Oct 25, 2022
Around the world, integrated financial products (IFPs) are burgeoning to meet demand from investors. According to a definition published by the FMA in its guidance Disclosure framework for integrated financial products (Guidance, December 2020), IFPs are “financial products that incorporate non-financial factors alongside financial factors (Guidance p. 4). IFPs are described in the Guidance as being “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” (ibid.). The Guidance lists various, non-equivalent terms that are used to distinguish IFPs from other types of investments, such as “‘ethical’, ‘responsible’, ‘sustainable’, ‘green’ and Environmental, Social and Governance (ESG)” (ibid.).
The FMA has dedicated some attention to IFPs because their “green” non-financial features and benefits are deployed by issuers to attract investor capital. In order to maintain confidence in markets, non-financial factors must be described truthfully and accurately in advertisements and disclosure documents for financial products. Failure to describe these products correctly can lead to IFP issuers making false, confusing, misleading or deceptive statements about them, which is dubbed “greenwashing”. The FMA has stated more than once this year that it is coming after greenwashers because it regards their practices as illegal.
It is however, one thing to sort out bond and managed fund issuers so far as their advertising and disclosure obligations are concerned, as codified in the Financial Markets Conduct Act 2012 (FMCA) Part 2 Fair dealing and Part 3 Disclosure of offers of financial products. It is quite another to raise the level of financial literacy in wider society concerning IFP non-financial claims. Arguably, the financial literacy of the public at large concerning basic financial claims about investment products is not as high as it could be. Non-financial claims add a whole new overlay of complexity for the public to learn about and understand. Even if IFP issuers keep their houses in order with respect to advertising and disclosure, it does not follow that the average investor will be any much the wiser without receiving some kind of help and assistance.
The FMA has responded to the need to educate the New Zealand public on IFPs. In July 2022, following on from its Guidance to industry, it published a research report entitled Ethical investment journey research (Report). The FMA commissioned research house Fivefifty5 to interview 20 New Zealanders (8 male, 12 female) of various ages, locations and family situations about their motivations and concerns regarding ethical investing into retail managed funds and KiwiSaver schemes. The term “ethical investing” was chosen over “responsible investing” as a grab bag to capture IFP non-financial claims as it was the one most used by members of the survey group.
The Report is of interest to IFP issuers, including KiwiSaver providers, because it gives insight into the thinking and emotions of retail investors and reveals the needs, goals and motivations of people in seeking out IFPs to invest in. Case studies are in included. The Report also offers a list of five recommended things IFP issuers should do in order to assist people to invest in their products:
(Report p. 39)
As a result of the report, the FMA has set up a webpage library entitled Ethical investing (Library) to assist retail investors who are interested in IFPs. This resource should also be of use to IFP issuers as it sets out the sorts of standards that the regulator expects and encourages investors to enquire about. IFP issuers could use the library for anticipations of what to explain about the non-financial features and benefits of their bonds and funds to retail investors and how to go about that explanation.
Given that 2022 is the year in which the value-for-money regime has come into effect for assessing managed fund fees, it is notable that the Library has a section which deals expressly with the fees of IFPs under the heading Are there additional risks or costs?:
All investment products have risks. These should be clearly explained in the investor materials. Some integrated financial products have additional risks. The investment materials should explain whether there are any:
Risks to not achieving the non-financial goals, and if so, what these are.
Financial performance implications. For example, could investment options be limited by the criteria applied to the product?
Fee implications, for example, because of costs related to external assurance, operations or non-financial analysis.
Risks of the policies being breached and therefore investor funds not being allocated as intended or expected, and the implications of that.
(Library)
Managed funds, including KiwiSaver funds, that are IFPs will be subject to scrutiny of the relationship between their fees and their non-financial features and benefits under VfM assessment criteria. This scrutiny will be driven by the FMA guidance Managed fund fees and value for money (VfM Guidance):
Risk and return are critical
The two key indicators of value for money for members are how well the manager’s process and capabilities appropriately minimise investment risk that members experience (i.e. through volatility and loss); and members’ return after fees.
(VfM Guidance p. 5)
And:
Other value-adding services – useful questions for managers and supervisors
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)
Clearly, if an IFP poses higher risks or charges higher fees due to its non-financial features and benefits, then those aspects will stand out in VfM assessments as matters to be adequately explained and justified by the issuer. Supervisors, who are required to review managed investment scheme (MIS) managers’ self-assessments of VfM in their funds, will need to be alert to the implications of fees and risks distinctively associated with IFPs.
Like the FMA, financial regulators worldwide realise that some form of market intervention is necessary from their side not just to keep IFP issuers in line, but also to lift the general level of financial literacy about IFPs so that investors can make informed decisions and avoid the pitfalls of greenwashing.
