomes will be important as it will drive the data and management information (MI) the firm requires.

Please note that for the purposes of this blog ‘greenwashing’ refers to misleading or exaggerated sustainability-related claims about investment products – claims that don’t stand up to scrutiny.

For more insight on the Duty please see our blog on the product lifecycle here. For more detailed insights on greenwashing risks in asset management see our paper.

Boards and senior management

Greenwashing risks that may lead to foreseeable harm:

• Definitions: there may be an inconsistent understanding of what greenwashing is across the firm.
• Training: Boards and senior management may not have sufficient training or expertise on sustainability strategies, objectives, and metrics.
• Management information (MI): Boards and senior management may not receive MI on the firm’s greenwashing risks, or how the firm is managing them.
• Culture: there may be an inconsistent tone from the top and remuneration policies that do not support good customer outcomes.

How firms can use their Duty implementation programme to mitigate these risks

The Duty requires that its obligations are reflected in governance arrangements, and the SDR also proposes that firms meet certain governance principles to qualify for Sustainable Investment Labels. Moreover, the FCA recently published a Discussion Paper on the importance of governance and culture in the area of sustainability (see our blog here).

When governance arrangements and culture are being reviewed under the Duty, the risk of greenwashing should be flagged to Committees as a key foreseeable consumer harm, supported by training and consistent definitions. A culture that neglects good customer outcomes due to commercial pressure may facilitate greenwashing - Boards and senior management will need to consider their tone on the importance of avoiding greenwashing and make their expectations clear to staff.

As part of the Duty’s annual Board report requirement, Boards will need to assess compliance with the Duty’s Outcomes – Boards should use this opportunity to review the MI collected about controls put in place to prevent greenwashing and any greenwashing complaints and actively consider improvements. Separately, periodic Board meetings should also feature discussions on the firm’s exposure to greenwashing risk.

Products and Services

Greenwashing risks that may lead to foreseeable harm

• Target markets: firms run the risk of sustainable funds not being matched appropriately with target markets and clients’ preferences in the area of sustainability. Furthermore, it may be challenging for firms to determine who the vulnerable groups are for sustainable funds.
• Sustainability data: sustainable investment strategies, stock selection and performance metrics may be based on inadequate and unverified sustainability data from investee companies.
• Distribution: distributors may inadvertently greenwash end-investors if they do not understand the sustainability‑related characteristics of a manufacturer’s products.

How firms can use their Duty implementation programme to mitigate these risks

As part of complying with the Duty’s obligation to specify target markets at a ‘sufficiently granular’ level, firms could work with distributors to understand clients’ needs and expectations around sustainable funds (e.g. through surveys). In particular, the Duty requires firms to be aware of vulnerable groups in target markets. Firms should conduct research to understand who these might be for sustainable funds.

Also under the Duty, firms are required to act in good faith in relation to the design of products and review products to ensure that their design is not facilitating customer harm.

As part of this exercise, firms could assemble a team to carry out due diligence on sustainability data to ensure that it is sufficiently robust to inform investment decisions and contribute towards the design of sustainable investment strategies in sustainable funds or ensure coordination across programmes where such a team already exists. Where proxies are used, firms should consider actively whether sustainability strategies or stock selection based on proxies might give rise to greenwashing.

Furthermore, the Duty requires firms to maintain an appropriate distribution strategy. Research may be required to determine distributors’ expertise on sustainability and how accustomed they are to selling sustainable funds. In our view, firms should not only provide distributors with training on sustainability-related objectives, strategies and metrics, but also on areas of common misconceptions e.g., the fact that transition funds are sometimes exposed to greenwashing claims because underlying strategies are less well understood by investors.

Customer Understanding

Greenwashing risks that may lead to foreseeable harm

• Exaggerated/unclear language: fund documents may exaggerate the sustainability credentials of the fund, or not explain sustainable strategies, objectives and terms clearly e.g. documents for transition funds may not explain the rationale for investments in currently less sustainable stocks.
• Lack of distinction between E, S and G: fund documents may not explain clearly which sustainability issues (E, S or G or a combination) the fund intends to have an impact on.
• Managing expectations on performance: documents may not explain the time horizon over which sustainability performance may be expected.
• Technical metrics: KPIs used for reporting ongoing sustainability performance may be too technical or not well quantified. The latter is a particular concern for less quantifiable areas e.g. social impact on communities.

