2024-11-14
Added · Updated
Domestic Funds, Model Portfolios, and Foreign Funds holding themselves out as ESG must ensure ESG objectives form a core focus, disclosing strategies in constitutions, prospectuses, or agreements. They must specify screening methods, thresholds, and metrics, avoiding vague terms or misleading names. Vehicles must disclose minimum alignment thresholds, third-party attestation choices, and benchmark methodologies. Prohibitions include exaggerating features, cherry-picking data, or implying non-existent causal links. All disclosures must use plain language and accurately reflect risks and suitability.
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GUIDANCE ON ESG FUNDS AND MODEL PORTFOLIOS IN ADGM (VER01.141124)
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TABLE OF CONTENTS
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2. KEY TERMS USED IN THIS GUIDANCE
2.1 It is important to establish a common understanding of the key terms used in this Guidance.
While the term “ESG” is frequently used, other similar terms may be used interchangeably by stakeholders, including “sustainable”, “responsible”, and “socially responsible”.
2.2 The term ESG may be broken down into three separate components, each of which broadly
refers to policies, products, practices, aims and strategies that are intended to result in certain desired outcomes. Examples of desired outcomes that may be pursued are provided below. (a) Environmental
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ESG investment strategies
2.5 An ESG Investment Vehicle may pursue an ESG investment strategy of its choice. The FSRA does
not require an ESG Investment Vehicle to categorise itself by any of the following, better known, ESG investment strategies. (a) ESG Integration (i) ESG Integration is the “[o]ngoing consideration of ESG factors within an investment analysis and decision-making process with the aim to improve riskadjusted returns” 2 . (ii) ESG Integration incorporates ESG data and information into investment decisions to enhance risk-adjusted returns. A common feature of the investment strategy is the belief that companies performing better on ESG criteria are likely to produce higher financial returns. (b) Screening (i) Screening involves “[a]pplying rules based on defined criteria that determine whether an investment is permissible” 2 . (ii) Screening involves a process of determining whether particular assets from the universe of possible investments are eligible or not to be included in a portfolio. In the context of ESG investing, managers may screen for investments based on ESG criteria. Screening may involve “negative screening”, “positive screening”, and “best in class screening”. (iii) Negative screening, also known as exclusion investing, involves the outright avoidance of certain assets on the basis of predefined ESG criteria, essentially filtering the investable universe for undesired ESG criteria, e.g. excluding tobacco companies. (iv) Positive screening involves the selection of certain assets based on predefined ESG criteria, such as selecting carbon neutral companies. Positive screening filters the investable universe for desirable ESG criteria. (v) Best in class screening involves selecting certain assets on the basis of their performance on predefined ESG criteria relative to their peer group, for example, selecting companies that have higher than average employee diversity scores. (c) Impact Investing Impact investing involves “[i]nvesting with the intention to generate positive, measurable social and/or environmental impact alongside a financial return” 2 . 2 Please see Definitions for Responsible Investment Approaches: https://rpc.cfainstitute.org/- /media/documents/article/industry-research/definitions-for-responsible-investment-approaches.pdf, November 2023
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(d) Thematic Investing
Thematic investing involves “[s]electing assets to access specified trends” 2 . The underlying hypothesis aims to benefit from the expected allocation of resources to forecasted trends, for example, by investing in assets that may benefit from a move towards sustainable agricultural practices. Stewardship
2.6 Through practices that fall under the umbrella term “stewardship”, investing institutions may
be able to influence the behaviour and decisions of those companies and organisations they invest in as a result of managing clients’ capital. They may do this by using their proxy voting rights on company matters or by deciding to deploy more capital in a company or to divest from it. They may also do this through “soft power”, such as by allying with fellow investing institutions to encourage companies to advance their own practices in relation to ESG factors.
2.7 In relation to ESG considerations specifically, some commentators and market participants
consider stewardship to be a standalone ESG strategy in and of itself. For example, an ESG fund might purchase shares in a company with the express intention of using voting rights to influence company policy on ESG-related issues. The FSRA believes that an ESG Investment Vehicle should seek to engage with companies and exercise appropriate stewardship to deliver positive ESG outcomes as a matter of course. Accordingly, the FSRA does not view stewardship as a distinct ESG investment strategy but, rather, standard good practice by the managers of an ESG Investment Vehicle.
