On 28 July 2022 the Financial Markets Authority released the findings of its review of ethical investing claims in managed funds disclosures. ESG, SRI, IFP – however you refer to it, the FMA did not like the way providers who label their offerings as ‘sustainable’ or ‘responsible’ are describing their approach. In this Financial Law Insight we attempt to unpack what the FMA is saying and suggest a few ways forward.
Hot new flavour
Ethical investing – whether you think of it as applying Environmental, Social and Governance (ESG) factors in considering what you invest in, or as taking a Socially Responsible Investment (SRI) approach – is the hot new thing as far as funds management is concerned. Managers are at risk of finding themselves out of favour in the eyes of investors if they are unable to point to some form of ethical investing lens being applied to their investment decision-making.
As a consequence, the FMA has identified representations being made in this space as a strategic priority. The ‘documentation’ review that was released in late July 2022 provides a clear shot across the bows for those jumping on the ethical investing bandwagon. Sufficient care (at least in the eyes of the FMA) must be taken to tell the investing public what you are doing in practice.
While it is always good to know what the FMA is thinking, and what its expectations might be, we believe there are a few shortcomings in the review. And misleading headlines have already been generated off the back of the ‘findings’.
So how did we get here?
In December 2020 the FMA published its Disclosure Framework for Integrated Financial Products (IFP guidance). This gave ‘principles based’ guidance on the fair dealing and disclosure obligations that apply to financial products that incorporate non financial factors – such as ESG and SRI. The IFP guidance also encouraged market participants to consider how their conduct actively assists investors to make appropriate and considered investment decisions.
The FMA coined the phrase integrated financial products (‘IFP’) to refer to such offerings. That’s notwithstanding the fact that an IFP is not something that combines two or more different types of product, like an insurance offering within a managed fund as you might think from that term. It’s just a fund with an ESG or SRI or ethical tilt by another name. But hey, it’s a confusing space anyway, so adding some confusing terminology sort of fits.
Subsequently, the FMA began reviewing a selection of managed investment schemes offering IFPs to evaluate the extent to which the IFP guidance had been taken up. The candidate funds for review were identified and selected based on them being labelled or described on the Disclose register with terms such as ‘sustainable’ or ‘responsible’. The FMA’s focus was to review these through the eyes of a consumer. The funds reviewed were a mix of KiwiSaver and non KiwiSaver, including multi-fund schemes.
Scope of the review
Crucially, the FMA did not attempt to verify the ESG/SRI claims the funds were making. There has been no ‘true to label’ assessment. A manager could have waxed lyrical about their IFP practices, despite the lack of any practical application of those practices, and it sounds like the FMA would have given them an ‘exceeding expectations’ grade. The genuine ethical investing fund manager who opted for the concise approach in describing their practices would have ended up in the ‘could do better’ camp. It’s an odd outcome.
Greenwashing?
There is a clear gap between making unsubstantiated claims about ESG/SRI credentials (which is unlawful) and simply excluding from your disclosure documents all of the details that the FMA would like to see you spelling out. This might conflict with the IFP guidance, but is not unlawful unless actually misleading.
Creating the impression of widespread greenwashing for the media to feast on is unhelpful, and hardly consistent with the statutory objective of promoting confident participation by consumers in financial markets.
The FMA itself has added fuel to that fire, saying fund managers need to “take the necessary care not to mislead or confuse investors with greenwashing”, despite the fact the regulator was not assessing whether or not greenwashing was actually occurring. There is just a taste of irony in that warning.
For fund managers choosing to cook with ESG/SRI ingredients, the FMA’s expectations are fairly clear, but they don’t make applying the IFP guidance any easier in practice.
PDS Disclosure
The key concern the FMA’s findings focus on is a lack of detailed information about the particular ESG/SRI practices in the various PDSs reviewed. Those who have attempted to tailor a PDS will know the challenges that need to be overcome when constrained by prescribed wording, structure, word counts and page limits. For schemes that feature multiple funds, meaningful disclosure via a PDS becomes even more difficult.
As part of its review the FMA commissioned a consumer survey, the Ethical Investment Journey Research, to better understand the role disclosure plays in an investor’s decision to invest in an IFP. The findings? Surprise! The report found that PDSs are rarely read and are unlikely to be a factor in product or provider choice.
The FMA’s review also mentions that it is hard for investors to compare funds claiming an ESG/SRI approach to investing. Anyone who has spent time looking over a bunch of PDS documents will know this is true of all funds, regardless of investment focus. The bland prescribed sameness of these documents means that for the most part PDSs are only really able to differentiate what they have to offer by logo and colour scheme. The substantive content is essentially the same across the board.
Are our disclosure laws broken?
