By Harry Barnes, Senior Compliance Consultant, and Andrew Shrimpton, Chair, UK Regulatory & Compliance Solutions
The UK’s Financial Conduct Authority (FCA) has now published its Policy Statement on the long anticipated Sustainability Disclosure Requirements (SDR).
The Policy Statement (PS23/16), unveiled on 28 November 2023, notably includes a number of key changes compared to the consultation, which was released in October last year. It also follows the FCA’s statement earlier this month that fund managers have more work to do on embedding ESG.
In this article, we provide a brief background on the SDR before outlining its scope, implementation dates and key requirements for UK-regulated firms.
Why has SDR been introduced?
With sustainable and ESG investing becoming increasingly central to investment markets as a whole, the FCA recognises the need for investors to have confidence in the sustainability of investments in order to ensure capital flows and that those capital flows are put to good use.
To this end, the FCA has had growing concerns around greenwashing and investors being misled by firms making unsubstantiated or exaggerated claims about the ESG credentials of their products and investments. And so, SDR came to be.
Aims of SDR
The disclosure and labelling regime under SDR is specifically aimed at distinguishing between the purpose of different sustainable investing strategies, as opposed to attempting to measure the level of sustainable investing.
As Consumer Duty has been one of the FCA’s biggest areas of focus this past year, the protection of consumers and ensuring that consumers understand the products they invest in is an integral part of the regime. SDR also brings into existence the broader anti-greenwashing rules impacting all UK authorised firms, thus raising the bar even for firms that are not caught under its disclosure and labelling regime.
Who is subject to SDR, and who isn’t?
Firms in scope of SDR are:
- UK asset managers (including private markets and alternatives managers)
- Distributors of investment products to UK retail investors
As opposed to the consultation, in the Policy Statement the FCA has exempted portfolio management services from the regime but has stated that in Q1 2024 there will be a further consultation on bringing discretionary portfolio managers into scope.
Overseas funds are also not subject to the regime, even if they are marketing into the UK or managed by a UK manager, despite the FCA’s previously stated desire to see such funds included on the basis of wanting the rules to cover all funds marketed in the UK and ensuring that UK funds remain competitive compared to overseas funds.
Whilst overseas funds are not in scope, the FCA has stated that it expects them to have a clear and prominent notice to make clear to investors that the fund is not subject to the regime. The Policy Statement also mentions that the HM Treasury will consult on the matter separately under its continued work on the Overseas Funds Regime.
Implementation of SDR
There are different timetables for implementation of the various elements of the new regime. Key dates are as follows:
- 26 January 2024 – The FCA consultation on the anti-greenwashing rule guidance closes
- Q1 2024 – The FCA will consult on the extension of the investment labelling and disclosure regime to discretionary portfolio managers
- 31 May 2024 – The anti-greenwashing rule and guidance comes into force for all FCA-authorised firms
- 31 July 2024 – Firms can begin to use the labels with accompanying disclosures
- 2 December 2024 – Naming and marketing rules come into force, with accompanying disclosures
- 31 July 2025 – Earliest date for ongoing product-level disclosures for firms using investment labels
- 2 December 2025 – Entity-level disclosures for firms with AUM of >£50bn
- 2 December 2026 – Entity-level disclosure rules extend to firms with AUM of >£5bn
Main compliance requirements under SDR
- Optional sustainable investment labels aimed at helping consumers navigate the investment landscape, detailed further below
- Naming and marketing rules restricting the use of certain sustainability-related terms in product names and marketing materials of products marketed to retail investors unless the product uses a sustainable investment label
- Escalation plans covering the actions that the firm will take in the event that invested-in assets do not demonstrate sufficient performance against the sustainability objective or KPIs
- Requirements for distributors to ensure that product-level information (including labelling) is made available to consumers
- A general ‘anti-greenwashing’ rule applied to all UK–regulated firms emphasising that sustainability-related claims must be clear, fair and not misleading
- Sufficient governance and resources required to deliver the sustainability objectives
Main disclosure requirements under SDR
There are two forms of disclosure requirements imposed by SDR:
- Consumer-facing disclosures for products that are offered to retail investors and have a sustainability label or sustainability-related terms in their names or marketing materials. This is to help consumers understand the key sustainability-related features of a product
- Detailed disclosures targeted at a wider audience of institutional investors and consumers seeking more information, including:
- Pre-contractual disclosures covering the sustainability-related features of investment products that have a sustainability label or products that are offered to retail investors and have sustainability-related terms in their names / marketing materials
- Ongoing sustainability-related performance information including key sustainability performance indicators and metrics, in a sustainability product report of in-scope products
- A sustainability entity report covering how firms are managing sustainability-related risks and opportunities. It should be noted that all asset managers with an AUM above £5bn must make this disclosure
Labelling requirements under SDR
The FCA has introduced four optional investment labels for sustainable investments. There is no hierarchy between the labels, as their purpose is not to demonstrate the degree to which a product makes sustainable investments, but to give consumers clarity around the purpose of a sustainable fund and allow them to make investments aligned to their preferences.