3. UNDESIRABLE OR MISLEADING NAMES
3.1 The FSRA has regulations and rules that require reasonable steps to be taken to ensure that
statements or disclosures to investors are clear, fair and not misleading, nor deceptive. These requirements apply to both Authorised Persons and investment products.
3.2 It is important to note that these requirements extend to an investment product’s name as that
is likely to set investor expectations regarding what they are investing in and the assets they may gain exposure to. An investment product’s name is also likely to suggest what the primary focus of the investment is and what distinguishes it from other investment products. It is, therefore, of the utmost importance that an investment product’s name does not mislead investors.
3.3 In relation to Funds, pursuant to Section 117 of FSMR, the FSRA has the power to direct the Fund
Manager to change the name of a Fund if it is undesirable or misleading. For Model Portfolios, the FSRA has the power to take regulatory action against an Investment Manager or Fund Manager who has not taken reasonable steps to ensure its communications with investors, including in relation to the names of Model Portfolios, are clear, fair and not misleading.
3.4 An ESG Investment Vehicle will often use general terminology such as “ESG”, “sustainable” or
“responsible” in names or other communications with investors. Use of such broad labels can be confusing where applied inaccurately, for example where it is erroneously used to mean only one or two of the individual “E”, “S” or “G” components.
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Guidance
3.5 Misleading names of products or services -the name of an investment product or service should
not mislead with regard to its focus and investment objectives. An investment product or service should not use an ESG or seemingly equivalent name unless ESG or sustainability-related objectives and strategies form a core focus for the product or service.
3.6 Use of broad-meaning terms - terms that may be used synonymously with ESG, e.g.
”sustainable” and “socially responsible”, are often used broadly and may have different connotations for different investors. As such, when broad-meaning terms are used in the name of an ESG Investment Vehicle, clarifying disclosures should be provided to investors that adequately explain how the investment objectives of the product or service link back to and are consistent with its name. The FSRA encourages managers to make disclosures to investors in plain language to further understanding.
3.7 Use of the term “ESG” – particular care should be taken in using the term “ESG” where all three
“E”, “S” and “G” components are not included in a product or service’s investment objectives and policy. Where only one or two ESG component factors are relevant, it may be preferable to use alternative terminology to ensure clarity and mitigate any greenwashing risk.
4. ESG INVESTMENT STRATEGIES
4.1 As noted earlier, there are a number of ESG investment strategies that an ESG Investment
Vehicle may deploy, either in isolation or as a combination. An explanation of the distinguishing features of the ESG strategy or strategies used is necessary to inform investor expectations around the approach to selecting underlying investments and the types of assets to be found in the investment product portfolio, for example, the sectors or geographies that the underlying investments may be selected from. Failing to specify clearly which ESG investment strategy is in operation may fail to meet the FSRA’s overarching requirements, which is that communications with investors must be clear, fair and not misleading. Category error
4.2 The term “category error” in the context of an investment product or service is where the
investment strategy is poorly described or understood, or both. For example, where an investor expects that the use of the term “ESG” means that an investment product or service will follow an impact strategy, when in fact it is following an ESG integration or exclusion strategy. In such instances, investors’ expectations may not be met given the differences between the strategies and the intended outcomes.
4.3 Category error is most likely to occur in the case of an impact investing strategy, which may
result in investments in companies with an aim to influence their movement towards the achievement of particular goals. For example, an impact fund may invest in a company that lacks board diversity, with the aim of influencing a move towards a more diverse board.
4.4 This may create confusion for investors in terms of their expectations of the assets that a fund
may hold based on the name of the fund or broadly expressed objectives of the fund. Investors may assume that the strategy includes a screening strategy when that is not the case and so
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4.5 It is possible that more than one ESG investment strategy is employed by an ESG Investment
Vehicle. For example, a screening strategy to filter the investable universe initially followed by an impact strategy. It is also possible that over time an ESG Investment Vehicle may evolve its strategy, although this would need to be communicated to investors.