We think the FMA’s IFP review highlights bigger problems with the FMC disclosure regime as a whole, rather than with IFPs. ASIC’s Disclosure: Why it shouldn’t be the default report highlighted that disclosure, while necessary, is often not sufficient to drive good consumer outcomes. Moreover, disclosure can place a heavy burden on consumers – expecting them to make numerous comparisons of products and offerings.
When it comes to disclosure, one size does not fit all – or at least, it should not be required to do so. The world has changed since the current disclosure rules were designed. Maybe it’s time to revisit their effectiveness, and see whether what we ordered a decade ago is still a healthy meal now? Trouble is, that’s a huge potential workplan. We suspect very few would have the appetite for that right now.
What could the FMA do to help?
Encourage flexibility and informed participation
With a focus on flexibility and innovation, not to mention confident and informed participation, we think the FMA should look to put in place a class exemption (as well as seeking expedient regulatory reform) for schemes and funds that include non-financial considerations or an IFP focus. An exemption would provide space for additional information to be included in the PDS and readily allow managers to meet the FMA’s current ‘expectations’.
Of course, any class exemption would also need to provide for additional reporting to be included in fund updates. Fund updates are designed to report on performance. The FMA could facilitate a class exemption for IFPs to report against their sustainability and responsibility goals, as well as financial performance, in their quarterly fund updates. That would be a more effective way of ensuring fund managers are accountable for their ESG/SRI promises than asking them to cram that into the existing disclosure framework.
OMI is not the solution
Simply dumping more information into the ‘other material information’ section of the Disclose register, as contemplated in the FMA’s review findings, is not the solution. If, as the FMA’s own research indicates, investors are not reading the PDS then it is even more unlikely they are going to pour over information on Disclose. The OMI cannot become even more of a dumping ground for all ancillary material. That may help tick the compliance box, but we don’t feel it is truly effective disclosure – and the FMA keeps saying that it is effectiveness and good outcomes that market participants should focus on.
Websites are the key
The FMA was pleased to see information provided on manager websites was “generally more effective at communicating benefits to investors.” We agree! Websites are readily accessible and fairly easy to navigate. When we review a manager’s disclosure documents we invariably head to their website rather than the centralised Disclose register for copies. That’s where fund managers have the freedom to tell it like it really is, and move away from prescribed blandness. However, in the same breath the FMA has warned managers that website content is not a substitute for the PDS (and OMI).
Interestingly, the FMA’s Ethical Investment Journey Research survey found that “people don’t delve too deeply into disclosure documents, but rely on advice from other people, or basic information on websites.” The FMA’s original IFP guidance also encouraged the use of websites: “ideally also on the issuer’s website (which may be more accessible for some investors).”
Websites function as a good ‘one stop shop’ for all key scheme information. We think that the FMA should encourage managers to use their websites to augment their prescribed disclosure obligations: ‘available, free of charge, on an Internet site maintained by the manager’ (to paraphrase the FMC Regulations). Surely that will produce a better outcome than trying to shoehorn more content in a packed PDS?
Principles-based regulation, and FMA’s stated desire to not create undue regulatory burden, requires flexibility for evolving products and offers. Issuers should not be penalised simply because the law cannot keep pace with ever rapid change.
Concluding thoughts
The FMA suggests a race to the bottom where the distinction between IFP funds and ‘vanilla’ managed funds eventually disappears. This is already becoming the case under our current disclosure settings, just not for the reasons the FMA’s latest review highlights.
Given the increasing shift toward responsible investing, and the need to consider and report against climate matters, before long the so-called IFP offerings will be the norm. Now is the time for the FMA and policy makers to consider overhauling the ‘prescribed’ nature of our disclosure regime – or at least slapping a couple of band-aids on it.
Exemptions for IFP disclosure could act as a testing ground for broader reforms. At present fund managers are left with the not insignificant burden of meeting the FMA’s expectations, as set out in the IFP guidance from 2020, or face the regulator’s wrath as spelled out in the IFP review of managed fund documentation.
Aside from developing an exemption, it would also be useful for the FMA to expand its view on fund descriptors. The existing naming conventions guidance needs to cover when funds can be described as ‘ethical’, ‘responsible’, ‘social’, ‘green’ or the like. Clear and consistently applied names would at least assist investors to make some comparisons. Clear parameters around the naming of funds would also help determine when a manager could rely on an IFP disclosure exemption.
We see merit in the FMA leading workshops and consultation with industry to develop guidance and exemptions (capable of being updated as change occurs) on fund names and IFP disclosure.
The price on the menu has just gone up, but we’re not sure the meal will taste any better as a consequence. One thing is clear, it’s not just fund managers that have a bit of work to do in this space!
