The Financial Conduct Authority (FCA) has published its highly anticipated consultation (PDF 2MB) on proposed Sustainability Disclosure Requirements (SDR) and investment labels.
Overview of the FCA's proposals
The consultation, originally planned for Q2 2022, follows on from the FCA's 2021 Discussion Paper (PDF 485KB) and proposes:
- Sustainable investment labels for investment products based on the nature of the product's investment objective and how it purports to promote positive sustainability outcomes.
- Consumer-facing product-level disclosures that summarise the sustainability characteristics of products with a focus on retail investors.
- More detailed sustainability disclosures aimed at a broader range of stakeholders, including pre-contractual and ongoing performance disclosures at product level, and entity-level disclosures.
- Product naming and marketing rules to prevent firms using sustainability-related terms in product names and retail-facing marketing materials unless the product in question qualifies for one of the sustainable labels.
- A general “anti-greenwashing rule” for all regulated firms.
- Rules to ensure distributors provide sustainability information to consumers.
The wider UK context
The proposals build on the FCA's existing requirements (PDF 825KB) implementing the recommendations of the Task Force on Climate-Relate Financial Disclosures (TCFD) and codify aspects of the FCA's guiding principles. In future, the FCA intends to revisit the requirements to incorporate the work of the International Sustainability Standards Board (ISSB) once adopted. Similarly, the UK Green Taxonomy is still to be developed, but the proposed SDR could be enhanced in future to incorporate its definitions. There are also links to broader regulatory initiatives, including the FCA's incoming Consumer Duty.
The proposals open the door for wider consultations to take place. The FCA specifically sets out intentions to consult further regarding requirements for overseas funds marketing in the UK, financial advisers and investors' sustainability preferences, and asset owners.
Firms and products captured by the requirements
Firms that manage investment products for retail investors and their products will be captured by the product labelling and disclosure rules. These include wealth, fund and asset managers (specifically, firms providing portfolio management services such as UK MiFID firms, as well as UK UCITS Man Cos and UK AIFMs).
There are limited exclusions, including feeder funds or funds in the process of winding up. Some of the product level disclosures apply in a modified way for portfolio management services and UK AIFMs which manage unauthorised AIFs — for example, firms will not be required to produce product level disclosures in connection with portfolio management services but will be required to provide access to the relevant disclosures for the underlying products. Overseas funds are not yet in scope but may be in the future.
Distributors of in-scope investment products, including platforms and financial advisers, will be subject to more limited requirements. These centre around displaying labels prominently and making the labels and consumer facing disclosures available to investors. Although overseas products are currently out of scope, distributors of such products to retail investors will need to display a warning that the products are not subject to the UK requirements.
All FCA-regulated firms will be impacted by a new anti-greenwashing rule, which will reaffirm existing requirements, that information provided to consumers is clear, fair and not misleading, and link them directly to sustainability claims. The rule will also capture the approval of financial promotions.
Product labels
Compared with the Discussion Paper, the FCA has reduced the proposed categories of mutually exclusive and non-hierarchical labels from five to three:
- 'Sustainable focus': Products with an objective to maintain a high standard of sustainability in the profile of assets by ensuring 70% of the portfolio meets a “credible standard of environmental and/or social sustainability” or aligns with a specified environmental and/or social sustainability theme.
- 'Sustainable improvers': Products with an objective to deliver measurable improvements in the sustainability profile of assets over time.
- 'Sustainable impact': Products with an explicit objective to achieve a positive, measurable contribution to sustainable outcomes.
In-scope firms will be able to voluntarily label their products if they meet the relevant criteria for each category. However, to do so the firm and product must meet the “qualifying criteria” that underpin the labels. The criteria include five overarching principles, “cross-cutting” considerations associated with the principles and category-specific considerations relevant to each label.
Importantly, although it may challenge firms' selection of labels, the FCA will not approve them, and firms will be responsible for ensuring they have chosen an appropriate label and for conducting and documenting a review on the appropriateness of the label on an annual basis.
All other products will have no sustainability label. If a product does not have one of the three sustainability labels, but has environmental, social or governance characteristics as an integral part of its strategy, the product name and its marketing and associated communications will need to comply with the naming rules and firms will need to produce a truncated pre-contractual disclosure as well as the consumer facing disclosures required for all other products.
Having considered requirements around independent verification of labels in its discussion paper, the FCA has decided not to proceed with a mandatory requirement. However, it will encourage firms to seek verification if they think it will benefit their clients.
Product level — consumer-facing disclosures
Consumer-facing disclosures are intended to help retail investors understand a product's features and its objectives, and will need to be presented alongside existing disclosures. Even if firms choose not to adopt a label for a product, the disclosures will still be required.
The information presented will need to include information about a product's sustainability objective and how much progress has been made against the objective. The investment policy and approach to stewardship should be disclosed, alongside ongoing Key Performance Indicators (KPIs) to measure progress to the sustainability objective. If unexpected investments have been made (i.e. those a consumer may not typically associate with the sustainability objective), this should be disclosed. Although the FCA has not proposed a disclosure template, it will encourage industry to develop one.
Firms will need to be mindful of the new Consumer Duty rules, effective from July 2023, and consider how they will test, monitor and adapt their communications and disclosures to enhance consumer understanding. The FCA has signalled that it expects firms to undertake consumer testing in connection with the disclosures, and has undertaken its own research (PDF 1.6MB) which could serve as a minimum benchmark for firms to use when undertaking consumer duty testing.
