International Funds Legal Update | October 2022 | ESG developments

Over the last two months there have been a number of significant developments across the environmental, social and governance (ESG) regulatory framework which will have an impact on investment managers and their funds. In this edition, we round-up the key updates from the UK and internationally.

FCA publishes proposals for sustainability disclosures and investment labels

On 25 October 2022, the Financial Conduct Authority (FCA) published its long-awaited consultation paper on sustainability disclosure requirements (SDR) and investment labels. The proposals include rules on using sustainable investment labels, qualifying criteria that firms must meet to use a label, product- and entity-level disclosures, and naming and marketing rules. There is also a general "anti-greenwashing" rule, clarifying that sustainability-related claims must be clear, fair and not misleading. In addition, the FCA has proposed targeted rules for distributors of certain investment products (including platforms and advisers) to UK retail investors. 

What is the scope?

The anti-greenwashing rule will apply to all FCA-regulated firms. This means that it would capture firms that approve financial promotions for unauthorised persons, who will need to ensure that the promotions they approve for unauthorised persons comply with this rule as well as the financial promotions rules. The core elements of the regime – labelling and classification, disclosure and naming and marketing rules – will apply only to UK asset managers initially. While financial advisers may fall into scope in their capacity as distributors of fund-level information to retail investors, the FCA will be separately consulting on rules on product suitability for financial advisers in due course.

Accordingly, under the proposals:

• "In-scope firms" firms carrying out portfolio management, UK Undertakings for Collective Investment in Transferable Securities (UCITS) management company, full-scope UK alternative investment funds managers (AIFMs) and small authorised UK AIFMs.
• "In-scope products" comprise authorised funds, unauthorised alternative investment funds (AIFs) (including investment trusts), and certain portfolio management services.

There are various exemptions and the rules may also apply differently depending on whether the in-scope firm is marketing its fund to retail or institutional investors, and depending on whether the fund applies a sustainable investment label or not.

Notably, overseas funds are not included within scope of the FCA's proposals. However, a further consultation paper is expected from the FCA in due course on how this regime might be applied to them. In addition, the FCA also plans to consult on expanding the regime to cover FCA-regulated asset owners and other investment products (for example, pensions).

When will the rules come into effect?

The anti-greenwashing rule will come into effect immediately upon the FCA publishing its final rules, expected to be on 30 June 2023. The labelling, naming and marketing and initial disclosure requirements under this regime will come into effect at least one year later, on 30 June 2024. Thereafter, in-scope firms will need to comply with the first ongoing sustainability performance-related disclosures from 30 June 2025. There are staggered implementation dates for entity-level disclosures depending on the size of the firm, with the largest firms expected to produce their disclosures from 30 June 2025. All dates are provisional at this stage.

Does it map with the SFDR and proposed US disclosure regime?

The FCA has sought, as far as possible, to achieve coherence with the EU's Sustainable Finance Disclosure Regulation (SFDR) and proposals by the Securities and Exchange Commission (SEC) in the United States.

In annex I to the consultation paper, the FCA has provided a guide to help firms map product classifications in the SFDR and the SEC’s proposals to the FCA'S proposed classification and labelling system. As the FCA points out, UK managers of an SFDR article 8 fund may find themselves needing to "level up" to meet the FCA's criteria by specifying a sustainability objective, since it is "unlikely that an SFDR article 8 fund would meet the FCA's criteria for the label 'sustainable impact'".

Since the FCA and SEC proposals both begin from the same starting point (i.e. a labelling regime to determine disclosure requirements), they are in many ways more closely aligned than the SDR and the SFDR. For example, both the FCA and SEC proposals broadly include the same disclosure items, take a 'tiered' approach to disclosure, and include both pre-contractual and periodic disclosure obligations. Unlike the SFDR, the FCA's proposals do not require disclosure of principal adverse impacts, "do no significant harm", or taxonomy alignment at this stage. In some areas, the FCA has also raised the bar by requiring more granular information from firms, particularly with respect to their investment policy and strategy. In addition, unlike the European Commission and the SEC, the FCA has not proposed any mandatory templates, but instead encourages industry to develop their own if helpful.

Next steps?

The FCA aims to finalise these rules and publish a policy statement by the end of H1 2023. But the regulator is keen to emphasise that this is just the starting point – we can expect the rules to evolve in response to domestic, international and market developments. In particular, further consultation on expanding the scope of the regime to cover pension and other investment products and overseas funds is expected, as well as an updating of the rules to reflect international standards such as the International Sustainability Standards Board and a UK green taxonomy (see below).

