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Dear CEO: Beware the sustainable label


March 25, 2020

In this blog we focus on how potential “greenwashing” may play out in the U.K. regulatory environment and what to look out for in your insurance programme design.

My colleague Anthony Rapa recently examined how the U.S. Securities & Exchange Commission (SEC) is turning its attention to environmental, social and governance (ESG) risks for asset managers. Of course, while the political climate varies across jurisdictions, the risk of regulatory attention as to the adequacy of ESG disclosure is far from limited by geography.

It is widely accepted that the U.K. Financial Conduct Authority (FCA) is currently focussing on the asset management industry and recently issued a so-called “Dear CEO” letter, outlining its supervision priorities and matters to which an asset management firm should turn its attention. Dear CEO letters always require careful reading and it would be a mistake to skim through the content of the asset management supervision strategy and assume that ESG is not addressed at all. Greenwashing, defined by the Financial Conduct Authority (“FCA”) as “marketing that portrays an organization’s products activities or policies as producing positive environmental outcomes where this is not the case,” is certainly on the agenda, if not set out in terms.

FCA priorities

In October 2019, the FCA published a Feedback Statement entitled “Climate Change and Green Finance: summary of responses and next steps.” This followed on from its prior discussion paper and sets out the evolving regulatory approach in this area. Among the outcomes, which the FCA has now identified, are that

“Consumers have access to green finance products and services, which meet their needs and preferences, and receive appropriate information and advice to support their investment decision.”

It is noted of course that the (current) absence of common standards and metrics as well as insufficient and poor-quality data pose barriers to effective product design. This in turn may make it difficult for consumers to validate information they receive about products, increasing the risk that products are misleadingly marketed as producing positive environmental outcomes or “greenwashed.” As such the FCA makes a commitment in its Feedback Statement to challenge firms where it sees potential greenwashing and to engage with and consider the proposals of the European Commission’s Sustainable Action Plan. One part of this plan is to create a common language on sustainable activities.

Even before common definitions and standards are developed there are tools in the enforcement and supervisory armory which can be used now. Note that the discussion paper reports that the FCA has already carried out initial diagnostic work on firms’ sustainable offerings to gauge whether there is evidence of potential greenwashing. Early indications from this work are that the “sustainable label” is applied to a very wide range of products. On the face of it, the FCA reports, some of these do not appear to have materially different exposures to products that do not have such a label.

The current rules will suffice

The FCAs policy statement PS19/4 includes guidance that a fund should set out clearly in its Key Information Document (KID) if it pursues environmental, social and other non-financial objectives and how it does so. This should be done in a way which is “clear, fair and not misleading.”

And this basic regulatory requirement as to clarity and fairness is repeated in the Dear CEO letters —

“We expect you to ensure that Funds’ objectives are clear, fair and not misleading ….”

Furthermore, there may well be a correlation with new rules around value assessment. The obligation to conduct value assessments in respect of a firm’s authorized funds was introduced as part of the Asset Management Market Study published in 2017 and is now in effect. There seems to us to be a very close connection between whether a fund is value for money and whether it is meeting its published objectives.

Insurance and risk

From a risk perspective, any regulatory censure for misrepresentations could lead not only to investigations against the firm and its directors (or those of the fund) but also to follow-on litigation from investors. My colleague Anthony Rapa has recently identified a number of key points to check in your insurance program design.

Breadth of cover: 3 points to consider

  • Pollution, environmental, and nuclear exclusions - Often overlooked in the professional liability world, these exclusions could become particularly relevant with respect to ESG investing. Generally, these exclusions preclude coverage for actual or alleged release of pollutants, radiation, flooding, or other tangible or threatened environmental damages. When paired with broad “based upon, arising out of, or related to” preambles, these exclusions could be used to limit or deny coverage for claims where the underlying investment or misrepresentation is even tangentially related to the enumerated perils.
  • Mitigation - this valuable coverage allows asset managers to resolve potential claims in order to head-off customer demands or litigation. With respect to ESG investing, pre claim mitigation cover could allow firms to sell a non-confirming investment quickly but even at a loss, or to remedy a breach of a sustainable investment mandate, while passing the associated costs onto their insurance program. Policy terms vary however, and great care must be taken when reviewing notice obligations, coverage triggers, and other provisions.
  • Investigations - with the prospect of heightened regulatory scrutiny of ESG offerings and investments, coverage for investigations will continue to serve as an important risk management tool for asset managers. Attention should be paid to exactly what sort of investigations are covered by a policy.

Managing claims

The story in the world of professional liability risks over the last few years has been the spread of insurance claims to what once were discrete, insular policies or programs. Employment risk can become a cyber concern when employee privacy or personally identifiable information is involved. And in the world of sustainable investing, professional liability claims concerning the adequacy of investment options can quickly become a boardroom concern.
Care must be taken not only to ensure the placement of appropriate policy limits containing beneficial language, but to ensure that, when necessary, different policies will work in concert and not create gaps in coverage.

Asset managers should review Dear CEO letters holistically — adding consideration of how the firm’s insurance program might react in the event of customer complaints or regulatory investigation in respect of those matters of the supervisory radar is highly recommended. 

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