The UK regulator is planning a reality check on the asset management industry’s wholesale shift to ESG funds, outlining that it won’t stand for dubious claims about purity or performance.

Sacha Sadan, ESG director at the Financial Conduct Authority (FCA), shed more light on how it will raise the bar for any fund wanting to take on an ESG-type label.

Sadan also bemoaned how Europe’s taxonomy has become a race to classify funds as article 8.

Sadan acknowledged the industry is crying out for ‘guardrails’ and ESG standardisation. But he took aim at funds hiding behind terms like ‘integration’ and ‘stewardship’ without spelling out consequences in concrete terms.

Speaking at the SRI Services & Partners event for Good Money Week, he also:

• said funds with an ESG-related name would have to prove it or lose it;
• foresaw an impact for groups with a mix of ESG and non-ESG products;
• promised a crackdown on jargon and paperwork;
• predicted that ‘social-washing’ would become a hot issue;
• supported the regulation of ESG ratings agencies.

Sadan said the UK’s Sustainability Disclosure Requirements (SDR) would provide consumers with much-needed clarity and transparency.

‘If someone tells you that “ESG outperforms” – one of the phrases that I’ve heard over the years – what does that mean? I don’t know what that means, and I’ve been in the industry for a very long time,’ he said.

‘Or “I integrate ESG into everything!” Or “we cover all the SDGs”. Excellent. Wow. Can you give me an example?’

Sadan, the regulator’s first ESG director, said consumers want to understand why some ESG funds might invest in oil and gas or in companies with poor gender pay gaps and ethnic diversity, bringing a need for the industry to move forward in standardising regulations.

Pointing out that not everyone wants ESG, however, he said any claims must be substantiated with evidence.

‘There are other ways of investing. I know I am the director of ESG and I should care passionately [about ESG], and I do. But if you start saying it, you’re going to have to say more than “I’ve integrated ESG everywhere”. That’s not enough, and that won’t get you a label.’

Carrot and stick

On the disclosure requirements, Sadan said there will be one set of metrics on each sustainability topic that he hoped chief financial officers and asset managers have already agreed on. He said the FCA had been engaging with asset managers extensively throughout this process providing them with detailed information.

‘We try to give the industry time, because I am not going to say “journey”; we’re just early. So, we help them with labels, we help them with the International Sustainability Standards Board, and we’re helping with a “Dear chair” letter but if you don’t do it, then the stick will come afterwards as a regulator needs to have.’

Keep it simple

Simplicity was another point Sadan touched on, emphasising that neither he nor consumers understand a ‘76-page document’ laden with terms such as ‘stewardship’ and ‘transition’.

‘Give them the succinct version. It isn’t that hard to tell them why this is a diversity fund, or what metrics you’re going to be judged on. If it’s something that’s going to be surprising to a consumer, explain why in a two- or four-page document, consumers do not want to know that you’ve got 10,000 algorithms and used 55 data points. What does that actually mean?’

In July, Citywire Amplify found that 200 funds had adopted an ESG-related name in just six months. Referring to our report, Amplify asked Sadan how the FCA would approach renaming. He said the FCA’s rules on ESG labelling would force funds to either prove they are ESG compliant or change their names.

Amplify also asked whether the SDR would be tougher than the EU’s Sustainable Finance Disclosure Regulation (SFDR). Sadan said it would not be, and that lessons have been learned. He said one of the biggest lessons from the SFDR experience was the way regulation had morphed from a disclosure regime into a labelling system.

‘It was meant to be a disclosure regime, but it became [a labelling system]. And everyone didn’t want [an Article] 6, they didn’t want an 8, and so therefore it became a sort of a race to the top. So that’s one thing to learn: that one is not better than another. We’re definitely not using numbers.’

It’s all going to be worth it

Sadan also sought to reassure asset managers who had already undertaken work to comply with the EU’s regulations and said the SDR would not be ‘completely onerous or different’.

‘The work that you’ve done, and the scars and the grey hairs that you’ve got from some of this work will be useful for our regime. But of course, you’ve worked from that, and it has to be better. Otherwise, what’s the point of doing this?’

Sadan emphasised that he is the ‘director of E, S and G, not just E’. He said that despite his passion for the environment, social aspects are going to be very important over the next few years.

‘Greenwashing is something you hear all the time; you don’t hear the word social-washing as much, but that’s just as bad and just as important.’

He also wanted to see ESG ratings regulated in a similar fashion to what has happened to UK credit firms. However, he said he was also mindful that any regulation needed to be ‘internationally the same’.

Why so nervous?