Products must have at least 70% of their assets invested in accordance with the sustainability objective of the fund. Two exceptions are made here: (1) for funds investing their capital over time that have not yet fully deployed, and (2) for firms carrying out escalation plans. The remaining 30% or lower percentage of assets should not conflict with the sustainability objective of the product.
The four labels are as follows:
- Sustainability Focus – These products aim to invest in assets that a reasonable investor would regard as being sustainable on an environmental or social level, with these products typically being highly selective and applying extensive screening to investments
- Sustainability Improvers – These products aim to invest in assets that, whilst not sustainable in nature at present, have the potential to deliver measurable improvements in their sustainability over time
- Sustainability Impact – These products aim to invest in assets that make a positive, measurable contribution to real world sustainability outcomes, with commitments to delivering and reporting on contributions to sustainability. These products will be highly selective and will make investments aligned with a clearly specified theory of change
- Sustainability Mixed Goals – A new category introduced in the Policy Statement; these products make investments using a combination of the above sustainability objectives. Firms must identify and disclose the proportion of assets in accordance with the sustainability objectives of the other labels
For all labels, firms will be required to have an independent assessment to confirm that the standard used is fit for purpose. The Policy Statement has also introduced a new requirement for firms to disclose if a labelled product’s sustainability objective could result in any material negative environmental and/or social outcomes.
Firms that promote their funds to retail investors and do not opt into the labelling regime cannot promote themselves as sustainable using certain terminology, including “sustainable” and “impact”.
Non-labelled retail funds will, however, be able to use some terms such as “green”, “net-zero” and “responsible” so long as the use of the terminology is supported and in compliance with the new anti-greenwashing rule. There will be rules for how these funds will be marketed and a requirement for consumer-facing disclosures to clearly state how they’re invested and why they don’t use the label.
What needs to be done?
All UK-authorised firms should:
- Conduct a review of all marketing materials against the anti-greenwashing rules to ensure sustainability claims are clear, fair and not misleading
UK asset managers should:
- Determine if any funds are caught by the regime
- Undertake a review of how products will be classified under the new labelling regime
- Review websites, marketing materials, offering documents, factsheets and other documents that may be subject to the new requirements
- Identify KPIs to measure progress against the sustainability objective
- Update the firm’s governance as well as systems and controls, including investment policies, and processes for approving new products and marketing materials
- Prepare the relevant notices and disclosures to be available for retail investors, also ensuring there are notices for overseas funds to inform consumers those funds are not subject to the regime
How IQ-EQ can help
Our expert ESG team is able to advise on the applicability and implementation of SDR and assist in the implementation and embedding of the new regime.
To have an initial discussion on what the FCA’s new disclosure rules mean for your firm or to find out more about the regulatory compliance support available from IQ-EQ, please do not hesitate to contact us today.