FMA signals need for better ethical investing disclosures in latest review of IFP funds

The Financial Markets Authority (FMA) has given a strong indication of its expectations on disclosure for ‘integrated financial products’ (IFP) in its recently published report.  IFP is the FMA's term for financial products incorporating non-financial factors alongside financial factors. The report arrives at a time when the popularity of ESG-related investments continues to see growth in the New Zealand market.  Investor engagement in sustainability-related financial products is at a high, with the FMA's research showing 68 per cent of New Zealanders are interested in ethical investment.

The key focus of the review was to assess fund managers' uptake of the IFP disclosure framework  provided by the FMA's IFP Guidance issued in December 2020.  As such, the review focused on funds' disclosure documents, including Product Disclosure Statements (PDS) and Statements of Investment Policy and Objectives (SIPO), to see how IFP disclosures were being made in practice. 

The FMA reviewed 14 KiwiSaver and other managed funds which use an IFP label in their name or description to promote ethical investing policies.  The selection of funds was based on key terms employed to describe the funds, like "sustainable", "responsible", or "ethical".  The review did not attempt to verify any specific claims made by managers about the IFPs or actual investment allocations.

The FMA's key tips for better IFP disclosure

Overall, the FMA stressed that the current trend of disclosure practices relating to IFPs showed "deficiencies" in both the information provided to investors and the presentation of such information.  According to the FMA, these deficiencies are barriers to investors fully understanding the nature of their investments. 

The FMA stressed the following key suggestions for better IFP disclosure:

• Better consolidation of information – in order to improve the overall level of detail and clarity of information, managers could seek to consolidate all IFP relevant information into one easy-to-read source, which could then be linked in the PDS.
  
  
• Detail excluded investments – managers should provide robust explanations and descriptions of excluded investments and the reasons why they are excluded.This should include the decision-making process for excluding certain assets, and the weighting of financial and non-financial factors.

   

• Avoid vague descriptions of non-financial outcomes – ambiguous and generic terms, like "positive change" or "impact on climate change", do not provide adequate IFP disclosure. Managers should clearly identify and state the specific non-financial outcome(s) the fund seeks to obtain.

   

• Clearly state the risks – IFP funds should describe the risk and possible implications of integrating non-financial factors into investment decisions. Managers should explain the risks to the fund not achieving its stated non-financial outcomes or objectives and the monitoring of those risks, distinguished from strictly financial risks.

   

• Explain the consequences of non-financial outcomes – investors should be made aware of the fund's processes for dealing with any consequences of their IFP fund not achieving its non-financial objectives. This should consider how the fund will decide that the investment does not meet, or no longer meets, its IFP policies and what the fund will do with those investments.

The FMA's review chooses to focus on overarching themes for better disclosure rather than enforcing prescriptive methods for doing so.  For example, in implementing the above suggestions, IFP fund managers may choose to prepare a separate stand-alone document specifically for IFP-related disclosure to supplement the PDS or dedicate a page on their website for all consolidated IFP information.

ASIC on 'greenwashing' – a cross border concern?

The Australian Securities and Investments Commission (ASIC) issued guidance on disclosure of sustainability-related products (the Australian equivalent of IFPs) in June – a month prior to the FMA's review.  In Information Sheet 271 (Information Sheet), ASIC notes that with the increase in investor demand for sustainability-related products in the Australian market, comes a growing risk of 'greenwashing'.

'Greenwashing' is the practice of misrepresenting the extent to which a financial product or investment policy is sustainable, ethical or produce ESG-focused outcomes. Therefore, providing adequate disclosure material is key to ensuring no greenwashing ensues.

Both ASIC and the FMA express similar sentiments across their reports. The Information Sheet encourages the use of non-vague terms and emphaisised the need to clearly explain methodologies and policies for integrating sustainability-related considerations into investment decisions.  And while investigations into 'greenwashing' were expressly outside the scope of this review, the FMA stressed that avoiding greenwashing is key to ensure that the funds are 'true-to-label' and that IFP funds are properly distinguished from 'vanilla' managed funds.

Our views

The demand for IFPs is likely to see notable growth in the near future. Investor preference for values-based ethical investing will increasingly impact their investment decisions. The market has already reflected this as a key driver for growth in responsible investment; a 2019 Benchmark Report from the Responsible Investment Association Australasia (RIAA) indicated that demand from retail investors is the second-largest driver (38%) for growth in responsible investment funds managed by top New Zealand fund managers. 

However, in that same report, RIAA identified a gap between funds that claim to be practising responsible investing and funds that have embedded these practices through formal policies and accountability commitments including disclosing full portfolio holdings. These findings align with the FMA's review, in that there is some work required to meet the proper disclosure of IFPs to support investor needs and decision-making. RIAA commented on the FMA's IFP review, stating it was a 'welcome signal' from the regulator to the industry that disclosure and marketing practices require improvement.

While the FMA has relayed clear expectations for sophisticated IFP disclosure down the road, the existing guidance remains flexible enough to support fund managers in reaching that level of ideal disclosure. This approach is consistent with the developing landscape of IFP funds in New Zealand, and also accounts for the varying degree of IFP considerations relevant to each fund in the sustainable funds industry. We expect that the FMA will continue to provide clarification and guidance on further developments in this area, and also more generally on the requirements around offering of IFPs. IFP fund managers should, in the meanwhile, review their existing disclosure practices to ensure compliance with the FMA's most recent suggestions.