The UK’s financial watchdog has warned administrators of creating overly vague sustainability targets, after finding that most of these benchmarks are of poor quality and could lead to ‘greenwashing.’
The Financial Conduct Authority completed a review of environmental, sustainability and governance (ESG) benchmarks, which companies use to showcase progress towards sustainability goals.
It said the overall quality of benchmarks it reviewed was “very poor.” In particular, it said that the methodologies for too many benchmarks were overly vague.
“We are concerned that this can contribute towards or lead to greenwashing,” the watchdog said. The FCA said that ESG ratings had been “increasingly embedded” in investment, and therefore transparency was important to prevent “potential harm to markets.”
While a code of conduct exists for ESG rating providers, the FCA said it would support the introduction of Government regulations for the sector, such as its own Sustainability Disclosure Requirements (SDR). Until then, the watchdog said it would take action against ESG rating providers who do not address the failings it noticed in the review.
“We are working closely with Government on this, who are expected to shortly consult on whether and how to extend the FCA’s perimeter to include ESG rating providers,” the FCA said.
“We expect all benchmark administrators to have strategies to address the issues identified in this letter,” it said. “We will be doing more work in this area to address the potential failings and expect firms to be able to explain these strategies on request. We will use the full range of our tools where this does not happen.”
Demand for strategies that employ ESG metrics has risen rapidly from both institutional and retail investors, increasing regulatory concerns about greenwashing, where financial product providers make exaggerated or misleading environmental claims.
The City regulator also criticised index providers for failing to implement their own ESG methodologies correctly. It found examples of index providers using outdated ESG data and ratings as well as failures to properly apply exclusion criteria to the constituents of ESG benchmarks.
