After more than a year of tough talk and other regulatory sabre-rattling, action from the financial services watchdog to combat “greenwashing” appears to be on hold. Overseas watchdogs, including the Australian Securities and Investments Commission, are taking enforcement action and the Kiwi investment scene is ripe for an equally serious response. But the Financial Markets Authority (FMA) says it’s not its job to set industry standards for products described as ESG (environmental, social and governance) investments and local fund managers have been left to define ethical investing as they see fit.

Not all have come up to scratch. A recent review by the FMA found the managed fund sector’s disclosure documents were vague and imprecise, with information incomplete, scattered across different places or lacking enough detail. Fund managers have been on notice for the past year that they won’t be given much leeway if they fail to improve their ESG documentation, especially where investors consistently express concern about where their investments are being made and feel increasingly put off by impenetrable industry-speak and confusing information.

Greenwashing – or making false or misleading claims about a fund or product’s ethical credentials – is a breach of the fair dealing provisions under the Financial Markets Conduct Act 2013. These provisions, among other things, prohibit misleading or deceptive conduct, the making of false or misleading representations and the making of unsubstantiated representations.

Contravening the provisions may give rise to civil liability, including a pecuniary penalty set at whichever is the greatest: the consideration for the contravening transaction, three times the amount of the gain made or loss avoided, or $1 million for individuals and $5m in any other case. The FMA can also make stop orders to ban advertising or other representations that confuse, or are likely to confuse, investors on matters that influence their investment decisions. Compliance failures can attract a fine of up to $300,000.

The regulator in August 2022 was “done signalling, basically” and was sharpening its focus on greenwashing, FMA response and enforcement executive director Paul Gregory told LawNews at the time. But despite the FMA’s chief executive, Samantha Barrass, telling the market at the beginning of 2022 that cracking down on greenwashing was a priority, it’s understood the regulator has yet to bring a case before the courts.

It did formally warn the Australian arm of US fund giant Vanguard in March this year for failing to disclose within the required time details of infringement notices filed against it in Australia for alleged greenwashing. But the warning was more about procedural oversight rather than greenwashing itself.

Asked whether a court case was imminent, an FMA spokesperson declined to comment, saying fair dealing enforcement action was only part of the regulator’s supervisory work on integrated financial products. The FMA regularly gathered and assessed information on such offers, the spokesperson said, and checked for compliance. “To date, this work has resulted in a number of changes to disclosures for new and existing products and is ongoing,” he said.

Hot topic

Late in July 2022, the FMA released a review of 14 KiwiSaver and other managed funds, benchmarked against ESG investment guidance the regulator issued back in December 2020. Aimed at checking the industry’s uptake of December 2020 guidance, which included the type of framework the FMA expects managers to use to substantiate on reasonable grounds the claims they’re making about the credentials of their funds, the review found the managed fund sector’s view on disclosure was “immature”.

With “lots of imprecision, lots of vagueness” in the sector, “the reality is that there aren’t any defined standards as to what ‘ethical’ and ‘responsible’ mean and the regulator is the last person who should do that”, Gregory told LawNews last August. “So, if [fund managers] are doing that, [they] need to be very clear what [they] mean.”

In other words, it is up to individual managers to define “ethical”, “responsible”, “green” and “sustainable” – terms the FMA skips over in favour of using “integrated financial products”, which means financial products incorporating natural, social, human capitals and other non-financial factors alongside the traditional financial factors. In defining these terms, fund managers then determine the level of risk they are willing to accept.

There are broader policy and consumer tailwinds behind the FMA, including those that require claims to be “articulate, accurate and meaningful”, such as mandatory climate reporting standards for large financial organisations, which will come into force from January 2024.

Recent FMA research has shown more than two-thirds (68%) of New Zealand investors prefer their money to be invested ethically and responsibly, although just over a quarter (26%) of that portion have followed through on selecting an ethical fund manager. Complementary qualitative research has also found most investors are overwhelmed by technical jargon and rely on fund managers’ websites and marketing materials, and the opinions of their friends. Others abandon the search altogether, saying it’s too hard.

The regulator has so far concentrated on the hygiene of fund managers’ disclosure practices rather than the veracity of their specific claims. Following the review, which did not investigate whether greenwashing existed in the funds under scrutiny, the FMA said it had communicated its findings to each of the 14 selected funds and, “where appropriate”, offered feedback on how they could improve their disclosure. The FMA concluded all the funds were weak in at least one area of disclosure

Vacuum of agreed rules

The industry appears to be trying to resolve the definitional issue. The local sector is exploring the implementation of its own sustainable finance taxonomy, a system to classify ESG activities and facilitating the allocation of capital to them, with efforts underway by the government and the sustainable finance industry.

