The Financial Conduct Authority consults on the UK Sustainability Disclosure Requirements

On 25 October 2022, the FCA launched its long-awaited consultation on the UK Sustainability Disclosure Requirements (SDRs), Sustainability Disclosure Requirements (SDR) and investment labels (CP22/20). This is the next step in the government's Roadmap to Sustainable Investing and a crucial framework to support the UK's transition to a net zero economy.

The consultation will be of interest to investors, asset managers and product manufacturers, and banks and other entities lending directly to sustainable initiatives and manufacturing the green assets that are ultimately distributed to end investors.

At a glance

The proposals have some changes from those in the FCA’s related discussion paper, DP21/4. The new rules fall into four broad categories:

1. sustainable investment labels
2. disclosure requirements
3. naming and marketing rules (including an anti-greenwashing rule)
4. rules for distributors

Categories 1, 2 and 3 apply to portfolio managers and fund managers who manage or market authorised funds and unauthorised AIFs.

Category 4 applies to firms that distribute authorised funds and unauthorised AIFs to retail investors.

The FCA is introducing a new "anti-greenwashing rule" which will apply to all regulated firms and will take immediate effect upon publication of the final rules (expected June 2023).

It is being considered whether the scope of the rules should be extended to regulated asset owners, financial advisers and overseas products.

Sustainable investment labels

Three sustainable investment product labels will be introduced, to give consumers greater confidence in the products they seek to invest in. These proposed labels have changed since DP21/4 based on feedback that they should be simpler and clear for consumers to understand. The proposed labels are:

• Sustainable Focus: Invests mainly in assets that are sustainable for people and/or planet
• Sustainable Improvers: Invests in assets that may not be sustainable now, with an aim to improve their sustainability for people and/or planet over time
• Sustainable Impact: Invests in solutions to problems affecting people or the planet to achieve real-world impact.

Firms can choose whether to apply a label to their investment products. But if a firm wants to apply a label, it must first meet a set of objective threshold qualifying criteria. Firms will need to assess and apply the criteria at the various stages of product development, from initial due diligence, screening and product design stages through to management and oversight review and signoff for final marketing materials.

Disclosure requirements

The new rules propose a range of disclosures aimed at giving consumers confidence in their product selection. Unlike the labelling regime, they will not be optional for in-scope products.

Here’s a summary of the required disclosures:

• Consumer-facing disclosures - aimed at giving consumers clear, targeted information to help them make considered choices about their investments.
• More detailed disclosures - targeted at a broader range of stakeholders including institutional investors.
  
  • Pre-contractual disclosures - legally binding, static information for investors to make informed decisions about which products meet their needs and preferences.
  • Sustainability product-level reporting - on an ongoing basis, a dedicated sustainability product report, including key indicators and metrics, which builds upon the product report that is required to be aligned with the recommendations of the Taskforce for Climate-Related Financial Disclosures (TCFD).
  • Sustainability entity-level reporting - entity-level reporting that builds on the TCFD entity-level disclosure requirements, helping investors to understand how firms offer their products and are managing sustainability risks and opportunities.

The FCA has proposed rules and guidance on location, scope, format, content and frequency for the disclosures. With no templates to start from, firms must consider the guidance holistically and work through their customer journeys to ensure all communications and marketing materials are considered and the labels appropriately applied. We expect firms to work with industry bodies to create a market-standard approach to disclosure.

Comparisons with other regimes

In the EU, the broadly equivalent regime, SFDR, is already partially implemented and becoming established. In the US, the Securities and Exchange Commission (SEC) made two ESG-related proposals in May 2022.

There’s some overlap in the approach adopted under the SFDR and the SEC rules, but there are some key differences.

For example, the FCA is not proposing to introduce the EU principle of “do no significant harm” at this stage. Most fundamentally, the FCA is describing part of the SDR measures as a “labelling regime,” whereas both the EU and SEC are at pains to emphasise that their rules are not a labelling regime (despite market practice).

Naming and marketing

The FCA has proposed “naming and marketing” rules to protect consumers from greenwashing.

Notably, a new and general “anti-greenwashing” rule is being proposed, requiring sustainability-related claims be clear, fair and not misleading. This is proposed to apply to all FCA-regulated firms from 30 June 2023.

Though in the same vein as existing financial promotion requirements, the new anti-greenwashing rule is another tool in the FCA's enforcement toolkit, allowing it to challenge communication and marketing in a sustainability context in a manner we’ve increasingly seen from other agencies, such as the Advertising Standards Authority.

The FCA has expressed concern about firms making misleading or exaggerated claims regarding sustainability that it considers do not “stand up to close scrutiny.” So we should expect enhanced supervision and scrutiny around firms' use of the sustainability labels – both now (under the “fair, clear and not misleading” principles) and even more so when the UK SDR is introduced.

We expect significant overlap between the naming and marketing rules in the SDR and the new Consumer Duty standards applicable to certain firms. Firms currently implementing the new consumer duty regime should consider how these requirements interact.

The FCA will consider separately whether the scope of the rules will be extended to overseas products. In the meantime, when the SDR rules are finalised, the FCA is proposing that overseas product communications containing prohibited sustainability terms should alert retail investors that the product is not subject to the FCA SDR regime, and include a link to the FCA webpage on SDR labelling and disclosure.

Rules for distributors

Distributors must ensure that labels and consumer-facing disclosures are accessible and clear to consumers.

This builds on the FCA’s July 2021 Dear CEO Letter to AFMs. The FCA acknowledges the breadth of intermediaries involved in distribution activities and the important role these participants have in communicating sustainability-related information to retail investors.

First, the FCA proposes that labels must be prominently displayed digitally or other mediums. A label should be used only where the product has been assigned that label by a fund manager. Second, distributors would be required to keep any communications updated to reflect changes made to the label and consumer-facing disclosures.

Securities lending, short-selling and derivatives

In this consultation, the FCA concludes neither securities lending nor short selling are inherently incompatible with ESG. The FCA is not proposing any specific constraint on the ability of strategies that involve securities lending to qualify for one of the FCA sustainable investment labels.

Looking ahead

Firms must send any responses to the consultation by 25 January 2023. The FCA intends to publish final rules by the summer of 2023, with expected implementation as follows:

• 30 June 2023: General “anti-greenwashing” rule
• 30 June 2024: “Labelling,” “Naming and Marketing,” “Consumer Facing,” “Pre-Contractual” disclosure requirements and rules for distributors
• 30 June 2025 onwards: “Entity level” disclosures for the largest fund manager

In the meantime, firms should assess:

• which funds and products are in-scope
• which labels may be suitable (if any)
• what disclosures are required at the relevant entity level
• what information (and information rights from counterparties) will be required to support and evidence the use of the labels and disclosures

All regulated firms will need to review their sustainability communication and marketing communications to ensure they don’t fall foul of the “anti-greenwashing” rule. Firms should expect FCA supervision and enforcement action in this space after the rules are implemented.

The FCA is expected to publish follow-up consultations on extending the scope of the SDR to include, for example, overseas products, certain insurance products, and financial advisors. It’s also expected to give more guidance on the metrics to support the use of the label and on the location, content and form of disclosures.

We’ll publish more on CP22/20 in due course. In the meantime, if you have any questions, please get in touch.