[co-authors: Ruth Butterworth and Radu Suciu]

The United Kingdom’s Financial Conduct Authority (FCA) has issued proposed rules to establish a U.K. sustainability disclosure regime (SDR) providing a U.K. take on a topic many investment managers have been dealing with in preparation for the European Union’s (EU) Sustainable Finance Disclosure Regulation (SFDR)¹, the proposed disclosure rules by the U.S. Securities and Exchange Commission (SEC) relating to environmental, social and governance (ESG) issues, and other proposed regulations.

The rules are subject to consultation until January 25, 2023, but are expected to require both manager-level and product-level disclosures, introduce a fund labelling regime and set out anti-greenwashing guidance. The rules are expected to be finalized by the end of Q2 2023, with disclosure rules applying from 2024 and reporting commencing in 2025. The current proposals apply to certain FCA-regulated firms. The below focuses on examining key impacts on UK investment managers. Read on for further details.

Background

Further to the U.K. Government’s Roadmap to Sustainable Investing published in October 2021, the FCA has issued a consultation paper (“CP 22/20”) on its proposed regime of sustainability disclosure rules. CP 22/20 builds on responses to the discussion paper on sustainability disclosure requirements and investment labels and furthers the FCA’s anti-greenwashing initiatives. Relatedly, the proposal is aimed at increasing transparency regarding the sustainability of investment products and facilitating like-for-like comparisons, particularly for retail investors.

Summary of key proposals

At a high level, the FCA’s proposals introduce:

• Sustainable investment labels (SILs), used at the option of in-scope firms selling in-scope products, provided that they meet the requisite criteria. These criteria are intended to substantiate claims of sustainability by setting clear, explicit objectives and requiring additional reporting on performance against these objectives on an ongoing basis². The FCA has proposed three mutually exclusive SILs: (1) sustainable focus, (2) sustainable improvers and (3) sustainable impact.
• Product-level sustainability disclosures, being pre-contractual disclosures for sustainable products, as well as pre-contractual consumer-facing disclosures applicable to all products (including those without a sustainability focus). On-demand disclosures are also to be provided to investors seeking additional information, while more detailed product-level sustainability reporting is required for certain firms.
• Firm-level sustainability disclosures applicable to firms with £5 billion or more assets under management (AUM), in the form of an annual sustainability entity report focusing on governance processes surrounding sustainability risks and opportunities.
• Requirements for distributors (including platforms and advisors) of in-scope products to retail investors, to ensure that product-level information, including any SILs, is made available.
• Naming and marketing rules restricting the use of certain sustainability-related terms (e.g., “ESG” and “green”) in marketing in-scope products to retail investors where the product does not have a SIL³.
• A general “anti-greenwashing” rule applicable to all managers, specifying that sustainability-related claims must be clear, fair and not misleading.

Scope

While the anti-greenwashing rule is applicable to all FCA-authorized firms, the remaining proposals apply to U.K. Markets in Financial Instruments Directive (MiFID) portfolio managers, Undertaking for Collective Investment in Transferable Securities (UCITS) management companies of U.K. UCITS and U.K. Alternative Investment Fund Managers (AIFMs) in respect of authorized and unauthorized funds (including investment trusts) and certain portfolio management services, as well as distributors of those products. They apply principally with respect to strategies and products that are focused on sustainability or ESG, but some requirements apply to all managers, even those without any sustainability or ESG focus.

Extraterritorial Application: The FCA has noted that it intends to seek further consultation on the applicability of the proposed rules to non-U.K. investment managers at a later date.

When will the rules take effect?

The FCA intends to publish the rules in a policy statement by the end of the first half of 2023, with the anti-greenwashing rule becoming effective immediately upon publication. The SIL regime, additional consumer-facing and pre-contractual disclosures, naming and marketing rules, and requirements on distributors would take effect 12 months later. This would be followed by the ongoing product- and entity-level disclosures, which are expected to take effect 24 months after publication of the rules, subject to some exceptions⁴.

The FCA notes that the product-level disclosures may be further updated to align with the U.K. Green Taxonomy, once developed.

Interaction with SFDR requirements and SEC proposals

The FCA has described how it considers the SFDR requirements and the SEC proposals to interact with the SDR. In particular, the FCA highlights that although there is some overlap between the SILs and Article 8 and Article 9 products under the SFDR, there will likely be some Article 8 products that will not meet the criteria for any SIL. However, the FCA’s disclosure requirements under the SDR are less technical and data-focused, and do not apply the “do no significant harm” test. CP 22/20 also includes tables comparing the entity- and product-level disclosure requirements under the SDR against the SFDR and the SEC proposals.

We have set out a more detailed discussion of the proposals in the Annex accessible here. We continue to follow the development of the proposals.

¹EU Regulation 2019/2088 on sustainability-related disclosures in the financial services sector.

² Where a firm is in-scope by virtue of its role as a portfolio manager (see “Scope” below), 90 percent of the assets in the portfolio must use the relevant SIL in order for the portfolio itself to be eligible for that SIL.

³ Portfolio managers with a portfolio consisting of 90 percent of assets using a SIL are exempt from these restrictions, provided the terms used are not misleading.

⁴ For portfolio managers, the proposals in respect of consumer-facing disclosures and the naming and marketing rules would come into effect after 18 months.