The new UK Financial Conduct Authority (FCA) sustainability disclosure requirements (SDR) and investment labels regime for managers of funds launches in July 2024, with a phased application through to December 2026. The SDR and investment labels regime comprise a labelling regime for qualifying sustainable investment funds, consumer-facing disclosures, pre-contractual and ongoing fund disclosures, and fund manager disclosures. The FCA altered its proposals significantly from its consultative incarnation.

In addition, the FCA introduced a general anti-greenwashing rule applicable to all firms regulated by the FCA, irrespective of industry sector, which is scheduled to commence on 31 May 2024. Following its consultation paper CP22/20 on the SDR and investment labels regime in October 2022 (detailed in our prior LawFlash), the FCA released its final rules and guidance in November 2023 [1] and, in relation to the new anti-greenwashing rule, separately consulted on draft guidance [2] about the rule that month (see our recent LawFlash).

Interestingly, in September 2023, the European Commission, aware of the FCA's consultation and progress on its own labelling regime, issued an unexpected ad hoc consultation about whether the EU Sustainable Finance Disclosure Regulation (SFDR) [3] was working as a disclosure framework as intended or whether root and branch reform was required to change its underlying ethos to a labelling regime.

On 1 March 2024, the FCA issued a letter addressed to the chief executives of alternative and mainstream asset management firms under its jurisdiction. The FCA warned managers who promote their environmental, social, and governance (ESG) credentials to ensure that their governance systems are enabled to oversee the resourcing of and management information about those activities, related compliance change programmes, claims made, and third-party ESG data providers used.

UK fund managers potentially subject to the SDR and investment labels regime or wanting voluntarily to comply with the requirements for business purposes, will need to establish new compliance processes, start mapping the relevant requirements to their funds and existing procedures and create a monitoring process to ensure ongoing compliance.

SCOPE OF SDR AND INVESTMENT LABELS REGIME

In a significant departure from the consultative proposals, the FCA has decided not to include discretionary portfolio managers within scope pending a separate consultation to be launched in Q1/24. Chapter 3 of the FCA's ESG sourcebook sets out the following refined scope:

• Full-scope UK alternative investment fund managers (AIFMs)
• Small authorised UK AIFMs
• UK managers of FCA-authorised UK funds which are typically promoted on a retail basis but may also be available to professional and/or institutional investors

The FCA has clarified that the SDR and investment labels regime will not apply initially to overseas funds or their non-UK managers. In practice, this means that funds marketed in the UK cross-border, for example, alternative investment funds marketed by a non-UK AIFM under the UK national private placement regime or EU funds marketed in the UK under the temporary marketing permissions regime are out of scope.

In addition, the FCA, aware of the role distributors play in communicating sustainability-related information to consumers along the investment chain and that regulatory failings often crystallise at the point of distribution, requires them to

• communicate the labels to and provide retail investors with the requisite consumer-facing disclosures;
• keep the labels and consumer-facing disclosures up to date with any changes made by the fund manager; and
• include a notice on overseas (i.e., non-UK) funds to clarify that they are not subject to the SDR and investment labels regime.

LABELLING REGIME

The FCA is introducing the following four sustainability labels to help consumers (also known as retail investors) navigate the market and give them confidence that the product has a specific sustainability objective as part of its investment objective and the fund manager has committed to high standards (through the qualifying criteria summarised below) to deliver on the sustainability objective:

• Sustainability focus
• Sustainability improvers
• Sustainability impact
• Sustainability mixed goals

The “sustainability mixed goals” label was not canvassed in the consultation and was designed by the FCA in response to stakeholder demand for a label that would cover funds that invest across a range of sustainability objectives in a blend of strategies within the labelling regime.

In an apparently subtle but significant shift, the term “sustainable” has been replaced by the FCA with “sustainability” in recognition of consultative feedback to reflect that some assets are on a journey to becoming sustainable and to avoid giving consumers the impression that all labelled funds are invested in assets that are already sustainable.

