Regulators Crack Down on Greenwashing in Fund Management Industry

Regulators in the UK and US crack down on greenwashing in the fund management industry, introducing stricter definitions for sustainable funds and potential fines for misleading consumers.

Greenwashing has become a mainstream term in finance, and it has drawn the attention of global regulators to how supposedly "green" funds are marketed to consumers. In the UK, the Financial Conduct Authority (FCA) has announced new rules on what funds count as sustainable as part of its sustainable disclosure requirements. The FCA plans to create three main categories for sustainable funds: sustainable focus, sustainable improvers, and sustainable impact, with funds that exclude certain sectors no longer able to call themselves sustainable at all. This could be quite a big shake-up as only a third of funds that currently call themselves sustainable will remain in that category, according to the FCA's estimates.

The fund management industry, while supportive of the need to clamp down on greenwashing, has reservations about the new rules. It worries that the rules will be too restrictive and may stop some funds that it considers sustainable from being allowed to call themselves that. At issue are funds that exclude certain sectors, such as fossil fuels. At the moment, they can call themselves sustainable if they want to, but the FCA thinks that this is too loose a definition.

The FCA has been consulting the industry on its planned changes since the end of 2021, and one of its initial ideas was to create a separate category for such funds and call them "responsible" rather than "sustainable." This idea has now been scrapped. However, it seems to fit the mindset of a group of retail investors who may not need to feel that their investments are actively doing good, just that they are not doing harm in certain core areas.

The Investment Association, which represents UK fund managers, disagrees with the FCA's decision to ditch the responsible category, but it seems likely that a compromise will be reached by the summer. The FCA thinks ditching the responsible category is a reasonable price to pay for cracking down on greenwashing.

There are more practical points to consider. The Treasury’s subcommittee for new financial regulations complained that nobody had yet worked out how much these new regulations would cost the consumer. Retail investors who discover that their recategorised fund isn't really sustainable may want to shift their money elsewhere, incurring transaction costs.

The FCA is keen to avoid the experience of the EU, where new categories for sustainable funds have caused a scramble for some funds to attain what’s seen as a higher sustainability standard – the Article 9 label – while the Article 8 label is akin to the looser "responsible" term.

The issue of fines for greenwashing also remains unresolved. So far, the FCA hasn't fined anyone, despite complaints that investors and funds have been misleading consumers about how sustainable their product is. If a fund is greenwashing, the harm may only lie in the consumer not getting what they thought they were getting. But that may not constitute financial risk to their capital, and others may disagree over whether the fund was definitely breaking the rules because there is no clear definition of sustainability anyway.

Proper rules should clear up some of this ambiguity. If these things are set in stone from the summer, then we may see more enforcement in this area from the FCA. The overarching aim is to make the UK a trusted place to invest sustainably and for consumers to understand what they’re getting. By culling the range of options through stricter definitions, that should allow the industry to expand in a healthier way.

The FCA's move to introduce stricter definitions of sustainable funds comes after the US Securities and Exchange Commission (SEC) last year started fining financial firms, such as Goldman Sachs, with ESG-related fines, while Deutsche Bank and DWS, its majority-owned asset management arm, were raided by German police after a probe into greenwashing allegations by the German regulator.

Another issue that needs to be considered is the potential cost of implementing these new regulations for consumers. Retail investors who discover that their recategorized fund is not sustainable may want to shift their money elsewhere, resulting in transaction costs. There are also concerns over larger-scale sell-offs, as big investors such as pension institutions may have a mandate to invest in sustainable funds. If their target fund is no longer classified as sustainable, they might want to move, which could affect the fund.

Additionally, there is the issue of fines for greenwashing. So far, despite complaints that investors and funds have been misleading consumers about how sustainable their products are, the FCA has not fined anyone. This may be due in part to the difficulty in defining what constitutes greenwashing when it comes to the subjective issue of sustainability.

Proper rules and definitions should help clear up some of this ambiguity. If these new regulations are set in stone from the summer, we may see more enforcement in this area from the FCA, bringing it up to speed with other regulators such as the US SEC. Last year, the SEC started imposing fines on financial firms, such as Goldman Sachs, for ESG-related violations. The German regulator also investigated greenwashing allegations against Deutsche Bank and its majority-owned asset management arm, DWS.

Overall, the FCA's efforts to define sustainable funds more clearly and crack down on greenwashing are positive steps toward making the UK a trusted place to invest sustainably. While the fund management industry may have reservations about the new rules, they should ultimately lead to a healthier and more transparent industry, which benefits both consumers and investors.

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