UK's FCA lays down rules for sustainability disclosure requirements and investment labels

The Financial Conduct Authority (FCA) has recently published a policy statement on the long-awaited rules for the sustainability disclosure requirements (SDR) regime. The primary aim of the regime is to improve the trust in and transparency of sustainable investment products and minimise "greenwashing". What are the core components of the SDR regime and who it will impact?

Scope and implementation

The implementation schedule of the SDR regime will run from May next year to December 2026, with a range of UK asset managers and other authorised firms affected by the regime.

The anti-greenwashing rule

The anti-greenwashing rule applies to all FCA-authorised firms making sustainability-related references about their products (such as funds) and services.

The rule requires that all communications made or approved by any authorised firm about its products or services are "fair, clear and not misleading", in line with Principle 7. Part of this requirement is ensuring the communication is consistent with the environmental and social characteristics of the product or service.

This greenwashing rule will be supported by guidance on which the FCA is currently consulting. The guidance will include proposing that references must be:

• correct and capable of being substantiated;
• clear and presented in a way that can be understood;
• complete and not omit, or hide, important information. They should also consider the full lifecycle of the product or service; and
• fair and meaningful in relation to any comparisons to other products or services.

Product labels

Most UK asset managers, such as AIFMs of UK unauthorised alternative investment funds (AIFs), can choose to use the sustainability labels, where both "general" and "specific" criteria which relate to that particular label have been met, and continue to be met, on an ongoing basis.

In summary, the four labels are:

• sustainability focus
• sustainability improvers
• sustainability impact
• sustainability mixed goals

The "general" criteria that need to be satisfied for UK asset managers to use a label include, for example:

• The product has an explicit sustainability objective as part of its investment objectives that both aligns with one of the sustainability labels and is clear, specific and measurable.
• At least 70% of the gross value of the product’s assets is invested in accordance with its sustainability objective.
• The product has robust and evidence-based key performance indicators that can demonstrate the product’s progress towards meeting its sustainability objective.

"Specific" criteria apply to the relevant label used. For instance, UK asset managers may only use the "sustainability focus" label if the product’s sustainability objective is consistent with the aim of investing in assets that are environmentally or socially sustainable or both and determined using a robust, evidence-based standard.

Naming and marketing rules

Broadly, UK asset managers using a sustainability label are allowed to use certain sustainability-related terms, such as "ESG", "responsible" and "green" in the product name.  The FCA provides a non-exhaustive list of terms as examples. However, UK asset managers not using a sustainability label may only use sustainability-related terms in its name if certain conditions are met. For example, the product must have sustainability characteristics and a name which accurately reflects those characteristics; and it should not use the terms "sustainable", "sustainability" or "impact" in its name or any other variation of those terms to refer to the sustainability characteristics of the product.

In these instances, the UK asset manager must then comply with applicable disclosure requirements, including the consumer-facing disclosures, pre-contractual disclosures and ongoing product-level disclosures. The FCA also requires disclosure that the product does not have a sustainable label and the reasons why.

Consumer-facing disclosures

UK asset managers of products using labels or sustainability-related terms in their names and financial promotions must prepare consumer-facing disclosures for retail clients following set parameters on format and content to ensure consistency, allowing  retail clients to compare information between disclosures. The FCA did not go as far as introducing a prescribed template.

Detailed product-level disclosures

UK asset managers of all labelled products, as well as those using sustainability-related terms in their names or promotions, must produce "detailed product-level disclosures".

The requirements relate to both pre-contractual disclosures and ongoing annual product-level disclosures. Detailed pre-contractual product-level disclosures relating to funds will typically be included in the fund's prospectus. Ongoing product-level disclosures will need to be included in a "sustainability product report" for certain asset managers (of authorised funds or unauthorised AIFs listed on a recognised investment exchange (RIE); that is, investment trusts). Where public disclosures are not appropriate – for UK asset managers of AIFs not listed on a RIE – asset managers will need to provide the relevant information "on demand" and not publish a sustainability product report.

Entity-level disclosures

If UK asset managers have AuM above £5 billion (which relates to in-scope business such as AuM of their unauthorised UK AIFs), they are required to produce disclosures on how they are managing sustainability risks and opportunities in a "sustainability entity report". Among other things, this would include disclosures on the asset manager’s approach to governance, with respect to managing sustainability risks and opportunities, and how the manager identifies, assesses and manages sustainability-related risks.

The sustainability entity report builds on the existing requirements in the FCA's "ESG sourcebook" for some firms, including UK asset managers within scope of the SDR regime, that must make periodic disclosures in their Task Force on Climate-related Financial Disclosures entity report. The entity-level disclosures required until the SDR regime are to be phased-in, with UK asset managers with in-scope AuM of above £50 billion being caught in the first instance.

Distributor compliance

Distributors must ensure the labels accompany the product (where the product has been labelled by the UK asset manager) and provide retail clients with consumer-facing disclosures.

They must keep the labels and consumer-facing disclosures up to date with any changes that the UK asset manager makes to a label or the disclosures. The SDR regime also imposes disclosure requirements on distributors for the promotion of overseas exchange-traded funds to retail clients in the UK.

Osborne Clarke comment

Authorised firms should now be preparing for the new anti-greenwashing rule, if they make claims about the sustainability characteristics of their products or services, to ensure sustainability claims are fair, clear and not misleading. They should also familiarise themselves with the FCA's consultation on further guidance to the anti-greenwashing rule.

UK asset managers will need to decide whether to label products that aim to achieve positive sustainability outcomes if they meet the qualifying criteria. The will also need to familiarise themselves with the FCA's requirements and prepare to meet the relevant requirements within the implementation timeframes.

In practice, this will mean UK asset managers will need to have implementation project teams to ensure, for instance, they have in place sufficient data collection and analyses processes. These processes will enable UK asset managers to meet the ongoing annual disclosure requirements (with respect to labelled products or those that have environmental or social characteristics that are integral to their investment policy or strategy). Distributors will also need to be mindful of their responsibilities outlined above.

While firms are generally happy with changes to what was consulted on by the FCA – such as the introduction of a fourth “sustainability mixed goals” label and making the naming and marketing rules a little less restrictive – there are some big questions and gaps remaining.

For instance, the SDR regime does not apply to "portfolio management products and services" and, therefore, does not apply in the context of firms managing segregated mandates or managing funds on a delegated basis. The FCA will consult on proposals to follow a similar approach for portfolio management, with a focus on where it is undertaken for UK retail clients, in early 2024.

Significantly, overseas funds are not in scope – the FCA is continuing to work with HM Treasury on the approach to such funds. Overseas asset managers who generally market to UK-based investors will be keeping a close eye on movements in this space.

If you would like help around any of the issues raised in the policy statement and their impact on your business, please contact us.