The Financial Markets Authority (FMA) has released guidance on financial products that integrate non-financial factors such as natural, social and human capital impacts along with financial returns (integrated financial products). The guidance sets out how the fair dealing provisions of the Financial Markets Conduct Act 2013 (FMCA) apply to integrated financial products.
The FMA has also updated its Green Bonds information sheet to clarify the application of same class exclusions for vanilla bonds that have undergone the ‘greening’ process.
Links to the guidance,media release and information sheet.
Who needs to read it? Why?
All issuers, supervisors and arrangers of financial products should carefully note this guidance, as it sets out the FMA’s expectations on the disclosure of integrated financial products following the industry feedback collected by the FMA in October 2019. In particular, climate-related claims will come under increased scrutiny over the next year, as the proposals for TCFD-style climate related financial reporting are consulted on next year.
This guidance will be of particular interest to bankers, issuers in the sustainability space and managers of funds (including KiwiSaver) who have responsible investing policies. The updated information sheet is particularly relevant to issuers of green bonds.
What does it cover?
Responsible investment guidance
The guidance sets out how fair dealing provisions in the FMCA apply to integrated financial products and the FMA’s disclosure expectations from issuers of such products.
Fair Dealing Provisions
The FMA expects issuers of integrated financial products to comply with the fair dealing provisions. In particular, issuers need to be able to justify the “green” label attached to an integrated financial product, specifically what sets it apart from a regular financial product. Evidence and support for this may be required to avoid breaching the fair dealing provision that prohibits making unsubstantiated representations.
The FMA has included a framework for issuers when disclosing non-financial features of their integrated financial products. The key disclosures are:
- Non-financial features: Where outlining the non-financial features of the product, issuers should include what the integrated financial product aims to achieve (for example, reducing carbon emissions by a certain amount by a particular date). To hold issuers accountable, the FMA expects that any non-financial outcomes be measured and reported on.
- Benefits of selecting that product: Where an issuer only invests in particular investments based on non-financial criteria, the issuer should set out details of that criteria and the benefits to the investor.
- How the issuer’s governance supports the product:The issuer should disclose how its governance framework supports the non-financial aims of the financial product, specifically, how the board shall integrate the financial and non-financial aspects of the product. Each issuer should have an integrated financial products policy (which may be contained in a SIPO for fund managers) that sets out the issuers environmental and social aims.
- Risks associated with the product:The FMA considers that integrated financial products have different risks that need to be considered and understood by investors such as the financial performance implications of choosing an investment that has other social or environmental aims.
- Consequences of failure:Issuers should disclose whether there are any consequences if the product fails to achieve its non-financial outcomes, such as the product losing its “green certifications” or what the investor’s options are if the issuer breaches its integrated financial product policy.
Green bonds information sheet
The FMA has updated its information sheet to clarify that vanilla bonds that have undergone a ‘greening’ process may have the benefit of the ‘same class exclusion’ in clause 19 of Schedule 1 of the FMCA. “Greening” refers to a process of re-characterising a vanilla bond as a green bond. The process typically involves the issuer being certified as green or establishing a green borrowing programme outlining, among various other topics, the existing assets being financed, and disclosing the basis for which these existing assets are now classified as green.
The FMA recommends that an independent third party reviews the assessment undertaken by the issuer in determining the bonds’ green classification. Issuers also need to disclose how the vanilla bond was “made” green and whether the terms of the bond have been varied. Issuers should engage with the FMA if they intend to rely on this exclusion.
However, the FMA has confirmed their view that an offer of green bonds off the back of an existing quoted vanilla bond cannot benefit from the exclusion because the features of a green bond (rights, powers and privileges) attach specifically to the green bond, making it of a different class from a vanilla bond. The FMA has acknowledged the market view that green bonds are the same class as vanilla bonds and that, as such, the same class exclusion should be available, but has rejected it. The FMA notes that individual exemptions are an option.
We welcome the FMA’s clarification of how issuers of financial products, who wish to claim environmental or social features, should disclose those features of their products. In particular, we welcome the FMA’s expectation that issuers of green products must be able to substantiate their “green” representations.
We welcome the FMA’s clarification that vanilla bonds which are “greened” can have the benefit of the “same class exclusion”. However, the FMA’s decision not to extend the exclusion to green bonds issued off the back of an existing quoted vanilla bond, will not please some market participants. In our view, subsequently issued green bonds should be considered as the same class for the purposes of the exclusion.
We still look forward to FMA’s setting out its views on how systemic risks, such as climate change risk, should be disclosed to investors, and how issuers are expected to engage with this global issue. By contrast, the Australian Securities and Investments Commission (ASIC) issued guidance on this area back in 2018, updated in 2019, highlighting climate change as a systemic risk that affects all issuers and which should therefore be addressed.
That the FMA pro-actively addresses that issue is all the more important since Climate Change Minister James Shaw announced in September 2020 the proposal to make climate-related financial disclosure mandatory, on a comply or explain basis, for some entities. See our previous alert on this here.
The Ministry of Business Innovation and Employment is currently working with the Ministry for the Environment on legislation requiring listed issuers and large banks, insurers and managed investment schemes to report on the impacts of climate change on their businesses. The objective of this legislation (likely to be an amendment to the FMCA) is to move to a position where the effects of climate change become routinely considered in business and investment decisions. It requires businesses to measure and report clear, comparable, consistent, timely and decision-useful information about their risks and opportunities arising from climate change. In parallel, the External Reporting Board (XRB) is currently preparing to consult on a standard to apply to financial years starting in 2022, but it is expected more issuers will move to comply voluntarily with the Taskforce on Climate-Related Financial Disclosure (TCFD) recommendations before then.
If you have any questions in relation to integrated financial products or green bonds or are considering how this guidance may affect your business, please contact one of our experts.