SUSTAINABILITY CHAMPIONS INTERVIEW SERIES: BREAKING THE VICIOUS CYCLE OF GREENWASHING, BUILDING MUCH-NEEDED TRUST IN ESG INVESTMENTS

My next guest in the Sustainability Champions interview series needs no introduction.

Sacha Sadan, the UK Financial Conduct Authority’s (FCA) first-ever Director for Environment, Social, Governance (ESG), facilitates the embedding of ESG across a wide spectrum of regulatory activities, and promotes the UK as a global financial leader in ESG.

Earlier this year, the FCA also welcomed its new Chair, Ashley Alder, whom Britain in Hong Kong magazine readers should be all too familiar with, successfully led the Hong Kong Securities and Futures Commission (SFC) for the past decade.

Hong Kong itself is taking steps to promote itself as a global financial leader in ESG, with Alder’s successor at the SFC, Julia Leung, who is a vice chair of IOSCO sustainability task force with Sacha. SFC recently announced (14 April, 2023) that “Hong Kong’s early adoption of climate-related corporate reporting requirements will consolidate its position as a leading green and sustainable finance hub within the region and globally,” in response to Hong Kong Exchanges and Clearing’s (HKEX) proposal to introduce more rigorous climate and sustainability risks and opportunities disclosures by listed firms, including but not limited to disclosure of:

1. Risks and opportunities identification: Climaterelated risks (both physical risk and transition risk[1]) and opportunities and their impact on the business model, operations, and strategy,

2. Scenario analysis: Climate resilience of the business model, operations, and strategy to climate change through climate-related scenario analysis,

3. Transition planning: Climate change mitigation and adaptation efforts, and climate-related targets set,

4. Financial impact analysis: Quantitative disclosures of the current (material) financial impact, and a qualitative description of the future financial impact from climate-related risks and opportunities on a listed company’s balance sheet, profitability, and cashflows.

When? The new rules will apply to ESG reports to be published in 2025, for financial years commencing on or after 1 January 2024. All in all, requiring significant time and effort from listed companies and companies pursuing a listing, who may not necessarily have the required people (expertise), processes (frameworks and governance), and technology (technology and data) in-house

Adopting clear sustainable investment product labels and technology to fight greenwashing

Greenwashing is making exaggerated, misleading or unsubstantiated sustainability-related claims that do not stand up to closer scrutiny. This can be perceived as a form of mis-selling, which may be deliberate or inadvertent.

Question 1: Sacha, what is the FCA as a responsible regulator doing to build trust in ESG investments and protect UK investors from greenwashing?

While it is excellent that financial institutions and listed companies are starting to think about ESG investment opportunities, it can be confusing for investors when terms like “ESG”, “green”, or “sustainable” are being used interchangeably. The market is currently difficult for consumers to navigate, and they do not know what or who to trust, they are asking for guardrails. That needs to change.

We need to tackle greenwashing and rebuild consumers’ trust. That is why consumers are at the heart of our Sustainability Disclosure Requirements (SDR) and investment labels proposals. Our proposals set out a package of measures designed to improve transparency, build confidence, and help consumers make more informed decisions These include:

1. A general anti-greenwashing rule applying to all regulated firms, to clarify that sustainability-related claims must be clear, fair and not misleading and must be consistent with the sustainability profile of a product or service.

2. Naming and marketing rules proposing requirements on the use of sustainability-related terms in the naming and marketing of products that do not use a sustainable investment label.

3. Sustainable investment labels to distinguish between three different types of sustainable product according to how they aim to invest:

a. Sustainable focus: investing in assets already regarded as environmentally and/ or socially sustainable.

b. Sustainable improvers: investing to improve the environmental and/ or social sustainability of assets over time.

c. Sustainable impact: investing to achieve positive, measurable, real-world impact.

Question 2: The FCA as an innovative regulator introduced the concept of the regulatory sandbox. How does the FCA leverage innovation and technology to fight greenwashing?

We’ve set out an ambition to be a more innovative and adaptive regulator We are committed to supporting creative platforms to bring people together to help address sustainable finance issues collectively And we have a unique convening power as a regulator to shape the direction of innovation for market-wide issues such as greenwashing.

A very topical example is the Greenwashing TechSprint that the FCA is leading as part of the Global Financial Innovation Network (GFIN), and which is being hosted on the FCA’s Digital Sandbox This is our first international TechSprint, following on from our Sustainability Techsprint in 2021 It will bring together 13 international regulators - with representation from Dubai, Malta and Singaporealongside firms and innovators. They will have the objective of developing a tool or solution that could help more effectively tackle the risks of greenwashing in financial services The TechSprint launched at the start of June and runs for 3 months, ending with a showcase day in September 2023 I’m deeply involved and excited to see the results.

