Legal briefing | 03 May 2024 |

Travers Smith's Sustainability Insights: The UK's anti-greenwashing rule

Listen now or read the full briefing below

A regular briefing for the alternative asset management industry.

Greenwashing is a hot topic. If sustainability reports were once the exclusive domain of marketing and investor relations teams, it is now clear that legal and compliance need to be all over them as well. High profile enforcement action in Europe and the US has made clear that regulators regard greenwashing as a priority – and they are doubling down.

Later this month, the UK will reinforce its commitment to clampdown on the practice by introducing a brand new, stand-alone "anti-greenwashing rule". The rule is part of the UK's package of reforms known as the Sustainability Disclosure Requirements, or SDR – the British version of the EU's SFDR – and it will be the first part of that package to come into effect. (Our detailed analysis of the guidance is here.)

The UK's anti-greenwashing rule is clearly designed to bolster the UK regulator's powers to take action against firms whose sustainability claims are overblown – but, in fact, it is mostly a pre-emptive strike, designed to help firms to do the right thing before the FCA comes knocking.

Seen in that light, the UK's approach is welcome. The rule itself – effective from 31 May, and applicable to all UK-regulated firms – is uncontroversial. As well as making explicit that all sustainability claims (made to a UK person) must comply with the existing "fair, clear and not misleading" rule, it also says that any reference to the sustainability characteristics of a product or service must be "consistent with the sustainability characteristics of the product or service". It's hard to argue with that.

But, importantly, the FCA has also issued detailed guidance, designed to help firms in their application of the rule. This guidance was issued in draft form last year, and finalised last month, taking on board comments made by the market during the consultation period.

The FCA expects regulated firms to have an evidential basis for any claims relating to environmental and/or social characteristics in their communications to UK clients, and to be able to substantiate such claims on an ongoing basis. Importantly, the rule applies to periodic ESG reports, in-person communications, teasers and marketing decks, as well as to more formal marketing documents like the PPM and SFDR template disclosures. Firms will need proper procedures in place to check any claims about their ESG credentials – especially those that relate to specific products, but more generally if firm-wide claims could give a misleading impression about the sustainability characteristics of a particular fund.

        
    
"The UK's anti-greenwashing rule is mostly a pre-emptive strike, designed to help firms to do the right thing before the FCA comes knocking."

In developing procedures, firms will need to be sure they can prove that any sustainability-related claim about a fund is factually correct and not exaggerated. In other words, it is not enough that the firm believes the claim to be true, it must be capable of being substantiated. Any claims must also be clear and easy for the audience to understand, not omit any important information, and only make fair and meaningful comparisons with other products. Images and icons can also be in scope. Procedures will also need to ensure that claims remain compliant with the guidance for as long as they continue to be made, not just tested at the outset.

As with most UK regulatory interventions since Brexit, there is a clear and welcome distinction in the FCA guidance between firms dealing with retail clients and those – like many in the alternatives space – with professional-only investors. Although professional-only firms are covered by the rule and should take it seriously, the regulator accepts that retail clients are different, and communications with them need to be calibrated accordingly. Firms with retailisation platforms, and those subject to the UK's "consumer duty", will need to take extra care to ensure that sustainability communications are complete and easy to understand. That will be the case even if the funds are managed out of Luxembourg if there is any UK firm in the distribution chain.

Particularly helpful are the examples of good and poor practice that are included in the guidance, and these have been adjusted and expanded in response to market feedback – including feedback from the BVCA. Examples of poor practice include claims that all investments are reviewed for their sustainability characteristics when, in reality, clear processes do not exist to ensure that every investment does undergo such an assessment; and prominent statements that a fund is "fossil-fuel free" when the small print reveals that there are, in fact, companies in the portfolio which earn a small proportion of their revenues from fossil fuel.

The UK's approach to sustainability disclosures for financial firms has so far been quite different to the EU's. The UK regulator has taken far longer to finalise its rules – many will say, too long – but the result is more considered. The FCA has learned from the EU's missteps and responded to market needs. Although the anti-greenwashing rule is the first part of the package to become effective, hundreds of funds are expected to adopt one of the four available labels later this year – although these will almost exclusively be public funds aimed at the retail market.

Whether the labels and other aspects of the UK disclosure rules will have much impact on private funds remains to be seen. Although the planned extension of SDR to portfolio managers and overseas funds will increase their coverage among alternative asset managers, the impact will remain limited. But the anti-greenwashing rule will apply to many, and – with 31 May fast approaching – now would be a good time for all UK firms to review how they are guarding against greenwashing.