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ESG is no longer a synonym for sustainable; it’s increasingly used as a financial risk metric that any investor should consider, given that ESG issues can cause financial harm to a company.Delcia Lopez/The Associated Press

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Get ready for another terrible metaphor courtesy of the fund management industry: it’s trying to make “green bleaching” happen.

Most investors have accepted reluctantly that greenwashing, a play on whitewashing, in which companies or funds pretend to be more environmentally friendly than they really are, has become a mainstream term in finance.

Greenwashing is an accusation levied at the finance industry and is the reason that global regulators have paid more attention to how supposedly green funds are marketed to consumers. In the U.K., the Financial Conduct Authority (FCA) plans to announce new rules on what funds count as sustainable this summer, as part of its sustainable disclosure requirements (SDR).

The regulator estimates that only a third of funds that currently call themselves sustainable will remain in that category, so fund managers are heading for quite a big shake-up.

But the fund management industry, while insisting that it is, of course, supportive of the need to clamp down on greenwashing, has reservations.

In particular, it worries that the rules will be so restrictive that they stop some funds it considers sustainable from being allowed to call themselves that. So, it’s hitting back with its own term: green bleaching.

At issue are funds that exclude certain sectors: for example, funds that don’t invest in any fossil fuels. At the moment, they can call themselves sustainable if they want to. But the FCA thinks that this is too loose a definition. It carried out research on consumers and found that most thought sustainable meant actively doing some good.

In fact, 81 per cent of adults would like the way their money is invested to do some good as well as provide a financial return, according to the FCA. With that in mind, it’s planning to create three main categories for sustainable funds: sustainable focus, sustainable improvers and sustainable impact. Funds that simply exclude certain sectors won’t be able to call themselves sustainable at all.

The funny thing is many consumers take their first steps toward sustainable investment by requesting exclusions. Some research has found people often decided to invest sustainably after discovering to their horror that they were invested in, for example, a big oil company through a standard mutual fund or their workplace pension.

So, the first thing they do is look for places to put their money that don’t cause harm – as they define it, of course. Excluding sectors is an old game in finance and started off with gambling or arms. The difference of opinion between what “causing harm” and “sustainable” actually means is what makes this exercise so tricky.

The FCA has been consulting the industry on its planned changes since the end of 2021, and one of its initial ideas was to create a separate category for such funds and call them not sustainable but “responsible.”

That idea has now been scrapped. But it does seem to fit with the mindset of a group of retail investors who may not need to feel that their investments are actively doing good, just that they’re not doing harm in certain core areas.

Emma Wall, head of investment analysis at Hargreaves Lansdown PLC, points to Aegon Ethical Equity Fund, which describes itself as having “green-led client exclusions at its heart,” as one that might not fall under the new definition of sustainable.

Of course, the case against allowing funds to call themselves responsible is that it might be too wide a term. Is a fund that considers environmental, social and governance (ESG) issues when making investment decisions responsible? Sure, but only in the way that any fund, sustainable or not, should be responsible.

ESG is no longer a synonym for sustainable; it’s increasingly used as a financial risk metric that any investor should consider given that ESG issues can cause financial harm to a company.

The FCA is also keen to avoid the experience of the European Union, in which new categories for sustainable funds have caused a scramble for some funds to attain what’s seen as a higher sustainability standard – the Article 9 label – while the Article 8 label is akin to the looser “responsible” term.

The FCA thinks ditching the responsible category is a reasonable price to pay for cracking down on greenwashing. The Investment Association, which represents U.K. fund managers, does not. But it seems likely a bone might be thrown on this issue by the summer.

There are more practical points to consider. The Treasury’s subcommittee for new financial regulations complained this month that nobody had yet worked out how much these new regulations would cost the consumer.

These won’t just be broad costs of implementing new rules. Retail investors who discover their recategorized fund isn’t really sustainable may want to shift their money elsewhere. This could incur transaction costs.

There is also some concern over larger-scale sell-offs. Big investors such as pension institutions might have a mandate to invest in sustainable funds – so if their target fund is no longer classed as such, they might also want to move, which could affect the fund. Working out the impact of all this remains on the FCA’s to-do list.

Then there’s the issue of fines for greenwashing. So far, despite the FCA complaining that investors and funds have been misleading consumers about how sustainable their products are, it hasn’t actually fined anyone.

This could partly be because it’s been hard to define misleading when it comes to the subjective issue of what’s considered sustainable. It’s easier to fine a bank for failures in money laundering controls because the harm is a lot easier to pinpoint.

If a fund is greenwashing, the harm may only lie in the consumer not getting what they thought they were getting. But that may not constitute a financial risk to their capital. Imagine if they didn’t know they were invested in oil in the first quarter of 2022, for example, and others may disagree over whether the fund was definitely breaking the rules because there’s no clear definition of sustainability anyway.

Proper rules should clear up some of this ambiguity. If these things are set in stone from the summer (with a window of around a year for the fund management industry to sort itself out), then we may see more enforcement in this area from the FCA.

That would bring it up to speed with other regulators after the U.S. Securities Exchange Commission last year started slapping financial firms, such as Goldman Sachs Group Inc., with ESG-related fines, while Deutsche Bank AG and DWS Group, its majority-owned asset management arm, were raided by German police after a probe into greenwashing allegations by the German regulator.

Overall, it is a good thing that the FCA is doing this, and it is bound not to please everybody with its new definitions. The overarching aim is to make the U.K. a trusted place to invest sustainably and for consumers to understand what they’re getting.

By culling the range of options through stricter definitions, that should allow the industry to expand in a healthier way. And the sooner that industry and regulators agree on the new rules, the less we may have to hear about green bleaching.

Alice Ross is an FT contributor.

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