The Responsible Investment Association Australasia’s responsible investment certification program also helps investors identify good-quality ESG products and services on both sides of the Tasman. Internationally, in response to the fragmented requirements of different voluntary labels and industry standards, Institutional Shareholder Services’ ESG arm has created a solution to help asset managers and owners meet multiple label, awards and industry standards requirements in a single, regionally focused solution.

LawNews wanted to ask the FMA’s Gregory how ESG funds are being appraised ethically, how their ethical performance can be quantified and compared if no common set of standards exists and why the FMA shouldn’t define ethical investing. While Gregory wasn’t available to discuss this issue, his recent comments indicate the regulator is unwilling to wade into this debate. Last month, speaking on the FMA’s “5 mins with the FMA” podcast, Gregory said only individuals define ethics.

“Regulators don’t – and they shouldn’t – have a view on what investors and the fund managers they use should and should not invest in…From a regulatory perspective, it’s actually ok for managed funds to do very little in environmental, social and governance areas, provided they don’t pretend or advertise they are doing otherwise. But for investors, of course, that might not be good enough.”

But Barry Coates, founder and CEO of the Mindful Money charity, wants the FMA to get involved in problem definition. The biggest issue facing the financial sector is figuring out what standards fund managers are being compared to. And yet the lack of defined standards doesn’t sit right, he says. “How can the consumers have any confidence in the claim that something is ‘green’ or ‘ethical’ or ‘responsible’ or ‘sustainable’ when they don’t really know what they’re referring to? There needs to be a process of defining those standards and [it] should be up to the financial regulator to say, ‘When you use the term “sustainable”, then you are referring to these characteristics of a fund’.”

Coates says a regulator can’t do its job if it’s operating within a vacuum of agreed rules. “How can they do their job and say ‘we’re going to challenge misleading claims’ if they have never really said what it is that’s misleading? The danger is that they then look around and pick somebody and say, ‘We’re going to make an example of you’.”

This ad hoc regulatory approach can send a chilling effect throughout an industry, he says, and it’s already playing out in at least one way. The phenomenon of “greenhushing” – when organisations go radio-silent on their green or ESG credentials to avoid scrutiny, either by under-reporting or hiding their efforts from public view – is becoming more prevalent internationally.

Coates says even the relatively few green funds that are practising what they preach are reluctant to share their stories for fear of being outed.

Beyond acceptable evils

One of the main reasons the FMA is refusing to define ethical investing is because ethics are personal and capable of shifting or, in Gregory’s words, “There is not a fixed catchment of unacceptable ethical harm”. But what the FMA does expect, and what fund managers can anticipate, is the need to make such judgment calls.

Much of the concern about greenwashing relates to funds investing in companies that cause harm. The kinds of harm that the public wants to avoid in their investments have been remarkably stable since 2018, according to Mindful Money’s Voices of Aotearoa: Demand for Ethical Investment in New Zealand 2023. The top five issues – human rights violations (90%), labour rights abuses (89%), environmental damage (88%), indigenous rights violations (87%), and companies that don’t pay their fair share of tax (86%) – were unchanged from the 2022 survey results and have sat at similarly high levels.

There’s a high degree of commonality across ethical preferences, Coates says. “People do have different ethics but, actually, it’s far less of an issue than most people think.” While there are some universally accepted evils – slavery, cluster bombs, and other illegal activities, to name a few – some things that one person might see as immoral may be seen amorally or morally by others. “The further away you get from the core of ethics, the more subjective it gets,” says Dentons Kensington Swan partner David Ireland. “A bit of differentiation is a good thing.”

Greenwashing is a hot topic for the FMA, Ireland says. But placing the burden to make value judgments on the regulator would be a “negative, retrograde step”, as it would result in disputes about a topic where “no one is actually going to be right. It isn’t a black-and-white equation in this space. There are different shades of what ought to or what ought to not count.”

The emergence of a homogenous view of morality or the pigeonholing of investments into tightly defined boxes of “good” and “evil” would stifle innovation – a concern of Ireland’s. So long as investment product providers are clear in how they view the world and what steps they take to make their worldview real or meaningful, then “we should be encouraging differentiation within reason”, he says.

In any event, the fair dealing provisions can do much of the heavy lifting. “The further you push the envelope, the greater the risk you might be regarded as confusing or misleading people. [The law] is a natural constraint on how creative people might be in describing what it is they are doing.” ■