Product level — more detailed disclosures for a broader audience
Two types of disclosures are proposed to deliver more granular information:
Pre-contractual (“Part A”) disclosures will need to be made in a dedicated section of the fund prospectus and published in a prominent place for products that use a label, and for products that don't use a label but adopt integral sustainability-related features. The disclosures would cover details of the product's sustainability objective, investment policy and approach to stewardship, as well as disclosing whether any unexpected investments have been made.
Ongoing “sustainability product reports” (“Part B”) disclosures will follow on from the pre-contractual disclosures and inform stakeholders of the ongoing performance of the product. They will only be required for products that use a label and will build on existing TCFD product reports. Where the UK requirements ramp up in the future (e.g. through future adoption of ISSB standards) the reporting requirements for these disclosures may also increase.
As part of an ongoing product report, the sustainability objective and progress towards it should be disclosed. KPIs which allow stakeholders to assess the stewardship and progress towards the sustainability objective should be provided.
For UK AIFMs managing unauthorised AIFs, or firms providing portfolio management services, modified reporting requirements apply.
Entity-level disclosures
Entity-level disclosures also build on the FCA's requirements for TCFD-aligned reporting and will roll out gradually depending on the value of firms' assets under management (AUM). These disclosures must be made prominently on the firm's website. In a similar fashion to TCFD implementation, cross-referencing to other firms' reports will be allowed under certain circumstances.
Four core disclosure requirements will be based on the TCFD's recommendations relating to governance arrangements, actual and potential impacts of sustainability-related risks and opportunities, the risk management process and metrics and targets used by the firm to manage sustainability risks.
Firms may find it helpful to refer to the ISSB's standards to consider the types of disclosures to be made in relation to sustainability-related risks and opportunities more broadly.
Naming and marketing rules
In addition to the new, general “anti-greenwashing” rule, requirements around product naming and marketing will apply to all investment products available to retail customers which do not qualify for or use a label. The requirements will restrict the naming of these products and their communications and marketing — including prohibiting the use of terms such as 'green', 'sustainable' or 'ESG' in retail-facing marketing materials. However, the prohibition will not apply for the purposes of disclosing factual information in required SDR disclosures or other disclosure requirements, for example to disclose that an unlabelled product follows an ESG-tilted benchmark. Products only offered to institutional investors will be exempt from this requirement.
Interaction with EU requirements
Although the proposed SDR is not incompatible with EU Sustainable Finance Disclosure Regulation (SFDR), it is not aligned. There is a large gap between the defining criteria of the SDR labels and SFDR Article 8 and 9 products. As such, SFDR Article 8 and 9 products may or may not meet the SDR product label criteria and cannot be translated across without interpretation. Where an SFDR Article 8 or 9 product is largely aligned to an SDR label, it is likely that some uplifts will be required to meet the SDR label requirements in full.
At entity-level, SDR builds on existing TCFD framework disclosures and the intention is to update the requirements to incorporate ISSB disclosures as they are adopted in the UK. As such, no principle adverse indicators statement is required, unlike SFDR.
At product level, SFDR and SDR both require pre-contractual, ongoing and entity-level disclosures. But unlike the SFDR where the EU authorities have mandated reporting templates, the FCA is not mandating reporting templates to meet SDR requirements. The format and content of disclosures will be left up to firms to determine, and the FCA will encourage industry-led innovation. Additionally, the 'do no significant harm' disclosures required under the SFDR will not be required under the SDR proposals. In the future, the FCA may consider disclosure of a baseline of sustainability metrics.
Considerations for firms
The scale of the challenge for the industry is clear. The FCA estimates that 450 funds and over 1,500 asset managers with £10.6 trillion of AUM could be impacted by aspects of these proposals. Although some requirements would be implemented on a phased basis, others are more imminent. Firms should act now to understand the nature of their investment products in the context of the new rules and their exposure to various disclosure requirements. This means carrying out a detailed scoping and product classification exercise to determine the extent of alignment of existing products with the proposed labels and any uplifts required to attain the most appropriate label.
Firms should consider the findings of the FCA's recent mapping exercise and consider the areas where existing products with sustainability-related features do not currently meet its criteria. For products which have an existing sustainability objective, firms should ensure that it is sufficiently specific and measurable, and that the outcomes of the objective are well-defined. And where the investment policy and strategy are aligned to sustainability outcomes, the disclosures which accompany this strategy should be detailed, including how they are measured — this includes disclosing appropriate KPIs.
For products that are not likely to attain a label, firms should assess the extent to which they are exposed to the proposed ban on sustainability related-terms in marketing literature.
Given the busy regulatory agenda, SDR should not be implemented in isolation, but in parallel and with consideration to wider initiatives. In particular, there are clear links to the Consumer Duty requirements that the industry is currently busy implementing.
Provisional implementation timeline
- 25 January 2023: Consultation period ends.
- By 30 June 2023: Policy statement confirming SDR rules to be published. Anti-greenwashing rule for all FCA-regulated firms comes into force.
- From 30 June 2024: Rules on product labels, initial disclosures, product naming and marketing come into force.
- From 30 June 2025: First ongoing product-level disclosures required, including part B reports.
- From 30 June 2025: Largest in-scope firms with more than £50 billion AUM make their entity-level disclosures.
- From 30 June 2026: All other in-scope firms with more than £5 billion AUM make their entity-level disclosures.
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