ESG Index Demand Grows but UK Financial Conducts Authority (FCA) Warns That Misleading Benchmarks are Creating a ‘Trust Deficit’ for ESG ETFs


The number of environmental, social, and governance (ESG) benchmarks and indexes demanded by the asset management community has grown at an unprecedented rate over the past two years. That’s according to the latest survey of the Index Industry Association (IIA) members.

Unpacking these high-level numbers, ESG indexes have expanded beyond more traditional areas of integration into new asset classes and strategies. The IIA queries their membership each fall in their annual benchmark survey to understand where the index industry’s growth is coming from. Last fall, the IIA found the number of ESG indexes increased 85% over the last two years.

In their most recent ESG Global Asset Manager Survey they found that ESG factors are even more important to global asset managers today than they were a year ago. A full 85% of asset managers reported that ESG has become a larger priority within their company’s overall investment strategy in the past year.

In a Dear CEO Letter published on 8 September, the FCA said it had concerns over the way benchmarks are being constructed and branded with particular issues around ESG benchmarks. Misleading construction of ESG benchmarks has the potential to create a “trust deficit” for investors of sustainable ETFs, the Financial Conducts Authority (FCA) has warned.

It said the subjective nature of ESG factors and how data and ratings are incorporated into benchmark methodologies mean they “may not align with the expectations of their users and/or end investors”.

“We have concerns that some benchmark administrators have not accurately described the economic reality that their benchmarks measure,” Edwin Schooling Latter, director of infrastructure and exchanges at the FCA, said.

“Poor design, description and naming of benchmarks, including ESG benchmarks, could create a trust deficit in the market for passively-managed sustainable investment products.”

Good quality disclosure for ESG benchmarks is vital for both intermediaries and investors so they can accurately assess the market and the sustainability claims of the benchmark.

The scrutiny comes at a time when asset managers are increasingly labelling their products either Article 8 or 9 under the Sustainability Finance Disclosure Regulation (SFDR). In Q2, 700 products switched their SFDR status with the majority upgrading from Article 6 to Article 8, according to Morningstar.

The FCA states that where the methodology for the ESG benchmark uses ESG ratings provided by a third party (e.g., an ESG ratings provider) to determine its constituents, benchmark administrators should ensure that the underlying rating methodology is clearly presented and explained to users.

More forward-thinking asset managers are increasingly building out their own ESG and Sustainability research, data analysis, ratings and risk control functions. Third party provider’s ratings and data are likely to remain an important input into these processes but driving their own analysis is now very much a key objective.

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