Labels and claims for integrated financial products under scrutiny

September saw two documents published of importance to fund managers and debt issuers who offer integrated financial products (IFPs – see Appendix 1 for FMA description). These products include the likes of green bonds and ethical managed funds. The first was a short report from the Financial Markets Authority (FMA) entitled Ethical investing disclosure insights (Ethical Investing). The second was a guidance note published by Responsible Investment Association Australasia (RIAA) entitled Product labelling P2: Make honest claims and label appropriately (Product Labelling).

Both of these documents take aim at wording issues that concern IFPs. There are two core concerns examined in each document:

Ethical labelling: Names given to IFPs that are representative of underlying ethical claims made about these products.

Ethical claims: Descriptions that are evidentially based upon and supported by the invested assets of IFPs.

A simple diagram illustrates the hierarchical relationship between ethical labels, ethical claims, and invested assets:

Diagram 1: Hierarchical relationship between ethical labels, ethical claims, and invested assets

 

 

When examining the appropriateness of IFP labelling, its underlying claims must be subjected to critical scrutiny. If there is any doubt arising as to the veracity of such claims, then it is the invested assets that must be investigated, because these assets will be the touchstone of the honesty of the claims. In all cases the invested assets will be the final evidence as to whether related ethical claims are honest and, by extension, ethical labels derived therefrom are appropriate.

The diagram above makes plain where greenwashing can arise. Greenwashing entails using false, misleading, or unsubstantiated language by issuers to describe the ethical characteristics of IFPs and can occur at the level of ethical labels and/or ethical claims. The test of whether the language used is false, misleading, or unsubstantiated will be comparison with the invested assets actually held by the IFP. Either both the ethical labels and ethical claims levels could be at fault or just one of them. In the latter case, an ethical label applied to an IFP might be appropriate, but underlying ethical claims could be flawed. Alternatively, the ethical label could be misapplied, but the related ethical claims could be correct. It is also possible for an IFP to have ethical claims made for it, but no ethical label attached. Diagram 2 shows these permutations.

Diagram 2: Permutations of truth and falsity in IFPs’ ethical labels and claims

*True = appropriate labels/honest claims; **False = false/misleading/unsubstantiated language

FMA’s latest take on IFP wording

Ethical Investing was the outcome of an FMA review of 10 managed investment schemes (MIS). The FMA issued the report (September 2024) as the third in a series dating back to Disclosure framework for integrated financial products (December 2020) and Integrated financial products: Review of managed fund documentation (July 2022). The usual free market assumption for consumer purchasing is caveat emptor, but this is not the approach that Ethical Investing espouses for retail investor acquisition of IFPs. The philosophy of FMA on IFP disclosure and sales and marketing is set out at the beginning of the report as follows:

Ethical investing is a high-trust relationship. When investors place their money in investment products that make ethical claims, it is with the expectation of an outcome that aligns with their values, and delivers an appropriate level of return. 

The underlying activities and approaches taken by issuers to demonstrate the ethical nature of their products can be complex and varied. Our research shows investors do not necessarily investigate the claims being made by issuers or the underlying details, such as which assets are in which funds. Investors rely on issuers to do what they claim to be doing …

Monitoring market participants’ ethical investment practices is now part of our supervision approach. Our supervision and guidance apply to all market participants making ethical claims for their products or services, not only to products that use ethical labelling.

(Ethical Investing, p. 1)

Accordingly, taking into account that retail investors do not necessarily undertake their own due diligence on IFPs that they buy into, FMA steps into their place by striving to keep IFP providers honest and truthful in their ethical labelling and claims. Ethical Investing reiterates the previous documents FMA has published on IFPs in pointing to the Part 2 fair dealing provisions of the FMC Act as the legislative basis for obligations not to make false, misleading or unsubstantiated claims. Implicitly referred to also is section 462(1) of Part 8 Enforcement, liability, and appeals where the report states that, “Confusing, unclear and inconsistent disclosure around ethical investing remains common.”

In respect of ethical labels and claims, Ethical Investing states:

There is a trend nationally and internationally towards clearer definition and standardisation of what constitutes a ‘sustainable’, ‘ethical’ or similar investment. We will be watching those developments and considering how they may impact the investment market in New Zealand. We will be taking account of any material developments that arise from the Sustainable Finance Taxonomy currently under development by the Ministry for the Environment, which would help investors to identify sustainable activities.

