FCA unveils proposals for UK sustainability disclosure regime

Consumers care about the environmental, social and governance (ESG) impact of their investments. Over 70% of respondents to the Financial Conduct Authority's (FCA) recent Financial Lives 2020 survey said they wanted to "invest in a way that is protecting the environment". 

To meet this demand, sustainable investment products are burgeoning in number and diversity, offering choice but also the potential for confusion. The FCA is concerned that, without shared standards, clear terminology and accessible product classification, consumers could be left struggling to understand these products and whether they are suitable investments. 

On 3 November 2021, to coincide with COP26 Finance Day, the FCA published a discussion paper (DP21/4) seeking views on new UK sustainability disclosure requirements (SDR) and a sustainable investment labelling system that will apply to asset managers and asset owners. These are the two main aspects of the government's recent policy paper, "Greening Finance: A Roadmap to Sustainable Investing", which require action from the FCA to implement and will have significant implications for the funds and wider financial services industry. The deadline for responses is 7 January 2022, and the FCA plans to consult on policy proposals to implement the new system in Q2 2022.

Which firms and products will be in scope of these rules?

The starting point suggested by the regulator is to adopt the position under the FCA's Taskforce on Climate-related Financial Disclosures (TCFD)-aligned proposals, which capture: 

• "asset managers", including investment portfolio managers, UK UCITS (undertakings for collective investment in transferable securities) management companies, full-scope UK alternative investment fund managers (AIFMs), and small authorised UK AIFMs; and
• "asset owners" – broadly, life insurers and FCA-regulated pension providers, including SIPP (self-invested personal pension) operators which provide a ready-made selection of investments. Defined benefit schemes are not within scope.

Asset managers and owners with less than £5 billion relevant assets under management or administration (on a three-year rolling average) will be exempt, meaning that in practice small authorised UK AIFMs are very unlikely to be caught by the rules. The proposed rules will not apply directly overseas firms, including firms in the Temporary Permissions Regime at the time.

The approach set out in this paper would apply to manufacturers of the products, rather than distributors. The FCA is asking for views on whether certain types of product should be excluded from the regime, such as separately managed accounts or products not targeted at retail investors.

The regulator is separately considering the best approach to SDR for financial advisers.

What will the new regime look like?

Firms will need to report on their sustainability risks, opportunities and impacts. The regime builds on measures to implement TCFD-aligned disclosure rules (on which the regulator aims to finalise its policy position by the end of 2021), expanding the scope to cover other sustainability topics beyond climate change. SDR will also include disclosure requirements relating to the forthcoming UK Green Taxonomy, a common framework setting the standards for investments that can be defined as environmentally sustainable.

The FCA envisages a three-tiered system for product labelling and disclosure, structured as follows:

1. Product labels
2. Consumer-facing disclosures (layer 1)
3. Institutional investor-facing disclosures (layer 2)

The regulator is seeking views on whether templates should be prescribed to ensure consistency and comparability, particularly for consumer-facing disclosures. It also suggests there could be independent third-party verification of product-level disclosures.

How will products be classified?

Five product labels are being proposed, to help consumers understand the sustainability characteristics of different products. The labels cover the full spectrum of products available to retail customers, not just products which make sustainability claims or are marketed as sustainable. 

The table below sets out an overview, including the FCA's view on how the product labels map onto the categories under the EU Sustainable Finance Disclosure Regulation (SFDR).
 

To use a "sustainable" or "responsible" product label, the manager must also demonstrate key attributes at an entity level. Examples include meeting existing governance, systems and controls requirements; identifying how ESG considerations are integrated into investment processes to minimise risks and take advantage of opportunities; and stewardship and using ownership rights (for example, voting and engagement).

What will the consumer-facing disclosures cover?

The layer 1 disclosures would give standardised information on the product's key sustainability attributes, allowing consumers to understand the product's sustainability characteristics better and compare different products or the same product over time. 

The disclosures, which may take the form of an "ESG factsheet", would cover areas such as the product label, sustainability objectives and the investment strategy pursued to meet these, asset allocation to sustainable investments, approach to stewardship, and wider sustainability performance metrics. 

The FCA is considering whether to prescribe baseline sustainability metrics (for example, carbon reduction metrics), to help consumers understand the sustainable performance of investments over time. The environmental metrics in the TCFD reforms are the proposed base for this, supplemented by additional social and governance metrics.

What will the disclosures for institutional investors cover?

These would supplement the information in layer 1, giving more granular and additional information on sustainability risks, opportunities and impacts. The layer 2 disclosures are aimed at institutional investors and other stakeholders. 

At product level, these disclosures will include detailed information on areas such as data sources and limitations, Taxonomy alignment, and benchmarking and performance, plus supporting contextual and historical information. There is expected to be some overlap between these disclosures and those required under other regimes. For example, the SFDR principal adverse impact indicators could be a starting point for the environmental metrics beyond climate.

At entity level, the disclosures will expand on the equivalent TCFD requirements.

Osborne Clarke comment

Much of the detail underlying SDR remains to be worked out, subject to the outcome of the discussion. 

The FCA is taking into account other regimes such as SFDR and the international sustainability standards in development by the International Financial Reporting Standards Foundation, and time will tell how these regimes interact with SDR. The regulator is conscious that many UK firms and their products are subject to SFDR due to cross-border EU business, and is considering how far it can remain consistent with SFDR while reflecting the needs of the UK market. Firms operating in both the UK and EU will be keeping an eye on how the SDR progresses, in the hope they do not end up bearing the increased burden of compliance with two drastically different regimes. 

In particular, it will be interesting to see whether the classification for the proposed product labels develops further, as the current labels may not map onto the SFDR categories in precisely the way envisaged by the regulator. For example, the FCA expects the "impact" label would apply to only a small subset of Article 9 SFDR products. Depending on where the eligibility criteria land, it is possible that most Article 9 products would fall under this label in practice, since they have "sustainable investment" as their objective. The "responsible" label, for products where sustainability factors are considered, does not seem to be a perfect match for Article 8 SFDR products, which we typically expect must be bound by sustainability criteria; the right fit for many "responsible" products may actually be Article 6 SFDR.