Regulatory enforcement mini-series part 5: What difference will the FCA's anti-greenwashing rules make?

Nathan:

Hello and welcome to the Ashurst Regulatory Enforcement Podcast. I'm Nathan Willmott and I'm joined here in the Fruit & Wool Exchange in London by two fellow specialists in FCA and PRA regulation. My colleagues, Lorraine Johnson and Anna Varga. Thanks very much Lorraine and Anna for joining me today.

Now, together we've got many years of grappling with regulators on a wide range of enforcement and supervisory matters, representing all types of financial services firms as well as their senior management. And our mission for this podcast series is to share with you the new approaches and strategies that we are seeing in financial regulation to highlight any areas of concern about how the regulators are carrying out their role and to suggest what they should be doing differently to ensure that they act fairly and effectively. And our topic for today is the FCA's new greenwashing rules and guidance and to explore how they might work in practice and what the real enforcement risk for firms are. So Lorraine, maybe we could kick off, perhaps you could summarise the main changes introduced by the FCA's new greenwashing rules.

Lorraine:

Sure. Thanks Nathan. So actually the new greenwashing rule or anti-greenwashing rule as it should be, is quite straightforward. So it's contained in a handbook, the ESG Handbook, a relatively new part of the FCA handbook. It's contained at 4.3.1. And what it says is this, and I'm going to read it out and you'll see why in a minute. "A firm must ensure that any reference to the sustainability characteristics of a product or service is consistent with the sustainability characteristics of the product or service. And is fair, clear, and not misleading." And I've read it out because actually sometimes I stumble because it's quite circular in nature. It doesn't really add anything to the FCA rule book. And arguably we've already got the fair, clear and not misleading rule in terms of financial communication and financial promotions. So there is a question, why have they added this? What does it add to the FCA's armoury?

And I think the point here is whether you agree with it or not, it does focus the mind. And it's worth remembering that when the rule was first proposed, it was going to enter into force immediately on publication of the policy statement that followed the consultation. Now, what industry and the financial services sector said was, "Whoa, whoa, wait. Actually we need some time to integrate this into our systems, to operationalize this. This isn't just something that will be business as usual for us." And the FCA listened to that and they actually then delayed the implementation of this rule to the 31st of May, 2024. So it is now in force, it's now part of that rule book, the FCA will be looking at how firms comply with it.

Nathan:

Fantastic, thank you. And Anna, how do you think it would work in practice? What difference would it really make to regulated firms?

Anna:

I mean, arguably these are things that firms should already be doing.

Nathan:

Yeah.

Anna:

So there's that, but now it should be at the forefront of their mind. So it should now be built into how firms think about communicating. And it shouldn't simply crop up when there's an issue. It should be business as usual now. And every marketing team, financial promotions approver, all of those should now have it in their playbook as a day-to-day.

Nathan:

Absolutely. And so does the guidance in this new chapter, does it really help firms in fleshing out what's required under the clear, fair and not misleading rule?

Lorraine:

Yeah, so great question. So to accompany the rule within the FCA handbook, we've also got finalised guidance. So FG24/3. Now again, that's gone through an iteration. It was consulted on, there's been a couple of tweaks, but not many since it was first published. It does help. It does give areas of where the FCA will focus on, particularly where there are retail products. One of the questions from many of our clients was what happens in relation to our TCFD reporting? So where we are reporting on us as a corporate entity, would that be in scope?

And I think the guidance is helpful insofar as actually no, there is a perimeter around about where this rule will apply. It will apply to products and services. Not necessarily unregulated products and services, but where you're within that existing perimeter, it will apply. And it also highlights some of the issues. So it talks about things like where statements are juxtaposed against imagery, for example, that choice of imagery where there's insinuation as to different claims that are being made. So I do think it is helpful to give some of that background, but there are still questions to be asked.

Nathan:

Yeah.

