The UK’s financial watchdog has unveiled a new framework designed to protect retail investors from misleading ESG claims.

The measures include an explicit anti-greenwashing rule, product labels to help investors understand a fund’s specific goals, and marketing requirements aimed at ensuring that products don’t promote a sustainability objective that doesn’t exist.

“We have been concerned that some firms may be making misleading or exaggerated sustainability-related claims about their investment products,” said Sacha Sadan, director of the Financial Conduct Authority’s environmental, social and governance unit.

Britain’s framework targeting ESG funds comes as the European Union faces a wall of criticism over its regime, which more than two years after its launch is being wheeled back to the drawing board for an overhaul. The EU’s Sustainable Finance Disclosure Regulation has been lambasted by investors and national regulators alike for its alleged failure to provide a user-friendly rulebook.

The EU, which has so far avoided a basic labeling system and insisted instead on a disclosure regime, is inviting market feedback through a consultation process that runs until mid-December. Mairead McGuinness, the EU’s commissioner for financial markets and services, has said the goal of the review is nothing less than to find out whether SFDR is “fit for purpose.”

The FCA says it wants to ensure that its ESG fund rules, which fit into its Sustainability Disclosure Requirements, are compatible with regimes in other jurisdictions.

“We’re putting in place a simple, easy to understand regime so investors can judge whether funds meet their investment needs,” Sadan said. The rules will allow the UK “to maintain its position at the forefront of sustainable finance, and capture the benefits of being a leading international center of investment.”

For asset managers operating in Europe, however, having two major ESG regulatory frameworks to navigate has the potential to complicate compliance efforts.

Raza Naeem, financial regulation partner at Linklaters, said the expectation now is that the UK’s new ESG investing rules “will be closely reviewed not just by market players in the UK, but also internationally – in particular by the EU.”

The landscape is continuing to evolve, however, he said, noting that the final rules currently don’t apply to overseas funds or separate account managers. That said, “the policy messaging is clear that such products will be brought in scope in due course,” according to Naeem.

Britain’s financial watchdog “has attempted to map its labels against the current EU SFDR, but notes that the EU’s regime is subject to change with the possible introduction of a fund labeling regime,” said Lora Froud, investment management partner at the law firm Macfarlanes. The FCA is signaling that it “stands ready to work with the EU authorities on this important issue,” she said.

With the value of managed assets listed as ESG now exceeding $18 trillion globally, there’s a clear need for regulations to shield retail investors from misleading labeling, the FCA said. Its plan follows a protracted consultation period during which market participants provided feedback on how best to design such rules.

Under SDR, Britain’s financial watchdog will now move ahead with four ESG labels. The FCA first proposed explicit fund label designations in October last year. Back then, it had sought to introduce just three labels. Its decision to move ahead with a fourth label was in response to market feedback, the FCA said.

Funds can label themselves as having a Sustainable Focus if they invest mainly in assets that achieve a high standard of sustainability; Sustainable Improvers need to hold assets that have the potential to improve, while Sustainable Impact will be reserved for funds that can prove they’re targeting solutions to social and environmental challenges. The fourth category will allow funds to market themselves as targeting Sustainability Mixed Goals, meaning managers are free to blend different strategies.

A fund can use an FCA label provided that at least 70% of the gross value of a product’s assets are invested in line with its sustainability objective. The regulator has estimated that about 630 UK-based funds will be affected by the labeling and naming and marketing rules.

The anti-greenwashing rule will come into effect at the end of May, while the labeling framework takes effect at the end of July.

The FCA said it is is also setting up an independent working group for the financial advice industry to work together to build on existing capabilities in sustainable finance, including how the SDR and labels regime supports their role.

Investors said they welcome the FCA’s new rules.

“The measures announced today by the FCA are a positive and constructive step forward,” said Peter Harrison, group chief executive officer at Schroders. “This looks like a robust package aiming to support the UK’s position as a leading center of sustainable finance.”

Joseph Pinto, CEO at M&G Asset Management, said the FCA’s package “should improve market confidence.”

“One of the big challenges for retail investors has been how to compare products from different firms and the new labels address this,” he said. “The new regulation rightly focuses on the protection of consumers whilst leaving plenty of space for product innovation within the asset management industry.”

--With assistance from Greg Ritchie.

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