Part 1 of this two-part series looked at the litigation risks from “greenwashing” – the practice of investment funds and other companies exaggerating their ESG credentials in order to take advantage of investor desire for ESG investments. These risks include claims for negligent or even fraudulent misrepresentation, brought either by individuals or group litigation – though the risks of representative actions may be lower following the Supreme Court’s decision in Lloyd v. Google.1
This article turns to the regulatory risks arising from greenwashing. We look at the current regulatory position and the FCA’s recent consultations on new rules for ESG disclosures, and the enforcement risks in this area.
The current regulatory position
The central FCA requirement regarding communications to investors is Principle 7 of its Principles for Businesses: “A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading”. Managers of authorised funds (UK-based retail funds directly regulated by the FCA) are also subject to the rules in the FCA Collective Investment Schemes sourcebook (COLL), which require an authorised fund’s prospectus to describe its investment objectives, the general nature of its portfolio and any intended specialisation; and also require its manager to manage the scheme in accordance with this description, and report to investors on how it has done this. Funds falling within the UK and EU UCITS and AIFMD categories will also be subject to the disclosure requirements under those regimes.
As mentioned in Part 1, the FCA signalled its concerns about greenwashing by issuing a “Dear Chair” letter in July 2021. This was addressed to chairs of authorised fund managers, but as it describes the FCA’s expectations of investor communications in this area, it is also relevant to managers of overseas and alternative investment funds, and to those marketing all types of ESG fund. The letter sets out the FCA’s “guiding principles” for ESG disclosure, and is intended to help firms apply the FCA’s existing rules.
The FCA said that its guiding principles are relevant where an FCA-authorised investment fund pursues a responsible or sustainable investment strategy and claims to pursue ESG/sustainability characteristics, themes or outcomes. The principles are targeted at funds that make specific ESG-related claims, rather than those that integrate ESG considerations into mainstream investment processes.
The overarching principle is that a fund’s ESG focus should be reflected consistently in its name, design, delivery, disclosure, stated objectives, documented investment policy and strategy, and holdings. Any reference to ESG or related terms should only be made if the fund pursues ESG characteristics in a way that is substantive and material to the fund’s objectives, investment policy and strategy. Firms should disclose ESG-related information in a clear, succinct and comprehensible way, using non-technical terms where possible. The information should enable investors to make informed judgments about the merits of investing in the fund. The fund’s periodic disclosures should evaluate its progress against stated ESG outcomes, and provide evidence of actions taken in pursuit of the fund’s stated aims.
The FCA’s recent consultation and discussion papers
In June 2021, the FCA issued two consultation papers on climate-related disclosures (a narrower concept than ESG-related disclosures generally). CP21/17 covered disclosures by asset managers, life insurers and FCA-regulated pension providers, while CP21/18 proposed to extend the climate-related disclosure requirements that currently apply to issuers of premium listed shares to issuers of standard listed shares.
The FCA proposes to require asset managers (including UCITS managers and most AIFMs), life insurers and FCA-regulated pension providers (including platforms and SIPP operators) to publish annual reports setting out:
- how they take climate-related risks and opportunities into account in managing or administering investments on behalf of clients and consumers; and
- a baseline set of consistent, comparable disclosures in respect of their products and portfolios, including a core set of metrics.
Most recently, in November 2021, the FCA issued discussion paper DP21/4 on Sustainability Disclosure Requirements (SDR) and investment labels. As a discussion paper, this is an earlier stage in the regulatory process and does not come with draft rules. It seeks initial views on SDR disclosure requirements for asset managers and certain FCA-regulated asset owners, as well as the sustainable investment labelling system.
The SDR regime is intended to be similar to the climate-related disclosure regime already consulted on, and to cover a similar group of firms. Labelling is potentially more ambitious, and proposes classifying and labelling investment products according to objective criteria, using common terminology. The FCA considers that this could help combat potential greenwashing and enhance trust.
Enforcement and other risks of ESG-related breaches
The FCA’s keen interest in ESG issues gives rise to a number of potential enforcement and other risks for firms and their managers and staff.
1. FCA enforcement action against the firm
Although in recent years the FCA has increasingly used “intensive supervision” measures such as imposing mandatory requirements on firms, the primary way that it enforces its rules remains the imposition of a fine on the firm found in breach. As well as the financial impact of the fine itself, FCA fines are public, leading to a reputational impact on the firm – particularly significant in the highly competitive ESG arena. In addition, the FCA will often require the firm to pay compensation to investors who have been affected by the breach. Unlike in the actions for damages considered in Part 1, the FCA is not obliged to follow the common law rules on causation and damages for loss, so it is possible that an FCA enforcement action could lead to a firm being obliged to compensate customers even where their investment has not only increased in value, but even outperformed “genuine” ESG funds.
2. FCA enforcement action against individuals
The Senior Managers and Certification Regime is meant to increase regulatory focus on the accountability of individuals for the actions of their firms. It is now common for the FCA to investigate both a firm and the senior manager(s) in whose area the suspected breach arose. Senior manager liability may be based on failure to exercise appropriate oversight, even without direct knowledge of the breach. Other individuals in a firm may also be found to be in breach of the FCA’s conduct rules. The FCA can and does impose fines on individuals it considers responsible for breaches, which are usually calculated as a proportion of their annual remuneration. As with firms, these fines are public and come with substantial reputational consequences. In particularly egregious cases, the FCA may decide that an individual is not a fit and proper person and ban them from the UK financial services industry.
3. Investor litigation based on rule breaches
As well as the litigation based on common law principles examined in Part 1, regulatory rule breaches may give rise to litigation by investors. Section 138D of the Financial Services and Markets Act 2000 allows “private persons” (broadly speaking, individuals) to bring an action against an authorised firm where they have suffered loss as a result of a breach by the firm of FCA rules. This right is subject to the normal principles on causation and damages, and the defences to an action for breach of statutory duty. The right does not currently apply to breaches of the Principles, though the FCA is considering removing this restriction as part of its implementation of a new “consumer duty”.
Fund managers and distributors should be highly conscious of the FCA’s focus on ESG disclosures and the enforcement risks of falling short of regulatory requirements. It is essential to ensure that investor communications accurately describe the fund’s ESG credentials, and that the management of the fund is conducted in line with the stated investment strategy. Firms should be able to demonstrate to the FCA that they have appropriate policies and controls in place to ensure compliance with their obligations in this area. Failure to do so may lead to FCA enforcement action which could have far-reaching reputational and financial consequences.
- Lloyd v. Google LLC  UKSC 50