Build confidence in ESG ratings providers through regulatory oversight

With projections that USD 33.9 trillion of global assets under management (AuM) will consider ESG factors within three years, financial services firms are becoming increasingly reliant on third party ESG data and ratings services.

Question 3: How do we support greater transparency and trust in the market for ESG data and ratings services?

ESG data and ratings providers are an important part of the sustainable investment world with significant influence For some time, we have said that there is a clear rationale for a globally consistent regulatory approach for certain ESG data and ratings providers and we have welcomed the launch of the Government’s consultation in March on whether and how to bring ESG ratings providers into the FCA’s regulatory perimeter Should the Government decide to give us the power to regulate, it would take time to get this in place, so we continue to push for improved standards in the interim Last November, we announced the formation of an industry group to develop a voluntary Code of Conduct for ESG data and ratings providers. We expect the Code to raise standards in advance of any potential regulation and the Code could also potentially continue to apply for providers that fall outside the scope of potential future regulation.

It would be a missed opportunity to create a standalone UK gold standard, and not a globally aligned standard. As such, the Code will seek to be internationally consistent, by taking into account recommendations from the International Organization of Securities Commission (IOSCO) which focus broadly on 1) transparency, 2) good governance, 3) sound management of conflicts of interest, and 4) robust systems and controls The Code will also consider regulatory developments in other jurisdictions such as Japan, where the Financial Services Agency (FSA) has already finalised their excellent Code of Conduct.

In terms of users of third-party ESG data and ratings services, we expect firms to carry out appropriate due diligence when using this information and data This expectation is included in our letter sent to the chairs of authorised fund managers in July 2021, which sets out our guiding principles to help ensure ESG-related claims are clear and not misleading.

Chief Sustainability Officers’ role and Diversity, Equity & Inclusion

The FCA’s disclosure requirements for listed companies to disclose against targets set on gender and ethnicity on a “comply or explain” basis.

- A Board comprising at least 40% women

- A woman holding at least one of the senior Board positions (Chair, CEO, CFO, senior independent director),

- A Board member from a minority background.

Question 4: An often-heard argument against mandating Board diversity is the lack of diverse talent pool to fill Board positions. Does that argument hold true to you?

13 years ago, in my last role as Director of investment stewardship at Legal & General, we were one of the first asset managers in the world to vote against allmale Boards Yes, there was pushback at the time based on arguments such as a lack of a diverse talent pool But reality has invalidated that argument Looking at the FTSE 100, over 40% of positions on Boards are now held by women, compared with 13% 10 years ago. And it was great to see that the wider FTSE 350 reached its 40% target for women on Boards 3 years ahead of target earlier this year – something that is definitely worthy of celebration Our multi firm review called out the importance of developing a talent pipeline Firms need to realise the importance of healthy, inclusive cultures in creating and retaining their own diverse talent pool. But as an industry, we are still not where we need to be in ensuring financial services is both diverse and inclusive There are no Black Chairs, CEOs or CFOs in FTSE 100 companies.

It is worth noting that whilst representation of women on Boards has improved, they are largely in nonexecutive roles rather than executive roles, so we need to continue the momentum. We are trying to address this with the requirement to explain if no women hold at least one senior Board position, for example.

Question 5: How can Boards ensure they have sufficient ESG expertise?

ESG needs to be embedded across the whole organization A firm’s governance, purpose and culture are central to how it embeds environmental and social considerations into its decisions This is normal business in the 21st century Firms need to have the right people with the right experiences to provide appropriate challenge and advice. That doesn’t mean there needs to be an ESG specialist on every Board, you can get creative. We have set up an ESG Advisory Committee to the FCA Board, which provides guidance on emerging issues and helps us think about how we can develop our ESG strategy in keeping with our regulatory principles.

Sacha, thanks for taking time for the interview and I look forward to catching up with you when you are in Hong Kong next.

[1] Transition risks according to Prof. Lee relate to financial and non-financial risks to a company’s assets (physical and financial) and liabilities, business model and strategy as a result of changes in consumer and investor preferences, regulatory policy, societal expectations, and technological advancements in the transition towards a low carbon economy The degree of transition risk exposure to a company depends on the nature, pace, and timing of the changes