The development of a UK green taxonomy makes further progress

The Green Technical Advisory Group has published the first part of its independent advice on the design and implementation of a UK green taxonomy. The advice focuses on onshoring the EU taxonomy, international interoperability, "do no significant harm" and taxonomy use cases.  

In its Roadmap to Sustainable Investing, the UK government set out plans to include disclosures against a UK green taxonomy. Accordingly, the FCA plans to consider how the SDR might be updated to include disclosures relating to the UK green taxonomy once it has been developed, subject to the usual consultation.

European Platform on Sustainable Finance publishes final report and recommendations

Earlier this month, the European Platform on Sustainable Finance (PSF) published a final report on minimum safeguards to help companies comply in practice with article 18 of the Taxonomy Regulation (TR). The purpose of article 18 is to prevent green investments from being labelled and regarded as "sustainable" when they involve negative impacts on human rights, including labour rights, corrupt practices, or are linked to non-compliance with the letter or spirit of tax laws or anti-competitive practices.  The final report identifies four core topics for which compliance with minimum safeguards should be defined, these are: human rights, including workers’ rights; bribery and corruption; taxation; and fair competition.

The final report will now need to be considered by the European Commission, which is not bound by the PSF's recommendations.

European regulators provide a 'fast-track' SFDR service

On 6 September, the Luxembourg financial services regulator, the Commission de Surveillance du Secteur Financier (CSSF), published an "confirmation letter" that should accompany the filing of a fund's pre-contractual disclosures updated in compliance with the SFDR Regulatory Technical Standards (RTS). (The letter is available here for UCITS and here for AIFs.)

The CSSF also announced that there would be a "fast track approval" process for Financial Market Participants (FMPs) that are intending to update pre-contractual documents. FMPs may benefit from an accelerated examination and visa stamping of the prospectus provided that certain conditions are fulfilled. Essentially, changes to the fund prospectus need to be limited to insertion of the completed SFDR templates. This accelerated examination and processing is available until 31 October 2022. Any submissions received after this date will only be considered on a best effort basis.

Similarly, the Central Bank of Ireland has confirmed its intention to apply a fast-track review process to SFDR RTS (or level 2) filings. The deadline for filings using this process will be 1 December 2022 and FMPs intending to use this streamlined process will need to adhere to similar conditions as was applied to the previous fast-tracks for SFDR level 1 and Taxonomy Level. Filings must be accompanied by an attestation from a responsible person, certifying that the changes being made relate to SFDR only. 

ESAs amend disclosing exposure to investments in fossil gas and nuclear energy activities under SFDR

On 30 September 2022, the European Supervisory Authorities (ESAs) published a joint final report on draft regulatory technical standards (RTS) on information to be provided in pre-contractual documents, on websites, and in periodic reports about the exposure of financial products to investments in fossil gas and nuclear energy activities. The draft RTS amend the RTS which supplement the SFDR.

The aim of the amendments is to ensure that disclosures about the degree to which investments are in taxonomy-aligned activities provide for full transparency about investments in fossil gas and nuclear energy activities, in particular on the proportion those investments represent within all investments and in environmentally sustainable economic activities. The ESAs confirm in an accompanying press release that the disclosures in the proposed RTS are in line with the Complementary Climate Delegated Act.

ESAs submit further SFDR queries to the European Commission

The European Supervisory Authorities (ESAs) submitted a further set of questions for the European Commission on 9 September 2022 relating to the SFDR. A number of the questions address the interpretation of fundamental principles underpinning the disclosure requirements, including (for example):

• How the definition of "sustainable investment" in article 2(17) of the SFDR applies to investments in funding instruments that do not specify the use of proceeds, such as the general equity or debt of an investee company.
• How should "investment in an economic activity that contributes to an environmental objective" or "investment in an economic activity that contributes to a social objective" in article 2(17) of the SFDR be interpreted?
• What it means to "consider" principal adverse impacts under article 7(1)(a) of the SFDR.

The Alternative Investment Management Association has published a letter to the Commission outlining its views on these issues and urging it to allow enough flexibility in application of the rules so that firms are not forced to radically change their processes, or SFDR classifications, at short notice.

ESMA publishes an updated infographic setting out the implementation timeline for sustainable finance

On 26 September 2022, ESMA published an updated infographic setting out an implementation timeline for key ESG measures including SFDR, the Taxonomy Regulation, the Corporate Sustainability Reporting Directive, the Non-Financial Reporting Directive, Markets in Financial Instruments Directive, the Insurance Distribution Directive, the Alternative Investment Fund Managers Directive and the Undertakings in Collective Investment in Transferable Securities Directive.