Today the Financial Markets Authority (FMA) published its review of managed fund documentation for “integrated financial products” (financial products that incorporate non-financial factors, such as ESG factors, alongside financial factors) (IFP funds). The FMA identifies issues with the quality, utility and accessibility of the information that IFP funds provide to their investors in required disclosures.
Who needs to read it? Why?
This review is relevant for managers and supervisors of IFP funds. It makes clear the FMA’s position on how the market is currently performing in meeting disclosure challenges, and indicates the areas it considers require improvement as this element of the industry expands and matures.
The review also contains a useful insight into the FMA’s thinking for other issuers of “integrated financial products” like green bonds, and financial institutions that may make broader claims about their ESG practices.
What does it cover?
IFP funds look past financial returns and integrate non-financial factors into investment decisions. These are becoming more common as New Zealanders seek investments that match their personal values. In its review the FMA took a sample of 14 KiwiSaver and non-KiwiSaver IFP funds and looked at the information managers provided to investors about those funds.
The FMA issued its disclosure framework for integrated financial products in December 2020. In the review, the FMA states that despite clearly stating its expectations as to disclosure and reasons for those expectations, its review “has established that Managers of IFP funds have a lot of work to do and we now expect them, assisted by their supervisors, to take the necessary care not to mislead or confuse investors with greenwashing.”
The FMA’s key findings were:
Investor decision-making is complicated by relevant information being scattered, partial or lacking
The FMA strongly recommends that managers improve the level of detail and clarity in the information they provide about their IFP approach, including by consolidating all relevant information into “one easy-to-read source” that could be updated in the case of a change to the fund’s approach. The FMA suggests that the source could be linked or otherwise included in the fund’s PDS.
The appendix of the review acknowledges that the word count limits for PDS’s may be an obstacle. It also makes it clear that disclosure of relevant information on the issuer’s website will not go towards meeting a fund’s disclosure obligations under the Financial Markets Conduct Act 2013 (FMCA), and that investors cannot be expected to have reviewed website information. To deal with this, the FMA suggests that if managers cannot include all the relevant information on their IFP approach within the PDS they should lodge that information on the Disclose Register separately as Other Material Information, and include a hyperlink in the PDS that takes the reader directly to that information.
Managers should provide clear explanations of the scope of exclusions
Managers should be cautious when implementing exclusions due to incidents or events that may not have been contemplated by their exclusion policy – for example, in response to the Russian invasion of Ukraine. FMA considers that, in addition to describing ‘foreseeable’ exclusions (such as tobacco manufacture), managers should seek to reduce ambiguity in their decision making by disclosing how they will apply judgement to unforeseen circumstances that connect with their IFP policies.
Investors need better information about what IFP funds exclude and why
The FMA found that only 8 of the 14 IFP funds included in the review had effective disclosure setting out to investors what their exclusion categories were, thresholds for those categories and any exceptions. The FMA identified six specific focus areas under this heading:How exclusions are reflected in any derivatives used in the fund
Disclosure should make the clear the extent to which derivatives are covered by an IFP policies. FMA encourages providers to carefully consider, and clearly disclose, how their integrated approach treats derivatives, and to keep abreast of developments in thinking and practice on how to best meet investor needs – especially as increasing numbers of derivatives incorporate ESG features. This is particularly important where an IFP Fund makes extensive use of derivatives.
Approaches to positive screening (‘tilts’)
In addition to using exclusions, eight of the funds reviewed also sought to invest in line with broader ESG policies. These policies would typically be used for desired outcomes where a direct exclusion policy might not be suitable, for example promoting clean energy or worker wellbeing/human rights (which FMA calls a “positive screening” approach). FMA recommends that funds that use positive screening ensure they are clearly explaining their IFP policies, and how those policies translate into investment decisions, with a particular focus on making any weighting or assessment transparent, and avoiding imprecise language. Where terminology or jargon is used, managers should endeavour to explain what they mean.
Investors need better information about risk and return trade-offs
FMA considered all 14 managers failed to adequately explain the financial performance implications (positive or negative) of integrating non-financial factors into investment decisions.
FMA also considers that managers should be disclosing the risks of failing to achieve any non-financial objectives they may have.
Investors need better information about the benefits of an IFP Fund
The IFP Guidance asks managers to provide information to investors describing the specific non-financial features of the IFP Fund that differentiate it from a standard managed fund. FMA considers this allows investors to understand the basis for the marketing label and assess whether the IFP Fund will meet their needs, and also connects to the requirements in the FMC Regulations for the fund’s PDS to describe the significant benefits of investing in the fund and summarise its significant features.
FMA found that while some funds did meet these requirements, other did not, including because descriptions of non-financial benefits were too high-level or subjective.
For non-financial outcomes to be meaningful, the consequences of failing to achieve them should be clear
In general, IFP funds focus on more than just financial return for investors. Because of this, the FMA believes that an IFP Fund should provide an explanation when it fails to deliver on its non-financial outcomes or objectives. The FMA suggested that managers should disclose to investors what the consequences would be if their IFP funds does not achieve its non-financial outcomes or objectives. Depending on the breach, consequences of failing to achieve those outcomes/ objectives may be significant, for example a redemption or return of funds to the investor, or the removal of the funds’ IFP label. It was pointed out that such significant consequences could appeal to investors as it indicates the manager will be incentivised to ensure that their non-financial goals are achieved.
The review also suggests that managers should be more explicit about what will occur should there be a breach of any IFP policies.
Investors must be able to understand the purpose and value of organisations providing assurance, measurement standards or endorsement
The FMA found that managers often, in the process of marketing their IFP funds, do so with reference to an external provider that provides measurement standards, endorsement and assurance related to the fund’s IFP characteristics. However, the FMA considered that most funds then failed to explain what these references mean in practice and the value they add to investors. FMA’s 2020 disclosure framework for integrated financial products makes clear that managers should explain why these external services have been obtained, and why they are appropriate for the purposes of advertising the IFP fund.
The FMA is clearly signalling that it will monitoring for potential “greenwashing”. All managers of IFP funds, as well as other issuers of integrated financial products, should carefully review their current disclosure approach to ensure they are comfortable they comply with FMA expectations.
The review includes useful guidance for managers (such as in relation to the use of derivatives and the approach to event based exclusions).
However, the scheme of the FMCA is to tightly prescribe the form of the PDS for a managed fund, with a view to ensuring comparability. In that regard, there is room for debate about whether some of the FMA’s findings and recommendations, particularly in relation to breaches and the consequences of failing to achieve non-financial objectives, go further than what the law in fact requires.
If you have any questions in relation to IFP fund disclosures or are considering how these changes affect your business, please contact one of our experts.
This article was co-authored by Elise Plunket, a Law Clerk in our Financial Services team.
Read more of our related insights.View all insights