The UK’s financial services regulator, the Financial Conduct Authority (FCA), has delayed the release of its policy statement setting out the final rules of the Sustainability Disclosure Requirements (SDRs), leaving asset managers uncertain as to the nature of the impending changes to labelling and disclosure requirements. The policy statement, originally due to be published on 30 June 2023, has been postponed to Q4 2023 following extensive feedback received during the consultation period. Whilst it is likely that some aspects of the proposals outlined in the FCA’s consultation paper may change, we expect that the fundamental principles will remain the same. This update provides a summary of the key proposals and who will be affected.

Background

The market for sustainable investment products is growing rapidly. Aviva Investors’ Real Assets Study published in January 2023 found that 93% of global institutional investors actively consider ESG and sustainability in their investment decisions and Broadridge Financial Solutions has predicted that the global market for sustainable investment products will reach $30 trillion by 2030. It is therefore critical that investment products that are marketed as ‘sustainable’ satisfy objective, measurable criteria and adhere to standardised labelling conventions. There have been studies and recent media reports on ESG loans that question whether some borrowers and lenders cite a company’s vague and unsubstantiated ESG goals as the basis for identifying a loan as an ESG loan (known as “greenwashing”).

The SDRs aim to crack down on misleading sustainability-related claims and provide an integrated, economy-wide disclosure regime that will require standardised sustainability information to be made available to market participants.

SDRs in a nutshell

The FCA plans to combat greenwashing by introducing new rules in three key areas:

1. Sustainable investment labels

• The SDRs will introduce three sustainability labels which firms can choose to adopt for their products. These labels will seek to differentiate products based on their sustainability objective. The three proposed labels are:

• Sustainable Focus – for products which aim to invest in assets which a reasonable investor would regard as being environmentally and/or socially sustainable;

• Sustainable Improvers – for products which aim to invest in assets which cannot currently be objectively regarded as environmentally or socially sustainable, but for which there is scope to improve sustainability under the stewardship of the investment firm; and

• Sustainable Impact – for products which aim to achieve a positive, measurable contribution to real world sustainability outcomes by investing in solutions to environmental or social problems.

In order to qualify for a label, investment products will be required to satisfy certain criteria based on five overarching principles: (1) sustainability objective, (2) investment policy and strategy, (3) key performance indicators, (4) resources and governance, and (5) investor stewardship. Each of the overarching principles will be supported by a number of ‘cross-cutting’ considerations, and there will also be certain category-specific criteria which must be met depending on which label is chosen. The labels are intended to be mutually exclusive (since products are expected to have a clear sustainability objective) meaning that firms with blended strategies must determine which label (if any) is best suited to each of their products.

Once all qualifying criteria have been met, firms will be required to display the relevant label using one of the FCA’s trademarked graphics. The label must be displayed in pre-contractual disclosures (e.g. in a fund prospectus) and sustainability product reports (see below). Firms must keep a written record of the basis upon which they have qualified to use a label and provide such a record to the FCA on request. It is not currently anticipated that independent verification of qualifying status will be required.

2. Disclosures

The FCA’s proposals include three new types of sustainability disclosures:

• Consumer-facing disclosures – designed mainly for products targeted at retail investors, these must include basic information about the product such as its sustainability goal, investment strategy, product label (if any), sustainability metrics, and a list of ‘unexpected investments’, i.e. a summary of the types of investments that the firm would reasonably expect investors to find ‘surprising’ based on the sustainability credentials of the product.

• Product-level disclosures – similar in nature to the consumer-facing disclosures, these more detailed disclosures are targeted at sophisticated and institutional investors. Currently expected to be required only for products using a sustainable investment label, product-level disclosures will be divided into pre-contractual disclosures (to be made in the fund prospectus or prior information document) and disclosures to be made in a sustainability product report. Only full-scope UK Alternative Investment Fund Managers (AIFMs) are expected to be required to make pre-contractual disclosures initially, although the scope of the FCA’s proposals is expected to expand over time.

• Entity-level disclosures – to be made in a sustainability entity report containing information relating to the governance around sustainability-related risks and opportunities and the potential impact of these risks on the firm’s business.

3. Naming and marketing

Products which do not qualify for a sustainable investment label will be subject to certain naming and marketing restrictions. Those aimed at retail investors will be prohibited from using certain sustainability-related terms (e.g. ‘impact’, ‘green’, and ‘net zero’) in their product names and marketing materials, and all regulated firms will be subject to a general ‘anti-greenwashing’ rule. This will require that naming and marketing of products is clear, fair, and not misleading, and consistent with the sustainability profile of the product or service.

Who will be affected?

The proposed regime will initially apply to asset managers and their UK-based fund products and portfolio management services (including full-scope UK AIFMs and small authorised UK AIFs). The FCA plans to expand the scope of the regime in due course. Note that the general ‘anti-greenwashing’ rule will apply to all FCA-regulated firms as soon as it comes into force.

Interplay with EU SFDR and U.S. SEC proposals

The SDRs overlap with, yet are notably distinct from, the EU Sustainable Finance Disclosure Regulation (SFDR) and the proposed fund categorisation regime of the U.S. Securities and Exchange Commission (SEC). The nature of the EU/U.S. rules is outside the scope of this note; however, it is important to understand that the SDR framework is primarily designed as a labelling regime, with detailed criteria to determine eligibility. It therefore has a different starting point to both the SFDR and SEC proposals, which are primarily disclosure regimes imposing different levels of disclosure requirements depending on how a firm chooses to categorise its own products. Any product categorised under either the SFDR or proposed SEC regime will still have to satisfy the cross-cutting considerations and category-specific criteria before it can qualify for a label under the SDRs. The disclosure requirements are designed to be as coherent as possible with those under the SFDR and proposed SEC regime; however, there are expected to be some differences, for example, the SDRs will not require disclosure of principal adverse impacts. The SEC and SFDR’s efforts to curb greenwashing in the investment funds market are discussed in more detail in our previous client alert.

Timing and next steps

The general ‘anti-greenwashing’ rule is expected to come into force immediately upon publication of the SDR policy statement, currently scheduled for Q4 2023. The sustainable investment labels, pre-contractual disclosure requirements, and naming and marketing restrictions are expected to be introduced twelve months later, with the ongoing sustainability disclosure requirements expected to be introduced after twenty-four months (i.e. Q4 2025). The proposals suggest that smaller firms may be given until Q4 2026 to comply, although this remains to be confirmed.

The precise nature of the labelling criteria and disclosure requirements will not become clear until publication of the final SDR policy statement.

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