Fund managers can choose whether to use a label for products seeking to achieve positive sustainability outcomes provided they meet both general and label-specific criteria. The general criteria apply to all products that intend to use a label and fall under five themes: sustainability objective to improve or pursue positive environmental and/or social outcomes; investment policy and strategy; key performance indictors (KPIs) to measure progress against the sustainability objective; resources and governance to support delivery of the sustainability objective; and stewardship.

Notably, under the second criteria, ordinarily, at least 70% of the value of any type of labelled fund’s assets must be invested in accordance with its sustainability objective, with reference to a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability.

Under the fifth criteria, managers must disclose the stewardship strategy needed to support the delivery of the sustainability objective and an escalation plan for use when assets do not demonstrate sufficient progress towards that objective and/or KPIs. Managers who promote a fund exclusively to institutional investors may nonetheless label that fund (provided that it qualifies) and will not be subject to the consumer-facing disclosure requirements.

The FCA has made clear that products that use an “ESG-integration,” [4] strategy will not qualify for a label; nor will products which rely solely on “exclusion/negative screening” or basic “ESG tilts.”

CONSUMER-FACING DISCLOSURES

These disclosures are designed to provide consumers with better, more accessible information to help them understand the key sustainability features of a fund and compare similar funds. The FCA has rowed back from its original proposal that these disclosures should be required even for unlabelled funds that do not use any sustainability related terms. They will only be required in respect of the retail promotion of (1) labelled funds; and (2) funds that are not labelled but use sustainability-related terms in their naming/marketing.

The FCA intends that the content should be a summary of the detailed product disclosures and contain certain specified baseline disclosures, not to exceed two printed pages of A4. There is no template in contrast to the EU SFDR disclosure regime. The first set of disclosures must be made available at the same time as the label.

The FCA originally proposed that the disclosures summarise the types of holdings that the firm would reasonably expect consumers of the product to find inconsistent with the sustainability objective. The FCA has decided not to pursue that aspect and instead require fund managers to disclose “any material negative environmental and/or social impacts” that may arise or have arisen in pursuing the sustainability objective.

This compares favourably to the heavier-handed EU SFDR approach to disclosure of “principal adverse impacts”; in particular, the FCA has decided not to specify any indicators that set out what such negative impacts may be. The FCA has confirmed its rules are consistent with the consumer understanding outcome under the new consumer duty.

DETAILED PRE-CONTRACTUAL AND ONGOING FUND LEVEL DISCLOSURES

These disclosures are aimed at retail investors who may want more information than just the consumer-facing disclosures and institutional investors. All funds using a label or using sustainability-related terms in their naming/marketing without a label must include sustainability information in

• pre-contractual disclosures (from the date the label is first used or by 2 December 2024 for funds using the terms without a label); and
• ongoing fund-level disclosures annually (after 12 months from either the date the label or terms are used).

For funds using a label, the information that must be disclosed is broadly associated with the qualifying criteria for the labels. For the “sustainability mixed goals” label only, the disclosures must include the proportion of assets invested in accordance with each of the relevant labels, and the information required in relation to those labels. For funds not using a label but using sustainability related terms in their naming/marketing, the pre-contractual and ongoing fund disclosures must, at a minimum, include information relating to the investment policy and strategy and any relevant metrics.

DETAILED FUND MANAGER DISCLOSURES

All UK fund managers with assets under management (AUM) above £5 billion (regardless of whether they use a label or sustainability terms) must produce disclosures annually on how they are managing sustainability risks and opportunities in a “sustainability entity report.”

Managers are required to disclose their governance, strategy, risk management, and metrics and targets in relation to managing sustainability-related risks and opportunities. Where managers use labels or sustainability-related terms in their fund names and marketing, they must also include details on their resources, governance, and organisational arrangements in relation to those funds.