Anna:

I suppose it somewhat illustrates the FCA's expectations or at least as they view their expectations at this point in time. Now obviously that's all still subject to developing and it has to move with the market, but I guess it's really kind of giving us an insight into the FCA's mind on this topic.

Nathan:

Yeah. And does it work as a sort of safe harbour that there are steps that if you follow in the guidance, you are comfortable that you'll be safe? Or is it more illustrative examples of steps that you could be taking?

Lorraine:

Yeah, I think it's more the latter to be honest. I think what the guidance does is show where your focus should be. So we know that green products, green services from financial services firms, there's a real appetite in the market for them. From consumer behaviour for example, that is a well-known thing. What the guidance does is say, "Look, you can service that, you can promote these products, but you can't over-promote actually what that sustainability impact is. You can't say this is the greenest insurance product out there in the market if actually you've got no facts behind that. You can't say this is the greenest mortgage product if actually there's no data that sits behind that that's not been subject to scrutiny." You've got no metrics that you're assessing against.

And I think what the guidance helps with is to show exactly that product governance framework that you need in order to be making these claims. So as Anna said, yes to your marketing teams, yes to your comms teams, but also that product team and that new business approval process that you would ordinarily go through, how is that now scrutinising sustainability claims in relation to these in scope products and services?

Nathan:

Yeah, so do you think it will make a real difference to how firms are approaching these communications and making sure that they're communicating in an appropriate way?

Lorraine:

So yes, I think it will because I think you will need people. I think there are a couple of things. I think there's a governance aspect, actually, where in the governance framework have we included scrutiny of these claims that are being made? Who is scrutinising that? Do those people have the right skillset? Are they sustainability professionals? We know there's a lack of sustainability professionals and expertise in the market. It's a great area to get into at the moment if you've got the background and experience. And again, how is it being understood? And I think one of the big changes in the market is Consumer Duty. So looking at this from a consumer understanding perspective, how are you testing that? Because ESG and sustainability means a lot of different things to a lot of different people.

Anna:

Yeah, I think actually it's also worth pointing out that this is very much product and services focused. What it doesn't do, what it doesn't cover is what the firm says about itself. For that you have to look elsewhere. For that you have to look, say to the Competition Markets Authority, the Advertising Standards Authority, principle six and seven of the FCA's handbook. And as Lorraine rightly points out, Consumer Duty. So far as the firm itself is concerned, there's already a wealth of regulation, guidance and all of that out there that has been enforced for a long, long time. So this is I guess the next bit now.

Nathan:

And so presumably the fact that the FCA has gone down this route shows that it's an area that they will be focusing on and therefore that they will probably want to be taking enforcement cases against firms who are not taking the right steps. So what do you see as the risks for firms in this area? Do you see that as being a real risk for firms that enforcement actions will be coming down the line?

Anna:

So I think the greenwashing and climate related litigation is a serious risk, and it is something that firms should be taking seriously and giving it proper thought. That's regardless of whether the FCA takes an interest in it or not. We've seen enough examples out there to date where climate litigation is really taking hold and that will continue to develop.

Nathan:

So you are thinking they are private law claims as being a significant risk.

Anna:

Private law claims, yeah. Yes. And I think if you look back in history, actually a lot of that type of litigation can then lead on to regulatory interest. And I think that's probably, if I had to look into my Magic 8 Ball, that's probably where it's going to go, whereby the interest in the general public will force the regulator to look at this and take some form of enforcement action. Otherwise, I think we might be some time off before we see the FCA do this of its own volition, partly because there's a transitional piece in terms of firms implementing this and this becoming part of their ethos and culture.

And secondly, ultimately the FCA has a limited amount of resources and it needs to think strategically about how and where it deploys it. Now anti-greenwashing and somehow demonstrating greenwashing evidentially is not going to be an easy task for the FCA. So will they do it on a market basis or will they go after a singular firm? Will, for example, the mortgage industry and where that interacts with Consumer Duty, will that be their point of interest? Now, I think Consumer Duty is where it's most likely to arise, whereby the FCA will take its Consumer Duty related regulatory obligations and apply it to greenwashing. So where there's that confluence between those two areas.