RIAA gets specific about using words rightly

In the same month as Ethical Investing came out, RIAA published Product Labelling as an updated document. Product Labelling is a certified responsible investment standard issued as part of RIAA’s product certification programme. New Zealand issuers of IFPs could benefit from studying Product Labelling for guidance on how to avoid the pitfalls of false, misleading and unsubstantiated language in ethical labels and claims. The guidance itself sets out its purpose:

• • P2           Make honest claims and are appropriately labelled:

1. 1. are named to accurately reflect the claims pertaining to social, environmental, sustainability and/or ethical outcomes or responsible investment approach applied to the product; and

1. 1. describe what could be reasonably expected by an investor in terms of the portfolio holdings of the product; and

1. 1. ensure all claims made about the product are honest and not false or misleading nor include puffery, un-substantiations and unqualified predictions.

• • P5e         Have relevant and accessible [responsible investment] disclosures: for products asserting certain sustainability outcomes or claims, publish the product’s social, environmental and/or sustainability performance against benchmarks, goals or targets, at least annually as well as the methodology for measuring the Product’s contribution to social, environmental and/or sustainability outcomes.

European Union disclosure regulations on sustainability risks

Product Labelling is broken down into several parts. Near the beginning comes a section that refers to alignment with the European Union’s Sustainable Financial Disclosure Regulations (SFDR), otherwise known as Regulation (EU) 2019/2088. These prescriptive regulations, set out as articles, represent an attempt to codify in black-letter law what must be disclosed concerning sustainability risks for financial products, financial advice, banking, and insurance. First promulgated in November 2019, SFDR were updated in January 2024 for staged introduction throughout the European Union. Although SFDR are not legally binding in Australasia, RIAA makes clear in Product Labelling that it will positively consider the alignment of Australian and New Zealand financial products with these foreign regulations when undertaking formal product certification. This alignment is not presently a requirement of FMA.

For IFPs, the relevant SFDR articles to consider are Article 6, Article 8 and Article 9 if alignment for comparative purposes is being sought with European Union standards.

Under Article 6 (Transparency of the integration of sustainability risks), financial products are not required to address sustainability risks but must disclose if they do not and explain why. An Article 6-aligned financial product would not necessarily be an IFP, although it could be one if the sustainability risks of its investment practices were taken into account in its disclosures.

Article 8 (Transparency of the promotion of environmental or social characteristics in pre-contractual disclosure) covers disclosures required for a financial product that “promotes [our emphasis], among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices ….” An IFP would be at least an Article 8-aligned financial product. Article 9 (Transparency of sustainable investments in pre-contractual disclosures) raises the bar even higher in applying disclosure rules to a financial product that “has sustainable investment as its objective [our emphasis] and an index has been designated as a reference benchmark ….” Not all IFPs would align with this exacting standard. There could be IFPs that only come up to Article 8 level, whereas others could potentially reach full Article 9 ranking.

As noted, SFDR do not apply within New Zealand and so have no operative compliance requirements in this country, but they could be helpful for looking at IFPs on offer here from the perspective of whether they would potentially qualify as either Article 8 or Article 9 financial products as a way of differentiating between them. Retail investors with more stringent ethical investment criteria might be expected to prefer IFPs that were more aligned with Article 9 than with Article 8.

Getting the words wrong

Another section of Product Labelling is headlined “Types of unsubstantiated product labels and claims the Certification assessment aims to combat”. This section provides “made-up examples” of language misuse about financial products that breaches various legislative requirements in several categories:

• • Use of normative terms

• • Redundant claims

• • Over or misleading statements

• • No explanation of broad terms

• • Use of qualifying statements

As a sampling of what is on offer, the section gives a made-up example of an imaginary fund as follows:

(Product Labelling, p. 4)

Whilst the above example might resemble shooting fish in a barrel, others provided in the section on defective language are more nuanced and tease out ways in which the language applied to ethical labels and claims can fall short of compliance with legislative standards.

Getting the words right

Of more direct use to IFP providers concerned about meeting standards for climate-related names, labels, and claims is the annex to Product Labelling. The annex is a tabulation of 18 items that each propose an FAQ that is then answered substantively.  As an example, item number 1 of the Annex tackles the question of defining climate-related terms and phrases:

(Ibid., p. 7)

Value-for-money assessment implications

Both Ethical Investing and Product Labelling have implications for the value-for-money (VfM) assessment regime that applies to retail managed funds in New Zealand. These documents teach that words used in IFPs’ ethical labels and claims are critically important to get right for two main reasons:

• • To inform and empower retail investor understanding and decision-making when selecting IFPs

• • To avoid false, misleading, confusing, and unsubstantiated ethical labels and claims and, more generally, greenwashing