In August 2022 the International Organization of Securities Commissions (IOSCO) published a final report entitled Retail Investor Education in the Context of Sustainable Finance Markets and Products (Final Report). This document analyses the needs and problems in educating investors about sustainable investing (using “sustainable” as a blanket term inclusive of ESG and other “green” terminology) and surveys in detail the various efforts undertaken by its member regulators, of which the FMA is one.
Clearly the global market for IFPs has taken off and now there are huge sums of money at stake, giving rise to the temptation to greenwash in order to capture wallet share and the concerns of regulators that such financial crime is repressed. The Final Report states:
[A]ccording to news and industry reports, assets under management by sustainable mutual funds and ESG-focused ETFs rose globally by 53% in 2021 to $2.7 trillion, with a net $596 million flowing into the strategy, and the issuance of sustainability-linked bonds and loans exceeded $1.6 trillion in 2021. According to one estimate, “green” assets are set to grow to $50 trillion by 2025 from about $35 trillion. Other estimates indicate that sustainable debt financing reached $1 trillion in 2021 and accounted for 10% of global debt markets.
ESG or sustainability-related products such as “sustainable” exchange-traded funds (ETFs) and “green” mutual funds are among the ESG products generally available to retail investors. It has been observed that, “[I]n the last five years, we have finally seen some interest in ESG investing among retail investors (individuals and families) both in Europe and the United States. By 2020, retail investors had reached 25% of the total global ESG market, soaring from 11% in 2012”.
(Final Report, pp 3-4)
Plainly, retail investor financial literacy is needed concerning non-financial features and benefits marketed by issuers and distributors as reasons to invest in IFPs. However, because of the complexity and differing terminology surrounding ESG or sustainable investing, it is not necessarily straightforward to design and build effective financial literacy campaigns. The Final Report states:
ESG products, like all investments in securities, involve opportunities and risks. Retail investors should understand the risks of sustainable products and the sustainability-related risks affecting different financial products. This understanding would help retail investors to make informed decisions and protect themselves from different risks, including greenwashing.
Despite the growth of ESG products and the increased availability of such products to retail investors, globally consistent terminology and common definitions in the area of sustainable finance are still in the process of development by industry and other groups, such as international standard-setters and regulatory authorities (although some efforts are under way, e.g., some regional initiatives and a European framework are in place or currently being developed). This lack of standard terminology may hinder the ability of retail investors to analyze and compare (purportedly) ESG products, including with respect to sustainability risk.
(ibid., p. 4)
The Final Report lists and expands upon a set of topics that need to be addressed in IFP financial literacy campaigns:
The Final Report canvases a range of financial literacy projects on ESG and sustainability themes run by various financial regulators around the world. IFP issuers could profit from looking at these case studies to see if there is anything they could adopt to utilise in their own advertising, disclosure and investor financial literacy education practices. The Final Report also carries some useful terminological definitions. For example:
Greenwashing – the practice of misrepresenting sustainability-related practices or the sustainability-related features of investment products. Such practices may vary in scope and severity, from the inappropriate use of specific sustainability-related terms used in an offering document, to misrepresentations about an entity’s sustainability-related commitments, to deceptive marketing practices that deliberately misrepresent a product’s sustainable impact.
(ibid., p. 6)
“Financial literacy pertaining to IFPs is an essential need to be met for retail investors who are concerned that their money should be invested the way they want it to be under ethical, responsible, sustainable and ESG standards,” said Matthew Band, General Manager of Corporate Trustee Services at Trustees Executors.
“IFP issuers, whether of debt securities or managed funds, have a vested interest in making sure that what they offer by way of non-financial features and benefits associated with their products is disclosed and advertised in ways that are true-to-label and readily understandable by the average person, and not false, confusing, misleading or deceptive.”
“Quite rightly, the FMA has made it loud and clear to New Zealand’s IFP markets that it views greenwashing as serious offending that demands vigorous law enforcement responses.”
“IFP issuers should be taking great care that their disclosures and advertising do not stray into greenwashing.”
“It is in the direct interests of IFP issuers to become effectively involved in boosting retail investor financial literacy concerning the non-financial features and benefits of their products.”
“The FMA and other financial regulators have produced some good examples of how to go about IFP financial literacy education that IFP issuers could emulate and improve upon.”
“For Supervisors, FMCA Part 2 and Part 3 considerations will rank highly when considering the advertising and disclosure documents for IFPs of any issuers that they supervise.”
“IFP-related costs to investors will also come into the ambit of VfM reviews undertaken by Supervisors in case there is evidence of higher fees or risks arising from product non-financial features and benefits that need explanation and justification by the issuer.”
“It is likely that an IFP issuer that provides good quality financial literacy education about product non-financial features to its customers will be able to present that service as evidence supporting its fees, supposing that such fees were not unreasonable or excessive to begin with.”
For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt at [email protected].