Nathan:

So you see that as the sort of low-hanging fruit. If the FCA enforcement division says we want to get out, I mean they've talked about the fact that they want to pick cases that go to their real priorities. This must be one of those priorities. So they will be thinking about, well, where is the low-hanging fruit if we want to bring a case like that? So you think that interaction between the Consumer Duty and the obligations under this ESG chapter.

Lorraine:

And I think that's right. I think there are a couple of things coming down the line. Interestingly, separate to the greenwashing rule, it's really important to understand that from the 31st of July, 2024, the UK will have a new sustainability label regime. So that's for retail funds being sold to retail investors. UK fund managers will be able to use sustainability labels on the permission of the FCA if they make certain disclosures and if they meet certain criteria. Those sustainability labels that are being used for funds and sold to retail customers will come within the Consumer Duty scope.

Similarly, we've got a separate consultation around about the extension of those labels to portfolio management. So where you've got wealth managers providing discretionary portfolio services to retail investors. And so we're seeing that sort of confluence of Consumer Duty, sustainability labels, anti-greenwashing. And while I think it will be difficult for the FCA to take a standalone piece of action, enforcement action under the anti-greenwashing rule, if you put all three of those together and you can see a misselling or a misrepresentation or a lack of consumer understanding as to sustainability characteristics of a product or service, I think that's where the real risk lies, that actually there is potential loss. Some of these products may not perform as well financially as non-sustainable products.

And I think that might be where the FCA wants to focus. Have you made that clear that there are now two objectives to your portfolio, not just financial objective, but also the impact on environmental or on climate, for example? And as a result, can you see that bearing out and how the performance of your assets or your investment has done basically?

Nathan:

Yeah. So it sounds like just stepping back that you think actually that the new obligation, the new fundamental rule there is not really anything new, that it duplicates preexisting obligations, that there's guidance that helps firms know the sort of steps that they should be taking. But if you were writing the rules, what else would you put in there that would really hone in on what firms should be doing that they might not currently be doing?

Lorraine:

So I think it's interesting, and I am not advocating for this, Nathan.

Nathan:

Of course. Of course.

Lorraine:

Because that is not what I would do. But I do think it's interesting that the anti-greenwashing rule has been scoped to be very specific to products and services because as Anna mentioned, the real feeling is that sometimes firms and companies put themselves out as the green bank or the most climate focused bank or the greenest investment firm at an entity level. And I think that's really interesting that the anti-greenwashing rule will not apply to those statements because arguably that brand, that reputation might be stronger than what a product or service that's being marketed as sustainable, the impact that that will have. So I am not advocating for an extension of this role Nathan.

Nathan:

Yeah.

Lorraine:

But I am definitely mindful that that was an active decision that was made by the FCA when it implemented this rule. So to keep it slightly smaller in terms of the scope.

Anna:

I don't know, Lorraine, it sounds to me like you're advocating for it .

Lorraine:

I am not advocating. I'm 100% not advocating.

Anna:

I've written it down. Lorraine advocates it.

Nathan:

Anna, any changes that you would make if you were the draughtsman?

Anna:

So it's interesting because when this got put out as a proposal, maybe I was being a bit of a Debbie Downer and I didn't quite understand what it was trying to achieve because there's already so much out there. I mean, it is a replica of Principle 7 firstly. The FCA has said that their anti-greenwashing rule is absolutely in line with the Consumer Duty. It's already covered under the Consumer Duty and there's lots of other stuff out there that already speaks to this particular point really, although it's more the kind of an umbrella format.

