Paul Gregory, Executive Director Response and Enforcement, FMA
Regulators don’t decide ethics. From a regulatory perspective – and pending mandatory climate reporting requirements aside – it is acceptable for managed funds to do very little on environmental, social and governance (ESG) and sustainability provided they don’t pretend (or advertise) otherwise. But investors are different. Increasingly, they are looking for investments aligning with their values, or which at least don’t deliver an ethical shock. So, managed funds marketed as ethical or responsible are more attractive.
Attractive rhetoric, though, isn’t enough. Providers using terms like ethical and responsible to describe their products must ensure there is cohesive substance in how they design such products, how they market and advertise them and, most important, how they manage them.
That’s because while we’re familiar with harm from unexpectedly poor returns, poor risk management and poor value for money over an investment horizon, we can’t – because it is so personal and because persistent demand for such products is relatively new – fathom the harm to investors from finding out their investments have compromised their values for 10, 15, 20 or more years. That they have been contributing to harming people, animals, or the environment over decades.
This is why greenwashing matters. Providing misleading or false claims about social or environmental benefits or impact goes to the heart of fair dealing, and the overall impression provided by marketing materials is critical here.
We know investors choose funds based on marketing and what they think they know about what the fund invests in, and how. That same investor can also be prepared to pay higher fees and/or accept lower returns for a fund they believe better fits their values. If, in reality, the funds’ investments don’t line up with what they believe they are investing in, that is a misleading value proposition.
Acknowledging that risk of harm was why, in 2020, the FMA published guidance saying if a fund is claiming green or sustainable credentials, that claim must come with sufficient detail to articulate and substantiate that story. And the detail must be high-quality, lucid, and easy to find.
Just over a year later, the FMA looked at the take-up by managed funds of the guidance and concluded, after looking at disclosure documents, websites and marketing and advertising, that the managed fund sector had an immature approach to their disclosure. Overall, it was vague, loose, and inconsistent.
We also researched how easy it is for investors wanting to invest according to their values, to make good decisions. We found this was complicated by the reason why most investors look in the first place: not from a cohesive, internal value system but by generalised unease or, very commonly, by finding out something about their current investment which surprises them – an ethical jump scare.
Many then set off to identify a better fit for their values, are quickly faced with extensive jargon and find it hard to meaningfully compare. Some rely on advice from friends and family. Lots take claims on trust. In the end, virtually all end up taking a ‘leap of faith’ that their choice is the right one. And then assume that their investment will continue to be managed consistent with their values, rarely checking back to see what may have changed and, critically, also don’t change product. The decision was hard – much harder than they thought – and they are done. This is why it matters the industry approach to disclosure is immature: it represents the ingredients of a potential, multi-decade ethical shock for many New Zealand investors.
It is also why FMA expects high-quality disclosure to provide insight into – and examples of – how future investment choices will be made, not just the make-up of the fund at a point in time. Like value of all kinds, ethical value depreciates if static. Even if the fund manager cannot anticipate events such as Russia’s actions in the Ukraine, how might their investors expect them to deal with it? What principles will the fund use to select future investments as policy and societal mores change?
Choosing and using financial products is hard. Global research repeatedly shows this. Introducing ethical or responsible or sustainable or impact concepts to it, makes it harder. It must be easier for people to make informed choices, especially if – as it seems from the FMA research – they would prefer not to make another one.
However, even if an investor never looks for the underlying detail and takes claims on trust, you can be assured the FMA will be looking. Since the 2022 review, we have seen a number of managed funds improve their disclosure or attempt to explain – including in-person – how they invest according to ethical or sustainable claims.
The FMA is sharpening its focus in this area and there are broader policy and consumer tailwinds for claims to be articulate, accurate and meaningful. Mandatory climate-reporting standards are here, broader sustainability standards are in the wings. Consumer expectation is growing. Fund managers can add substance to support their claims and labels and disclose accordingly, or stop using the claims and labels. Marketing without underlying substance won’t wash, green or otherwise.
