Asset managers actively managing investment funds in the EU have been urged to review the way they market the funds they offer after an expert warned of the risk of regulatory sanctions for ‘green-bleaching’.
Green-bleaching is a form of mis-selling. It is the opposite of greenwashing. Rather than making exaggerated or unsubstantiated claims about their or their product’s environmental credentials, green-bleaching is where businesses providing products or services that promote an environmental purpose avoid the additional regulatory pre-contractual disclosure and ongoing reporting responsibilities that attach to the provision of those products or services.
The risk of green-bleaching in the EU funds market has previously been flagged by the European Securities and Markets Authority (ESMA) (12-page / 244KB PDF) and Mark Shaw of Pinsent Masons said that risk is increasing as asset managers look to position funds so that they fall outside the scope of transparency obligations under the Sustainable Finance Disclosure Regulation (SFDR).
The SFDR requires fund managers to make a series of pre-contractual disclosures and ongoing reporting concerning the sustainability of the funds they manage. It has served to create a labelling of financial products – fund managers essentially choose between marketing their products as an Article 8 or Article 9 product, or neither.
An Article 8 fund is where fund managers promote “among other characteristics, environmental or social characteristics”. An Article 9 fund is where sustainable investment is the objective of the fund.
While fund managers in all cases would have to operate and publish sustainability risk policies, the SFDR’s most detailed reporting obligations – around adverse impacts of investment decisions on sustainability factors, on how sustainability risks are integrated into investment decisions and on the likely impacts of those risks on financial returns – only apply to Article 8 or 9 funds. The relevant information needs to be disclosed on company websites and in periodic reports and requires to be kept up to date, entailing continuous monitoring and due diligence.
Fund managers electing to market their products as neither Article 8 nor Article 9 funds face only a limited duty to explain to investors, at the pre-contract stage, why they do not consider adverse impacts of investment decisions on sustainability factors and sustainability risks to be relevant to their products.
“The SFDR’s purpose is an admirable one, to increase transparency over the impact funds and other financial products have on people and the environment and help channel capital towards ‘greener’, or more sustainable, industries, businesses and projects,” Shaw said. “In practice, however, there is a growing body of data that shows that capital is not flowing into funds that are being marketed as Article 8 or 9 funds as often as it was when the SFDR first came into operation, amidst concerns about the performance of ESG-related products compared to other financial products available to investors in the EU.”
“At a time when fund managers are coming under regulatory pressure to cut the cost of investing in retail investment products and at the same time grappling with increased regulatory burdens, it is not surprising that we are seeing a shift in the EU funds market to fewer funds being overtly marketed as Article 8 or Article 9 funds,” he said.
However, Shaw said the SFDR has been drafted poorly and that this exposes asset managers to the risk that they are considered to be promoting environmental or social characteristics even if they are not overtly marketing those products as Article 8 funds.
Disclosing adherence to the UN Principles for Responsible Investment or the promotion of screening undertaken to investment of the funds in certain types of assets, like consumer products linked to health problems or activities such as gambling, could be enough to trigger complaints of – and regulatory investigations into – green-bleaching, Shaw said.
“The recent ruling in the American Airlines case in the US has shone a spotlight on the potential for ESG-driven investment strategies to be challenged where they do not achieve the best possible financial returns for investors and comes at a time when asset managers actively managing investments in the EU have experienced difficulty in achieving comparable investment performance as passive investments and benchmark products,” Shaw said. “This raises the potential of investor complaints and regulatory scrutiny of the way asset managers manage and market their products. It is in this context that green-bleaching risks have to be considered seriously, particularly as some European regulators, such as the CSSF in Luxembourg, have set out their intention to closely monitor verification of asset manager disclosures under the SFDR.”
“Asset managers need to consider the potential for disconnect between their legal and marketing teams and review the way their funds are promoted, to ensure that any efforts to carve products out of the scope of Article 8 obligations will stand up to scrutiny,” Shaw said.
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