FMA ratchets up its campaign for better ESG disclosure from fund managers

This article originally featured on Good Returns and Jenni McManus. 

The FMA won’t be giving much leeway to fund managers who are promoting and selling ESG products but dragging their feet in bringing their disclosure documents up to scratch.

This follows the release earlier this month of a review and survey of 14 KiwiSaver and other managed funds, benchmarked against ESG investment guidance issued by the regulator in December 2020. This guidance included a framework the FMA expects funds to use to show they can substantiate the ethical credentials of their products.

The report found investors were confused and overwhelmed by the technical jargon in disclosure materials and often gave up their search for ethical investments. Of the 2500 people who responded to the FMA’s survey, 68% said they wanted ethical and responsible investments but only 26% had actually bought into these funds.

Paul Gregory, the FMA’s director of investment management, says disclosure documents must be written more clearly and crisply so prospective investors can understand them and make informed choices.

“The simpler it is, the easier it is to understand and for investors to substantiate,” Gregory says. “It’s up to fund manager to have their own processes. They just need to explain it well and prove it. They just can’t pretend to be impressive and lie about it.”

He says managers need to do a better job on product disclosure and ensuring their websites, marketing and advertising materials all “knit together”. Clear, effective and cohesive communications are the name of the game and as far as the FMA is concerned, it’s all part of the disclosure regime.

In terms of when the FMA might begin to up the ante around supervision and enforcement, Gregory said, “I think the time is from now on. We’re done signalling, basically. We’ve said, ‘this is our view, this is the guidance and this is what we expect’. We’ve shown there’s a lot of work to do on disclosure, we’ve shown in the other research why the investor perspective matters.

“And if you think about what’s coming by way of climate disclosure where it’s compulsory for some managers to report on this stuff, the direction of travel, plus the work we’ve done to date – it all points to doing a better job of this pretty quick.

“We’d expect to get a few complaints and that would be from investors or fund managers dobbing each other in because that’s what they do, so we’ll have plenty to go on, I suspect.”

While the FMA wasn’t specifically looking to uncover mischief with its review, had it found anything it regarded as misleading there were statutory provisions in the Financial Markets Conduct Act to deal with it.

It found no evidence of greenwashing “but what we did find was lots of imprecision, lots of vagueness, lots of things that were too high-level to determine what they meant, let alone what would substantiate them,” Gregory said.

He likes the idea of independent third-party certification so long as the basis for it is clear. He notes some managers have funds certified by RIAA where the criteria can be seen and the process is “reasonably robust”.

“But again, on the transparency and disclosure part, [there is a] need to disclose exactly what that certification looked at. How tough was it? Or was it just a rubber stamp?”

In part, the lack of precision around disclosure comes from the lack of clearly defined standards as to what ‘ethical’ and ‘responsible’ might mean.

Gregory says the regulator is “the last person” who should be defining standards. It’s up to individual managers to determine this and then be very clear about what they mean “so people who care about these things can figure out whether you’re doing the job they want you to do. They need to know what you do, when and how, and where you’ve drawn the line. And how you substantiate it”.

If people are making investment choices based on these claims, “then that better be what’s happening”, he says.

Barry Coates, founder and CEO of Mindful Money, wants the FMA to go further and get involved in standard-setting. Coates says he would like to see compulsory standards drawn up for ethical investing in a similar way to the standards the XRB has produced for listed companies and some fund managers on climate change.

The XRB has been asked to work on standards for ethical investing, but they will not be mandatory. Coates says standards are needed because the FMA’s guidance isn’t clear about exactly what needs to be reported for social and environmental issues.

He thinks it’s important that the RIAA provides product certification but it’s not a substitute for good public information.

“In the same way as you’ll want to know the data from financial returns from the funds you might invest in, we need information on the social and environmental impacts,” Coates says. “Certification is not a displacement for that. It’s useful but we need the proper disclosure and reporting for the public.”

Around the industry, Coates says he is hearing lots of anxiety about the compliance burden. And because managers will need to provide evidence for their ESG claims, there are worries about the volumes of paperwork that will ensue – and that investors will be even more reluctant to read it.

“I think that’s a valid concern which is why we’d like to see some clear reporting standards because once you get them, it becomes comparable across some funds. There is a risk of ending up with mountains of paperwork and no way of comparing funds.”

Law firm Chapman Tripp agrees. “The fundamental problem is the absence of agreed terms and definitions,” it says, “and the temptation this creates to resort to puffery in order to avoid potential legal liability. To its credit, the industry is working actively and collectively to address this through the development of clear taxonomies and certification programs.”

Chapman Tripp has five key messages to fund managers:
• Explain exclusions. Set out why the fund has excluded particular companies and sectors, and how exclusions will be applied in the future;
• Be clear about the relevance and weight of financial and non-financial factors in decision-making and the risks that come from including non-financial factors;
• Set out how you will select investments for your ESG funds;
• Don’t rely in ‘high-level’ and amorphous claims of non-financial benefits and impacts; and
• Explain how you will measure performance and deal with investments that no longer meet the original criteria for selection into ESG funds.