4.6 In addition, some ESG Investment Vehicles may retain the discretion to invest in assets that are
not consistent with the ESG strategy they are pursuing. For example, a fund that screens issuers that have publicly-disclosed and credible net zero transition plans may, nonetheless, have included the discretion to invest up to 10% of its assets in companies that have not disclosed net zero transition plans. Guidance
4.7 Where to disclose the ESG investment strategy - in the case of a Domestic Fund, the ESG
investment strategy should be clearly specified in the investment objectives and restrictions as stated in its Constitution and/or most recently published Prospectus. In the case of a Model Portfolio, the ESG investment strategy should be clearly stated in the Discretionary Portfolio Management Agreement. In both cases, the ESG investment strategy should be clearly spelled out in relevant sales and marketing material.
4.8 Prevention of category error - an ESG Investment Vehicle should identify and communicate the
ESG investment strategy employed in a manner that is clear, fair and not misleading. This should include sufficient detail on the screening, selection and prioritisation aspects of the investment process. It should also provide investors with a clear idea of the types of assets that may be acquired by the ESG Investment Vehicle. There should be clarity on the ESG factors or screens that will be used, how they are evaluated, i.e. whether qualitative or quantitative analysis is conducted and any relevant thresholds, where applicable. ESG investment strategies should aim to avoid using vague ESG factors that cannot easily be analysed.
4.9 Use of multiple ESG investment strategies – where an ESG Investment Vehicle uses more than
one ESG investment strategy, information should be provided to investors on all the strategies it uses and the prioritisation or interplay between the varying strategies in portfolio asset selection.
4.10 Incongruence between ESG investment strategy and underlying holdings – an ESG Investment
Vehicle should set minimum thresholds3 for investments aligned to its sustainability-related goals and disclose such thresholds to investors. Where an ESG Investment Vehicle does not set such minimum thresholds, it should communicate clearly to investors that it has not done so 3 As an example, in its guidelines for funds’ names using ESG or sustainability-related terms, the European Securities and Markets Authority outlines an expectation that if a fund has any ESG-related words in its name, a minimum proportion of at least 80% of its investment should be used to meet the environmental or social characteristics or sustainable investment objectives.
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4.11 Disclosures in plain and simple language - disclosures around the ESG investment strategy to
be pursued by an ESG Investment Vehicle should be made in plain and simple language and aim to ensure investor understanding. The disclosures should explain how the investment strategy will fulfil an ESG Investment Vehicle’s ESG objectives, the ESG factors being used, the types of assets that may be held, and clarify terms that may not be universally or well understood, particularly in the case of retail investors.
4.12 Use of indicators and metrics - where an ESG investment strategy aims to achieve measurable
ESG impact, the FSRA expects that an ESG Investment Vehicle employing that strategy will provide clear disclosures around:
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4.13 Impact strategy – where an ESG Investment Vehicle intends to follow an impact strategy, it
should clearly define and communicate this strategy to investors. In doing so, investors should be made aware of the ESG issues or challenges that the ESG Investment Vehicle aims to address, the target beneficiaries or stakeholders, the expected outcomes and impacts, and the indicators and metrics to measure and report performance and/or effect. Where appropriate, an ESG Investment Vehicle should demonstrate how its impact strategy incorporates the views and interests of affected communities and stakeholders into the design and implementation of the investment strategy.
4.14 Additionality – we encourage an ESG Investment Vehicle to consider adopting the concept of
additionality in developing its ESG investment strategies and associated disclosures to investors, which should consider and disclose the following information. (a) How its investment strategy is creating or enhancing a positive ESG impact that goes beyond what would have occurred in the absence of the deployment of such strategy. Where an ESG Investment Vehicle adopts a strategy of exclusionary investing, it should seek to demonstrate how that investment strategy may yield positive ESG impacts. (b) Evidence to support its claims that its ESG investment strategy has provided or will provide additionality, particularly in the case of an impact strategy, supported by a rigorous and credible methodology for assessing the level of additionality that has been achieved or is being sought. (c) Where applicable, an assessment and mitigation of any potentially negative or unintended ESG impacts of the ESG Investment Vehicle’s investments.
