Implementing the FCA’s Sustainability Disclosure Requirements

The FCA has proposed wide-ranging Sustainability Disclosure Requirements (SDR) for wealth, fund and asset managers. These include a product labelling regime, mandatory entity- and product-level disclosures, restrictions on the use of certain sustainability-related terms, and an anti-greenwashing rule.

This article recaps the latest developments, challenges with the proposals, and offers practical insights into how firms can approach “no regret” actions ahead of publication of the final rules.

Key actions for firms:

Carry out a scoping and product classification exercise to identify which products are in scope and whether any uplifts are required.
Conduct a post-implementation review of SFDR to identify lessons learned and enhancement opportunities for SDR implementation.
Review whether we have appropriate resources, governance and organisational structures to support our products' disclosed characteristics and sustainability objectives.
Assess the adequacy of our approach to stewardship, and whether appropriate technology for monitoring, recording and reporting engagement is in place.
Review to what extent potentially prohibited sustainability-related terms are in our marketing materials, and how we could use a technology-enabled solution to assist identification and monitoring.

Recent developments and the wider context

The UK regulatory landscape for ESG has continued to evolve since the publication of the SDR consultation paper in October 2022. The Government has set out its revised Green Finance Strategy which includes updated plans for a UK green taxonomy, and the FCA has published a wide-ranging discussion paper on embedding sustainability in firms.

Due to the “significant” volume of feedback provided on the SDR proposals, the FCA announced in March that it would delay the publication of its final rules to consider industry comments. In the meantime, the Treasury Sub-Committee on Financial Services Regulations has been scrutinising the proposals.

Meanwhile in the EU, amidst calls to reposition the Sustainable Finance Disclosure Regulation (SFDR) as a labelling rather than a disclosure regime ahead of a wider review later this year, the authorities have published another round of clarifications and proposed changes (for a summary and commentary on these developments).

The SDR policy challenges

The FCA's SDR proposals are wide-ranging and have attracted significant feedback from the industry. Some of the key challenges centre around the:

Significant gap between the existing shape of the market and the stringent labelling criteria — potentially requiring a fundamental re-engineering of sustainable investment products and reducing the overall universe of these funds.
Potentially high degree of regulatory divergence with other regimes such as SFDR (with implications for both product design and cross-border marketing, creating operational complexity).
Stringent proposed approach to marketing restrictions (potentially requiring a large “scrubbing” exercise to remove such terms), with the industry proposing at least a carve out for the term "responsible".
Apparent focus on actively managed equity funds, with potentially less consideration given to other asset classes and investment vehicles in the passive, fund of fund, wealth management and alternatives space (leading to compliance challenges for those asset classes and a potentially uneven playing field).

In response, the FCA has stated that it will carefully consider the industry's feedback on some of these points (for example on the approach to marketing restrictions, the label criteria, and wider asset classes). In addition, it notes that the policy statement will clarify matters “such as that primary and secondary channels for achieving sustainability outcomes are not prescribed”, and that it will not require independent verification of labels. The FCA also indicates that it may cater for products with sustainability-related characteristics that do not qualify for a label.

It remains to be seen how the FCA will address the feedback by making adjustments to its original proposals, and the precise nature of the final rules that will be published in Q3.

Preparing for SDR implementation

In the meantime, firms can still take proactive and practical steps to prepare for the SDR implementation challenge.

Firms should set out a roadmap for SDR implementation that should include the following steps:

Scoping and product classification exercise: The first step is to identify in-scope entities and products. Then, a detailed analysis of products against the general and specific labelling criteria should reveal the extent of alignment and the scale of change needed to meet the labelling requirements (if desired). Based on our experience with SFDR, it is likely that firms will need (or want) to make product changes.
Impact and gap analysis: A gap analysis can identify the specific product changes that are needed, as well as the disclosure requirements and oversight arrangements based on the SDR profile of the product suite.
Labelling operating model: The implementation of a labelling operating model and a consistent approach to the labelling criteria should help ensure ongoing compliance and delivery of necessary enhancements to investment management, oversight, product review and approval, and stewardship processes.
Disclosure production: Once these steps are completed, efforts can turn to putting in place a framework to prepare consumer-facing, entity-level and ongoing sustainability reports at scale.

Firms should use the lessons learned from SFDR implementation given the significant challenges here. A post-implementation review of SFDR implementation can help identify what worked well and where things could have been done better. Given that SDR is not highly prescriptive, firms may be able to leverage aspects of existing data capabilities and content from SFDR disclosures to meet some of the requirements and to react more quickly once the final rules are published.

ESG governance considerations

More broadly, firms will need appropriate governance and oversight arrangements to meet the SDR requirements.

In the context of the general criteria to use a label, this includes having “appropriate resources, governance and organisational arrangements commensurate with the delivery of the sustainability product's sustainability objective.” These proposed requirements focus on having appropriate resources, skills, expertise, and oversight by governing bodies, due diligence over data sources, and robustly supporting the investment policy and strategy through an aligned culture and purpose.

Firms should therefore proactively review:

Whether there are sufficient resources and expertise, as well as clear roles and responsibilities for greenwashing risk management across the relevant areas of the business.
Whether appropriate governance structures and oversight forums have been established to oversee the approach to sustainability.
How existing sustainable investment frameworks can be enhanced.
Any revisions to policies and procedures that may be required.

This review will support the more specific considerations in the implementation roadmap above.

Implications

Ahead of publication of the final rules, firms should be taking steps to prepare for the introduction of the SDR regime, such as undertaking an SFDR post-implementation review, as well as reviewing governance arrangements and controls to prevent greenwashing.

The expected timing of the final rules also presents an opportunity for firms to draw on lessons learned from implementation of the Consumer Duty and any overlapping areas (for example, on the Consumer Understanding outcome).

If you need assistance with understanding and implementing the SDR requirements, please get in touch.