So I don't really necessarily see the value in the anti-greenwashing rule as a standalone doing anything new or anything that shouldn't already be done. Now that's not to speak about that which is coming into force later on down the lines later this year. I don't remember the dates exactly, but anyway this year. So I do wonder actually, what is this going to do? And is the FCA going to use it as a way of bringing some form of enforcement action later on down the line as a way of effectively lauding, "Look what we've done in the market?" So I guess a roundabout way of saying what I would change about it, I'm not sure it was all that necessary.

Lorraine:

I may or may not have in the past described the introduction of this rule as virtue-signalling from the FCA, which is slightly strong, but I completely agree with Anna in terms of actually what does it add that they didn't have before, apart from profile and focus and message to the market?

Anna:

And who knows how long it will be before there's actually enforcement action on this very topic. So unless you put your words where your money is, what's it doing?

Lorraine:

Well, I think from an industry's perspective, and it goes back to Anna's previous point around about where do the risks lie? Well, we might be sitting here saying, "actually the risk of enforcement action may be lower than in other areas." The risk is not nothing. It's not zero. You have a number of other climate related litigation risk, for example. You've got supervisory risk as well. I think that we might see supervisory or supervision teams within the FCA asking questions, seeking information requests around about what have you done to adhere to this rule? What changes have you made? Because that is the expectation. The expectation is that you have looked at this rule, you have gap-analysed, and you have made changes to integrate it into your systems and controls.

Nathan:

Yeah. And are you seeing interest in this at Board level?

Lorraine:

Yes, absolutely.

Anna:

Yeah.

Lorraine:

So again, slightly in the round, where are the potential risks lying in terms of sustainability, product services and claims? But yes, absolutely. Directors want to know what their responsibilities are, what the firm's responsibilities are and where those risks might lie.

Anna:

Yeah, although I think that interest is not just being driven by the regulatory interest, but actually it's activism, it's shareholders being far more interested in terms of climate litigation. So in a lot of ways the FCA is somewhat late to the table on this front because Boards have been interested in this topic for some time now, and they do, and are increasingly so taking it seriously, I would say, I would argue. I don't know how Lorraine feels about that.

Lorraine:

I was pausing there because around about the FCA being late to the party, I think that was an active decision. And the reason that I say that is there were a couple of issues at play. So number one, you've got the political agenda in terms of who is driving this within government? And that has been a bumpy and sometimes u-turned road. And you've also got the slightly Brexit issue. Europe went very fast on this issue with introduction of disclosure requirements for sustainability products under what's known as SFDR, the Sustainable Finance Disclosure Regulation plus the introduction of the EU taxonomy.

They went out back in 2021. And that hasn't always been a success, particularly because the regulators have said that there's going to be wholesale reform as it looks like. And the market felt that the compliance burden associated with these regulations that were intended to reorientate that capital towards investments that had a sustainable impact, a real-world impact, hadn't always achieved that objective. Now, what the UK regulator has done, it has taken its time, it has been considered in its measures. And I think notwithstanding what we've said about the efficacy or the potential impact of the anti-greenwashing rule, there is a big focus here in the UK about how we can use, how we can support consumer behaviour, how we can support wholesale finance in moving capital towards that sustainable investment chain. So I think in defence of the FCA actually, I think that was a well-received or well-regarded course of action.

Nathan:

Yeah. And so you've identified that there's some enforcement risk, albeit perhaps a slight difference of view as to quite how serious that risk might be. But what would be the key messages in terms of the steps firms need to make sure that they're taking in order to keep that enforcement risk as low as possible?

Anna:

I'd actually start with a negative, i.e. make clear where your limitations lie in terms of the data and the information sources. Because I think if you are up front and disclaim that this is either what you currently understand to be the position or it has certain limitations, that is a really good mitigator in terms of possible risk crystallising in that space. So that would be my one big thing that I would say think about that.

Nathan:

Yeah. Lorraine?

Lorraine:

Yeah, so I think there's a couple of things. What I wouldn't want firms to do is to stop thinking of themselves as good corporate citizens. So again, climate change. The climate crisis exists. We are on a trajectory. We know that at government level, there's a real focus on how we as a society transition towards a net-zero carbon economy and how everyone within that society and within that economy supports that transition. So where firms are setting their own strategy, where they have their own ambitions, where they have their own views on how to support that transition, that shouldn't stop.

