The United Kingdom’s Proposed Approach to the Taxonomy Problem

As discussed in previous posts, the absence of an agreed taxonomy has and will continue to contribute to “greenwashing.” One obvious solution would be to develop an agreed taxonomy by defining terms such as “ESG,” “sustainable”, “green,” and “net-zero,” amongst many other sustainability related terms. But as the Australian Securities and Investments Commission (ASIC) has said, these terms mean different things to different people and in different contexts. So, this might not be such an easy solution.

This week, the UK regulator, the Financial Conduct Authority (the FCA), offered a different solution with the release for comment of the Consultation Paper (CP22/20) (“Sustainability Disclosure Requirements (SDR) and investment labels” dated October 2022). The Consultation Paper is a comprehensive document, which is worth reading for those seeking further detail to the summary below.

The FCA proposes three sustainable investment labels (i.e., sustainable focus; sustainable improvers; and sustainable impact).

The proposed labels are “mutually exclusive,” without “hierarchy,” and area designed to deliver a different profile of assets and consumer preferences. The labels are defined by a set of qualifying criteria, which includes five over-arching principles (i.e., sustainability objective; investment policy and strategy; key performance indicators; resources and governance; and stewardship), amongst other considerations.

Focusing on aspects of the qualifying criteria, the proposed labels are defined as follows:

  • sustainable focus: a financial product with an investment policy and strategy aimed at achieving a sustainability objective consisting of at least 70% of assets that meet a credible standard for environmental or social sustainability or aligns with a credible standard for environmental or social sustainability theme;
  • sustainable improvers: a financial product with an investment policy and strategy aimed at achieving a sustainability objective consisting of investment in assets that have the potential to become more environmentally and/or socially sustainable over time, including in response to active investor stewardship;
  • sustainable impact: a financial product with an investment policy and strategy aimed at achieving a sustainability objective consisting of achieving a pre-defined, positive, measurable real-world environmental and/or social outcome. This will require the firm specifying a “theory of change” which explains how its investment process aims to contribute to addressing environmental and/or social problems.

Could this be an approach that ASIC might adopt?

A couple of other interesting points raised in the Consultation Paper is the proposed new “anti-greenwashing” rule and the treatment of the “G” in “ESG.”

There are two aspects to the “anti-greenwashing” rule. The first is to introduce a specific rule that the naming and marketing of sustainable financial products and services is clear, fair, and not misleading. This will provide the FCA an explicit rule on which to challenge firms that are potentially greenwashing. Whether ASIC would adopt this measure is unclear given the myriad of provisions available in the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth).

The second aspect of the “anti-greenwashing” rule is interesting. It will prohibit the use of sustainability related terms such as “ESG,” “green” etc. in the “naming and marketing” of financial products to retail investors, where the financial products do not fall within one of the three proposed labels.

The FCA also considers “Governance” in the “ESG” concept to be an “enabler” of the “Environmental” and “Social” outcomes, rather than an end in itself. Therefore, in defining the sustainability objective of the three proposed labels (i.e., one of the qualifying criteria), that objective is limited to the environmental and social objectives of the financial product.

 

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