Responding to consultative feedback, the FCA has added guidance that managers should consider disclosing their impact on the environment and/or society. This is an interesting development as it introduces an element of “double materiality” [5] into the SDR and investment labels regime. These rules apply from 2 December 2025 to fund managers with over £50 billion in AUM and from 2 December 2026 to those with over £5 billion in AUM.

NAMING AND MARKETING RULES

The FCA is concerned about the risk that funds which do not qualify for a label will continue to name or market themselves in a way that may suggest they are sustainable. To address that greenwashing risk and the potential harms arising for consumers, the FCA has decided to introduce restrictions around names and marketing of unlabelled products where they are promoted to retail investors. These rules are scheduled to commence on 2 December 2024. Notably, the FCA dialled down its original overly strict proposal, which did not allow an unlabelled fund to use any such terms at all in their naming and marketing.

Sustainability-related terms may only be used in fund names and marketing if either

• the manager uses a label; or
• the manager does not use a label, but it does comply with certain requirements relating to the fund's name and its marketing including that
  • the fund must have sustainability characteristics and its name must accurately reflect those characteristics. The terms sustainable, sustainability, impact, and any variation must not be used in its name;
  • fund managers must produce the same types of disclosures as are required for a labelled fund so that consumers have consistent information across all products using sustainability-related terms;
  • fund managers must produce, and prominently publish, a statement to clarify that the fund does not have a label and the reasons why; and
  • the sustainability characteristics should be material to the fund in which regard the FCA gives guidance that, for example, at least 70% of its assets should have such characteristics. [6]

The relevant terms are ESG (or environmental, social and governance); environment, environmental, or environmentally; social or socially; climate; sustainable or sustainability; green; transition; net zero; impact; responsible; sustainable development goals or SDG(s); Paris-aligned; and any other term which implies that a sustainability product has sustainability characteristics.

ANTI-GREENWASHING RULE

The FCA will be introducing the general anti-greenwashing rule as proposed in the initial consultation requiring FCA-authorised firms to ensure that all sustainability-related claims made about their financial products or services are fair, clear, and not misleading as well as consistent with the sustainability profile of the product or service.

In response to feedback, the FCA has consulted on draft guidance setting out its expectations on this rule. Any sustainability-related claim is expected to be “correct,” “capable of being substantiated,” “clear,” and “complete.” Any comparisons to other products or services should be “fair and meaningful.”

The illustrative examples given in the draft guidance provide a useful indication of what behaviours the FCA would consider to fall short of such expectations. The very existence of this specific rule suggests it is likely that the FCA will take a robust supervisory/enforcement approach to promotional material making sustainability claims. Note that distributors and financial advisers are also subject to the new anti-greenwashing rule and must therefore ensure that all sustainability-related references comply with it.

The rule and guidance are scheduled to commence on 31 May 2024 to give some time for firms to address operational issues, rather than immediately on publication of the policy statement as originally proposed, but there has been some industry pushback that they should commence on 2 December 2024 alongside the naming and marketing rules.

[1] Policy Statement PS23/16.

[2] Guidance consultation GC23/3.

[3] European Parliament and Council Regulation (2019/2088/EU) of 27 November 2019 on sustainability-related disclosures in the financial services sector.

[4] That is, the consideration of ESG risks, opportunities, and impacts that may be material to the future financial performance of the product’s assets.

[5] The expression “double materiality” refers to an extension of the key accounting concept of the materiality of financial information, that is financial materiality. So, sustainability-related impacts on a business can be financially material inwardly on the business. So-called “impact materiality”—the twin of financial materiality within the concept of “double-materiality”—refers to the impact of a business outwardly on sustainability.

[6] In a recent EU-scope development, in December 2023, the European Securities and Markets Authority announced further guidance that funds which use “sustainable” or related terms in their name must apply a minimum of 80% of investment to meet the sustainability characteristics or objectives of the fund.

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