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New legislation and stakeholder expectations have shaken the market around ESG as greenwashing accusations fears drive change. 

A host of funds have changed strategies, which has caused a variety of different effects on the market, due to new rules and regulations – as well as stakeholder expectations – pushing back against greenwashing. 

The possible reputational issues coming from being in breach of those rules could be an operational headache that may have long-lasting effects.

The pushback has been twofold, with governments publishing anti-greenwashing rules and regulations over the past few months as well as the industry itself growing and developing – and pushing back against dishonest players. 

At the end of May, the UK’s regulator for financial services firms, the Financial Conduct Authority (FCA), introduced its Sustainability Disclosure Requirements (SDR). Anti greenwashing rules are one part of the SDRs. 

In a 2023 announcement on SDR’s introduction, the FCA said that, with an estimated $18.4 trillion of ESG-orientated assets now being managed globally, so potential greenwashing needed to be a key consideration.

“Tackling greenwashing is a priority for us,” said the FCA’s introduction to the guidance. “We want to protect consumers against greenwashing so they can make decisions that are aligned with their sustainability preferences. We also want to create a level playing field for firms in an evolving market, whose products and services genuinely represent a more sustainable choice and who are making genuine claims about their products’ and services’ sustainability characteristics.”

“On a deeper level, the FCA's decision to introduce these rules reflects a growing demand

for ESG-focused funds."

Due to these rules, asset managers will now be prohibited from vague references to ‘sustainability’, ‘ESG’, or related terms in fund marketing. Instead, asset managers will be required to provide “clear” and “complete” information – and select one of four specific fund labels. 

“On a deeper level, the FCA's decision to introduce these rules reflects a growing demand for ESG-focused funds,” said Morningstar on why SDR’s introduction had been so important - and the support for those who wanted it had been so strong. “Increasingly, people want two things: positive returns and a positive impact. The rules and disclosures are intended to increase transparency around investment products – a benefit to end investors.” 

The fear of being caught around ‘greenwashing’ has been noted for some time. Earlier this year, Morningstar also released research that said continued uncertainty around greenwashing and the consequences of possible mis-labelling of funds had driven more investors and fund managers to leave ESG-compliant funds in Q1 2024 in favour of those that were either not compliant or only semi-compliant. 

The analysis showed that, in the first quarter of 2024, flows into Article 8 funds rebounded and netted “€14 billion of new money after three quarters of outflows”, whilst others did not. 

“Article 8 funds are attracting money again after a year of redemptions, but they’re

still trailing the rest of the market."

“Inflows were driven by fixed income and passive strategies,” said Morningstar’s report. “SFDR Article 8 and Article 9 Funds: Q1 2024 in Review.” 

“Article 8 funds are attracting money again after a year of redemptions, but they’re still trailing the rest of the market,” said Hortense Bioy, Global Director of Sustainability Research, Morningstar, and the report’s lead author. “While active ESG managers are licking their wounds, passive ESG investments continue to appeal to more investors.” 

ESMA and ESG tourists 

Similar rules have also been introduced by the European Securities and Markets Authority (ESMA), the EU’s financial markets regulator and supervisor.

At the beginning of June, ESMA published its final report containing guidelines on funds’ names using ESG or sustainability-related terms – which it said it hoped would stamp out issues around perceived greenwashing. The EU’s flagship SFDR rules have also made greenwashing more difficult. 

ESMA’s new guidance set out requirements for fund managers using these terms in fund names. Its desired aim is to reduce greenwashing risks and to enhance investor protection from exaggerated or misleading sustainability claims, it said. 

As well as rules, there has also been backlash from those in the market that have helped pioneer the ESG/sustainable/impact investing area. 

In its report for H2 2023, the London-based impact investor WHEB Group said that “ESG Tourists” were exiting the market amidst a swell in anti-greenwashing regulation. 

The report said there were “thorny issues” of ESG and sustainable impact funds’ outflows, and that the challenging performance environment, and the waning popularity of the sector during 2023 were of key concern and were major issues that the industry needed to look at.

"After decades in the margins, sustainability investing enjoyed its place in the sun through 2018-22 but waned in prominence in 2023."

“’ESG tourists’ – asset managers that stampeded into the sustainability market just a few years ago – are now packing their bags,” said the report. “[This was] as the depth and breadth of anti-greenwashing regulation bites. This ‘market shedding’ of fund providers who do not have the staying power of dedicated impact and sustainable investment houses should provide clarity for financial advisers, fund selectors, and end clients.” 

“After decades in the margins, sustainability investing enjoyed its place in the sun through 2018-22 but waned in prominence in 2023, as interest rates and the rise of artificial intelligence dominated investment narratives,” said George Latham, managing partner at WHEB Asset Management. “This turbo-charged the performance of ‘mega-tech’ businesses like Amazon and Nvidia [that] we do not believe meet key criteria to be considered to provide a positive sustainability impact.” 

Latham added that “naysayers” pointed to recent volatility in environmental and healthcare services – large markets for sustainable and impact funds – as supposed evidence of failings in sustainable investing, rather than the typical behaviour of a market cycle. “Compared to AI, it’s not currently a sexy story to tell that companies are getting on with delivering carbon reductions, diversifying their senior leadership and employee base bit-by-bit, but that progress is occurring nonetheless,” he said. 

He reiterated that the ‘ESG Tourists’ were now leaving. “This, along with the huge swell of anti-greenwashing regulation, is clarifying the investment offer for retail and institutional investors alike,” he said. 

Latham’s words have been backed by actions, with a report earlier this year saying that global investors pulled £8 billion from “woke” ESG funds last year amidst a backlash over greenwashing and the ‘vague’ promises offered. 

The figures, from industry group Calastone, showed that the three-year boom in the funds focused on ESG issues was now “over”. 

Reputational issues 

One aspect of this that directly touches a firm’s operations is the effect of being named as one in trouble with the news rules on greenwashing and, importantly, reputational effects this could cause. 

Several market commentators said that funds that were possibly falling foul of the rules to not take chances as this as could have long-lasting effects. “[Fund managers] will need to be able to demonstrate that they have understood the scope of the requirements and are able to substantiate sustainability-related claims in all their communications relating to financial services and products in the UK,” said Richard Andrews, KPMG’s head of ESG for financial services. “They also need to consider the wider implications of any claims made at firm level and the impacts these could have on the perception of their operations.” 

 

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