The main focus of the FMA’s review was on whether and how ESG fund managers disclosed in key documents, such as the product disclosure statement (PDS) and the statement of investment policy and objectives (SIPO), the types of information noted as material in the FMA’s 2020 guidance on disclosure framework for integrated products.
The FMA found deficiencies in the quality and utility of the information provided to investors, as well as the way in which that information had been presented. In particular, the report notes that fund managers have not developed mature approaches to disclosure of the features, risks and benefits of ESG funds.
The review did not assess if there was ‘greenwashing’ in the selected funds, but in the FMA’s view the lack of maturity in ESG disclosures “risks exacerbating investor disengagement and a ‘race to the bottom’, where minimal effort is applied to achieving non-financial objectives and the distinction between ESG funds and ‘vanilla’ managed funds eventually disappears”.
Key areas for improvement
Some of the key findings and recommendations set out in the report include:
- Consolidation of relevant information: Overall, the FMA noted that it would be difficult for investors to decide on which ESG fund to select, because relevant information is scattered across different sources, and information that is provided often doesn’t give a complete picture, or lacks sufficient detail. Accordingly, the FMA is recommending managers improve the level of detail and clarity of information about their ESG approach. This could include consolidating all relevant information into one easy-to-read source, which could be linked or included in the PDS to ensure investors will find it before making an investment decision.
- Better information about what ESG funds exclude and why: ESG managers need to do more to adequately explain the scope of any exclusions and relevant thresholds, and how their exclusion policies apply to incidents and to derivatives. As well as describing ‘foreseeable’ exclusions, managers should seek to reduce ambiguity in their decision making by disclosing how they will apply judgement to unforeseen circumstances that connect with their ESG policies.
- Approaches to positive screening (‘tilts’): Managers using a ‘positive screening’ approach (where an ESG fund ‘tilts’ investment toward activities it regards as contributing to positive non-financial objectives or outcomes) need to do more to explain how the fund will select investments consistent with their approach, including using more specific language, and providing clarity about weightings between financial and non-financial outcomes or between competing non-financial outcomes.
- Better information about risk and return trade-offs: Achieving financial outcomes and non-financial objectives (such as natural, social, and human capital impacts) typically involves trade-offs, so ESG managers need to adequately explain the financial performance implications (positive or negative) of integrating non-financial factors into investment decisions. Managers should explain any risks to the fund achieving its desired non-financial outcomes or objectives, and how it monitors for and manages that risk.
- Better information about the benefits of an ESG fund: A number of the funds reviewed included high level descriptions of the fund’s non-financial benefits or objectives that were so high level or subjective that they provided almost no value.
- Consequences of failing to achieve non-financial outcomes should be clear: An ESG fund should explain what happens when it fails to deliver on its intentions, whether those intentions are implicit or explicit. It is particularly important for a manager of an ESG fund to explain what it will do if it identifies that:
- it has included or incorrectly weighted an investment in breach of the fund’s ESG policies,
- an investment no longer meets the fund’s ESG policies because its ESG policies changed, or
- an investment no longer meets the fund’s ESG policies because the nature of the investment changed.
- Measurement and reporting: The FMA strongly encourages managers of ESG funds to, at a minimum:
- regularly and accessibly disclose their portfolio holdings (largely for accountability),
- clearly and effectively explain how their holdings have delivered on their non-financial objectives or desired outcomes – whether those are negative or positive screening, impact, other objectives, or (most likely) a mix – ideally with reference to objective benchmarks.
- External providers: Managers of ESG funds frequently market their funds with reference to some separate organisation that may provide measurement standards, endorsement and even assurance, relevant to the fund’s ESG characteristics. In such cases, the ESG fund should provide clear and accessible disclosure to avoid potentially misleading or confusing an investor.
Interestingly, the report notes that it might be useful for funds with ESG characteristics to make those features more prominent. Of the 1,029 managed funds on the Disclose Register at 31 March 2021, about 5% could be identified as an ESG fund by name alone and a further 17% could be identified as an ESG fund from their detailed fund descriptions on the Disclose Register. From the FMA’s investor research, those additional 17% may be unknowingly overlooked as many investors do not closely read detailed fund descriptions.
The report also covers some helpful technical aspects on PDSs and SIPOs. In particular, the FMA recommends that for those managers that cannot include all relevant ESG information in their PDS due to the statutory length restrictions then they should separately lodge this information on the Disclose Register as Other Material Information, and include a hyperlink in the PDS directly to this information. The FMA has also confirmed that the SIPO is an appropriate place to describe any policies related to breaches of the fund’s ESG policies that would result in a fund divesting an asset.
We encourage all fund managers who offer sustainability-related products to read this report from the FMA.
If you have any questions about the matters raised in the FMA’s report please get in touch with the contacts listed or your usual Bell Gully adviser.