These reasons are relevant to VfM assessment of retail managed funds. Words used in ethical labels and claims promise distinctive value to retail investors in the way that they represent the invested assets of IFPs to which they are applied. This value may variously be expressed as a financial factor or a non-financial factor of the invested assets. Non-financial factors can be variously described under terms such as ‘ethical’, ‘responsible’, ‘sustainable’, ‘green’, and Environmental, Social and Governance (ESG), although the actual details of such factors will need to be identified through study of IFP issuers’ disclosure documents. In the VfM context, both financial and non-financial factors must be captured in fund managers’ self-assessments of their IFPs’ value propositions. Simply put, if ethical labels and claims are made concerning an IFP’s value to retail investors, then the factors – whether financial or non-financial – that these words relate to must be clearly identified and their investor value scrupulously accounted for in VfM assessments.

FMA specifically addresses this point under Principle 3 (Advice and service is received, not just offered) of its guidance Managed fund fees and value for money (VfM Guidance, April 2021). Therein, the guidance states:

If a scheme claims its asset stewardship, including taking account of non-financial factors within an integrated financial product, adds value, can they substantiate it by demonstrating how it fits member values? Or how it benefits investment outcomes? For example, does it reduce risk without reducing return, enhance return, have quantifiable non-financial impacts, or shape company behaviour? 

(VfM Guidance, p. 11)

VfM Guidance is not prescriptive, unlike SDFR, and instead advances four principles that fund managers are expected to apply to measuring the value to investors that their retail financial products actually provide. In the case of IFPs, that value will be comprised of both financial and non-financial factors to varying degrees depending on the characteristics particular to any managed fund being assessed for its VfM delivery. The onus is upon IFP fund managers to interpret the VfM Guidance passage quoted above and establish how to satisfy themselves, their Supervisors, and FMA convincingly that their IFPs provide the required value to retail investors. There will be no uniform way of doing so across the board.

In this context, ethical labels and claims applied to IFPs will be value markers that must clearly indicate how retail investors can receive some identifiable benefit(s) of financial and/or non-financial value to themselves. This value may be assessed either quantitatively or qualitatively by fund managers when performing VfM analysis on their IFPs. However the value is assessed, it must actually exist or at least be reasonably expected to eventuate. Otherwise, words used in IFPs’ associated ethical labels and claims may be false, misleading, confusing, or unsubstantiated and thereby in breach of the FMC Act. VfM analysis undertaken rigorously on IFPs should expose the truth of such words and flush out greenwashing.

Conclusion

“Words really do matter when it comes to labelling or making claims about the ethical properties of IFPs,” said Matthew Band, General Manager of Trustees Corporate Supervision at Trustees Executors.

“In all instances, ethical labels and claims must be able to be mapped unambiguously onto the invested assets of IFPs.”

“Ethical claims must be verifiable against the invested assets that they represent and ethical labels must be appropriate in relation to both these claims and the assets they relate to.”

“Failure to achieve coherence and consonance between ethical labels, ethical claims, and invested assets readily leads to the risk of greenwashing.”

“False, misleading, confusing, and unsubstantiated labels and claims for IFPs play into the vulnerabilities of trusting retail investors who take them at face value and place credence in what they state without further due diligence.”

“Honest claims and appropriate labels also have an important role to play for VfM assessments of managed funds that are IFPs.”

“An essential part of undertaking VfM assessment of such managed funds consists in testing out whether there is in fact any satisfactory value for investors that is accurately represented in ethical labels and claims for them.”

“If satisfactory value cannot be demonstrated for IFPs as a result of VfM assessments, then there may be grounds for suspicion of greenwashing and breaches of the FMC Act.”

“Supervisors have an important role to play in keeping tabs on ethical labels and claims when reviewing their supervised clients’ IFP disclosure documents, advertisements, and VfM self-assessments.”

“The two documents that came out in September from FMA and RIAA provide tools helpful to IFP debt issuers and fund managers in meeting their obligations under FMC Act Parts 2 and 8, and VfM requirements where applicable.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matthew Band at [email protected].

Appendix 1: FMA description of IFPs

(source Disclosure framework for integrated financial products, p. 4)

This guidance collectively refers to financial products that incorporate non-financial factors alongside financial factors as ‘integrated financial products’. These integrated financial products typically take one of two forms:

• debt securities such as ‘green bonds’, which fund projects or organisations claiming positive environmental impacts; or

• managed investment products (including some KiwiSaver funds) claiming non-financial impacts.

Our choice of the term ‘integrated financial product’ reflects that other terms for the concept, while commonly used, do not have commonly shared meaning (including the terms ‘ethical’, responsible’, ‘sustainable’, ‘green’ and Environmental, Social and Governance (ESG)).