However, I think the question is then how do we implement that through our business? How do we implement that correctly in the right way so that we are not misleading our customers, where we're not misleading our clients, where we are in fact making a change because we have changed our products or we have changed our services in such a way that we can see that effect? And that is where Anna's point around about data, around about metrics, around about clarity is absolutely key. So don't stop doing things just because there's a risk there, but actually think about how you're going to make those changes effectively with evidence.

Anna:

But I think the only point I would make in response to that, and I do agree with everything that you've said, but I think firms do have to be conscious and aware where their ambitions are mismatched with the reality. And if those ambitions are driven at reputational improvements and they are therefore embellishing what is in fact happening on the ground, that in and of itself is a key risk area. And firms should be cautious about being too complimentary of themselves and what they are doing if in fact it mismatches what's happening.

Lorraine:

I think there's a really interesting point there as well, because what we're going to see is the introduction of transition plans that are going to become mandatory for a number of different firms within the financial ecosystem. It's happening within Europe because of the capital requirements directive. If we see a change of government to Labour, we know that that will be one of the areas that they will implement as a priority. Transition plans require you to set out your commitment and also the steps that you're going to achieve, that de-carbonization journey of you and potentially your clients and your suppliers. Now, again, I don't think that's necessarily caught within the anti-greenwashing rule. It's an entity level, but it will be subject to scrutiny and it will create an additional risk because where do you set that commitment at the right level that it's achievable, but still stretching? Because a KPI that you've already achieved is no longer a KPI, it's just a tick on the to-do list. So I think that's an area actually where there'll be real focus for firms on what risk does that create and how do we do the right thing?

Nathan:

Yeah. And then just to finish off, I'd like each of your views on where firms are at at the moment in terms of if you could give them a mark out of 10 where 10 is perfect and 0 is dreadful, where do you see the market at the moment in terms of current standards on their communications on sustainability?

Lorraine:

I think the clients that I advise are up at the 9 or the 10s.

Nathan:

Well, of course.

Anna:

Of course.

Lorraine:

Of course. Look, it's difficult. I think that's such a broad question. I would hope that there are very few actors in the UK market that are actively trying to mislead their customers or their clients. I don't think that bad faith activity is as prevalent as some may think. Actually, I think people are trying to do the right thing here, are trying to kind of help make change happen. But the big point for me is show your workings. How are you justifying that? What's your sustainability finance framework for example? Do you have one? Is it robust enough? Is everyone understanding what it means? All of those questions I think are the challenge for the regulated sector.

Anna:

Yeah, I don't know if I'll be able to mark, give a mark on that one. I suppose because somewhat rehashing what Lorraine has said, corporations are quite unique beasts. They're just as individual, one might argue as humans are. So there's a huge breadth of good and bad behaviour or things that might be labelled as good and bad behaviour. I think what I would say is that every firm is considering the topic, and so that probably puts it above the 5 mark. Whatever the motivation underlying that is debatable, whether it's reputational or whether it's corporate responsibility, I don't know. And there's probably both of those, but I think probably around the 5 upwards.

Nathan:

Yeah, so it sounds like firms are doing well, but a bit like my son with his maths A level, they need to show their workings and it's no good just having the outcome.well.

Nathan:

You've got to show how you got there as well.

Lorraine:

You're going to get marks for those, aren't you?

Nathan:

Well, I'm afraid that's all we have time for this edition of the Ashurst Regulatory Enforcement Podcast. Thanks so much Lorraine and Anna for sharing your experiences and insights with us today, and a big thank you to you for listening to the podcast. We hope you found it interesting and useful. As ever, if there's anything we've discussed that you have your own views on, then please do drop us an email or give us a call. We would very much like to hear from you. Thank you.