How firms can use their Duty implementation programme to mitigate these risks

The Duty requires firms to test their communications to determine whether they are fit for purpose. In our view, firms could use this testing to understand whether there are certain biases around sustainability‑related terms such as ‘green’, ‘impact’, ‘clean’ etc. Test results could be used to name funds appropriately and inform language in documents. Communications testing under the Duty is also a good opportunity for firms to ascertain if their communications pass the clear, fair and not misleading test under the SDR’s proposed anti-greenwashing rule.

Furthermore, the Duty requires firms to use plain and intelligible language, and present information in a logical way that is optimal for explaining matters. Using simple language and user-friendly charts and diagrams will be particularly useful whilst presenting technical metrics or KPIs for reporting sustainability performance.

Where funds have sustainability strategies and choose to use Sustainable Investment Labels under the SDR they will have to make detailed disclosures on the fund’s attributes including on objectives, strategies, KPIs, governance and stewardship (subject to final SDR rules). Detail-heavy and technical disclosures can expose firms to greenwashing claims. Here, our view is that firms may benefit from utilising the Guidance under the Duty which suggests that in order to aid customer understanding firms should use the techniques of layering and engaging and keep in mind relevance.

Below we have suggested how these may be applied to mitigate greenwashing.

• Layering: providing the requisite details in disclosures succinctly with links to further information on websites.
• Engaging: on websites, using audio-visuals or other interactive mediums to explain over-arching sustainability‑related issues.
• Relevance: considering what information may be particularly useful for the specific target market.

Price and Value

The manner in which a fund’s sustainability performance is factored into value assessments may not lead directly to greenwashing, but a lack of clear explanations, remedies and appropriate weights may lead to a perception that greenwashing has occurred.

How a perception that greenwashing has occurred may arise

• Sustainability objectives not being given appropriate weighting or subject to remedies in the value assessment: if a fund underperforms against its sustainability objectives without this being appropriately factored into the value assessment and the firm determines that the fund offers ‘good’ or ‘fair’ value without offering clear explanations and remedies, investors may conclude that the firm places a low importance on the fund’s sustainability objectives, which may be out of step with the way that the fund has been marketed.
  

How firms can use their Duty implementation programme to mitigate these risks

Both the existing FCA COLL value assessment rules and the new Price and Value Outcome set out that value is not entirely derived from price and that any benefits and special features should be factored in. In the context of sustainable funds, firms will need to determine how sustainable performance should be included in the value assessment. In our view, to determine this, firms should take into account all relevant issues including how integral the sustainability features were to the fund’s strategies and objectives.

Financial performance and sustainability performance may vary over time and, depending on the circumstances in a particular time period, the fund may perform well in one but not the other. Firms should be cautious about always giving a higher weight to the better performing area in value assessments to conclude that the fund has ‘good’ or ‘fair’ value without a clear rationale. Pre-determined weights on how different types of performance should be factored into the value assessment may prevent this.

In addition, when considering potential remedies, firms should consider each type of performance separately, so underperformance against sustainability objectives should trigger further scrutiny and potential remedies regardless of their weighting in the overall assessment.

Customer Support

How a perception that greenwashing has occurred may arise

Inadequate customer support: inadequate customer support may result in customers not having access to the resources they need to understand the sustainability credentials of products. This may increase the risk that customers make greenwashing complaints which could otherwise have been avoided. Inadequate support could arise through lack of training, inaccessible website support regarding sustainability‑related information and lack of special support for vulnerable customers.

How firms can use their Duty implementation programme to mitigate these risks

In the context of sustainable funds, the key ways to support customers are to provide easily accessible supplemental explanatory material on sustainability and ready access to well trained staff who can deal with greenwashing concerns.

Conclusion

Since greenwashing can occur across firms’ activities including product design, communication and distribution, and poses significant risk of consumer harm, tackling this risk should be a key aspect of complying with the Duty’s Outcomes.

As we have set out in this blog, there are several ways in which firms can use the work they are doing to implement the Duty to identify and mitigate greenwashing risk. These include using governance requirements under the Duty to ensure that greenwashing risks are prioritised at senior levels, using the Duty’s target market and distribution strategy requirements to ensure products are appropriate for end investors and using the Duty’s guidance on customer understanding to ensure clear communication on sustainability‑related information.

In order to facilitate this, there should be clear lines of communication between the teams implementing the Duty and the teams in charge of firms’ sustainable fund offerings.