ESG products are seeing a boost in popularity

As environment, social and governance (ESG) products are becoming more popular, concerns from regulators are being raised amid misconduct from firms offering these products to a growing yet largely unregulated market.

It may soon become a new norm to find labels on investments just as you would find nutritional information on food. Despite complexities in funds that are largely well-diversified, regulators believe that investors have a right to know what they are contributing to, as more sustainability-conscious investors are opting to make investment decisions from an ethical point of view.

Financial regulators around the world, such as the Financial Conduct Authority (FCA), are turning harsher on greenwashing. The practice is recognized as unethical as more investment managers are making unjustified environmental claims for their products for marketing purposes.

The logic of regulators is that transparency should prevail, especially with growing global environmental concerns. If there is a buyer who is genuinely concerned about the environment and thus picks funds with this concern in mind, then such a buyer should be catered for, according to regulators who are cracking down on dishonest fund managers.

In practice, sustainable-branded funds that include unsuitable fossil fuel investments are clear targets for regulators who want to ensure that individual investors know what they are buying as complaints rise about greenwashing that intentionally misleads buyers.

The FCA has warned of risks of exaggerations and misleading or unsubstantiated claims which lead investors to purchase products. However, green marketing may not necessarily be backed by genuine sustainability credentials.

In the US, the Securities and Exchange Commission is also working on rules that will require funds to disclose how their investments satisfy claims of sustainability. Funds with names using words like “green” or “sustainable” will be targeted for this new regulatory practice.

Namely, three fund labels are being drawn up by the FCA to distinguish funds from each other. Funds are to be distinguished between those that currently hold exclusively sustainable assets; those that encourage their holdings to become more sustainable over time; and those that are focused on having a positive, real-world impact. Funds failing to fit the criteria for such labels will be restricted in their use of certain terminology, such as “net zero”, to promote their products, particularly in their names and marketing materials.

To take a recent example from the UK, a series of HSBC’s advertisements were banned for being misleading about their green credentials while at the same time failing to mention the bank’s financing of fossil fuel projects and its links to deforestation. Now that the ruling has set a precedent for the financial sector, firms are worried as this is the first time the regulator has barred ads on the grounds of greenwashing.

Similar ads run by Barclays and Standard Chartered were also flagged by campaign groups and coalitions such as those organized by the Rainforest Action Network. To take another example, German police raided DWS (asset manager) as part of an investigation into greenwashing in May.

The FCA and other authorities continue to propose ways of helping buyers navigate their green investments as global market regulation ramps up to ensure fairer, clearer, and more concise funds to enter markets without the risk of misleading people into falling for mislabelled products.