4.15 Stewardship – where an ESG Investment Vehicle undertakes stewardship to influence certain
outcomes in line with its ESG targets, it should:
(a) explain its rationale for engaging with particular investee companies to influence change in their behaviours; (b) provide details regarding the ESG Investment Vehicle’s approach to stewardship, including the aims of the ESG Investment Vehicle’s approach; (c) explain how those stewardship activities are aligned with its objectives, with examples of progress; and (d) provide updates on its progress or case studies of successful engagement(s) where it has undertaken stewardship activities. If proxy voting is an active part of an ESG Investment Vehicle’s stewardship activities, we encourage it to provide details of its proxy voting policies and procedures to investors, and to consider making its proxy voting records available to them. The aim of this would be to facilitate transparency and support a greater understanding of how the ESG investment strategy will be implemented through stewardship in practice. Other examples of disclosures that an ESG Investment Vehicle can provide to investors regarding stewardship activities may include its stewardship policy and/or engagement policy,
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5. ESG TAXONOMIES
5.1 In its existing regulatory framework for Green Funds, Climate Transition Funds, Green Portfolios
and Climate Transition Portfolios, the FSRA advocates the use of independent, third-party, published and credible taxonomies as a basis to select assets which are environmentally sustainable or, in the case of climate transition, in the process of becoming so. The FSRA provides examples of such taxonomies in its supplementary guidance4 . We encourage that a similar approach be applied to an ESG Investment Vehicle’s selection of assets.
5.2 The use of a published, credible, independent, third-party taxonomy for the purpose of asset
selection is preferable in order to help clarify the practical meaning of “ESG” in the context of that product or service. Where an ESG Investment Vehicle does not use an established ESG taxonomy, it is more likely that there will potentially be a mismatch between an investor’s individual interpretation of ESG and that applying to the ESG Investment Vehicle. This is a particular risk in terms of social issues, where the concept of a ‘positive’ social outcome may mean different things depending on culture, political persuasion or religious orientation.
5.3 There are a number of taxonomies in relation to environmental aspects that enjoy a high level of
recognition, however, stakeholders may not always be aware of credible, independent and published taxonomies that address social or governance aspects, or that consider ESG factors as a combination (i.e. E + S + G, together). Guidance
5.4 Taxonomy as a basis to establish common understanding – the FSRA is of the view that an ESG
Investment Vehicle should employ the use of an appropriate ESG taxonomy or an internationally accepted standard or framework5 as the basis upon which to determine what ESG investing represents in the context of its investment objectives and policy. It should be noted that the Guidance above is not relevant where an ESG Investment Vehicle uses an ESG benchmark or index as a basis for selecting assets, which is addressed in section 7 of this Guidance.
5.5 Selection of a taxonomy – an ESG Investment Vehicle should consider the following when
selecting an ESG taxonomy:
(a) The coverage and granularity of the taxonomy, standard or framework, i.e. whether it:
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8. DISCLOSURE AND MARKETING
8.1 An ESG Investment Vehicle should not exaggerate its ESG-related features or practices. ESGrelated information should be disclosed in a manner that is clear, fair, and not misleading. Our
expectations, as set out in this Guidance, address various areas in which the risk of greenwashing arises.
8.2 In addition, we encourage industry participants to contribute to industry-led efforts to achieve
improved alignment on definitions and commonly used terms.
Guidance
8.3 Greenwashing – we expect an ESG Investment Vehicle to, at a minimum:
(a) accurately describe the extent to which an ESG Investment Vehicle is focussed on ESG factors or goals and be clear about which of the ESG factors or goals it is focussed on; (b) provide appropriate qualifications, limitations or explanations when making ESGrelated claims; (c) not make ESG performance-related claims that might be considered misleading where those claims:
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8.6 Suitability – an ESG Investment Vehicle should ensure appropriate disclosures are provided to
investors around the characteristics and types of investors for whom the investment is suitable. If there are investors for whom the investment product or service is not suitable, this should be adequately highlighted. Further to the Guidance above about not conflating the “E”, “S” and “G” components inappropriately in the name of a Fund or Model Portfolio, an ESG Investment Vehicle should ensure that suitability-related disclosures do not conflate the separate aspects of ESG. If an ESG Investment Vehicle is focussed on particular ESG aspects, the suitability disclosure should adequately differentiate the particular types of investors for whom the product is appropriate given its ESG focus.
8.7 Educating investors - we encourage ESG Investment Vehicles, as well as other financial services
industry participants, to provide or direct investors to resources regarding the topic of ESG investment strategies, including, where appropriate, this Guidance.
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Source: Financial Services Regulatory Authority — original document · Summary generated with machine assistance and reviewed before publication; the authoritative text is the regulator's original document. How RegAlert works
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