The UK Financial Conduct Authority (FCA) recently published its consultation paper, CP22/20, on the use of Sustainability Disclosure Requirements (SDR) and investment labelling. The consultation paper proposes rules to help investors (particularly retail investors) navigate the investment product landscape and identify sustainable investment products, require additional sustainability disclosure, reduce greenwashing, and generally make the United Kingdom a trusted centre for sustainable investment. Subject to the consultation (responses to which are due by 25 January 2023), the FCA intends to review and set out its final policy statement by June 2023.
The genesis of the consultation lies in the UK government’s Roadmap to Sustainable Investing, published in October 2021, which sets out plans to introduce SDR across corporates (whether or not in the financial services sector), asset managers, asset owners, and labels for investment products. That document was swiftly followed in November 2021 by both the FCA’s Discussion Paper DP21/4, in which the FCA set out its preliminary views on the shape of SDR and investment labels, and its document, A strategy for positive change: our ESG priorities, which described the role financial services has to play in helping the UK economy adapt to transition to net zero and a more sustainable future.
Notably, a key theme of the FCA’s ESG strategy is the importance of building trust and integrity in sustainable instruments, products, and the supporting ecosystem. Furthermore, when releasing CP22/20, the FCA noted that it had already identified in funds proposed for FCA authorisation instances of misleading or unsubstantiated claims about how products meet ESG standards, i.e., “greenwashing.”
The proposed requirements cover the following:
The FCA intends for the proposed changes to facilitate the flow of consistent information along the investment chain, increase transparency, and build trust in the market.
All types of FCA regulated firms will be familiar with the longstanding requirement for clear, fair, and not misleading communications under PRIN 2.1, Principle 7, and COBS 4.2.1 of the FCA Handbook. The FCA considers it necessary to add a specific rule to the ESG sourcebook to link that requirement to sustainability claims by requiring any reference to the sustainability characteristics of a product to be not only clear, fair, and not misleading but also consistent with the sustainability profile of the product.
This rule will help the FCA challenge firms that it considers to be potentially greenwashing and to take enforcement action against them. The anti-greenwashing rule is first in line to come into effect, provisionally from 30 June 2023.
Generally, the other proposed requirements are directed at investment funds (primarily those marketed to UK retail investors) and the FCA-regulated firms that manage or distribute those products.
Technically, the proposed requirements will apply or otherwise be relevant to full-scope UK alternative investment fund managers (AIFMs), small authorised UK AIFMs, UK undertakings for collective investment in transferable securities (UCITS) management companies, investment companies with variable capital (ICVCs) that are UCITS schemes without a separate management company, and portfolio managers (collectively, in-scope firms), in relation to managing an AIF, managing a UK UCITS, and (subject to some conditions) portfolio management.
Portfolio management has an extended meaning under the current ESG sourcebook, covering not just discretionary portfolio management but also private equity and other private market activities comprising either (1) advising on investments or (2) managing investments on a recurring or ongoing basis in connection with an arrangement the predominant purpose of which is investment in unlisted securities. Also, only some of the new sustainability rules apply to portfolio managers.
The classification and labelling regime seeks to help consumers distinguish between (1) products on the basis of their sustainability characteristics, themes, and outcomes and (2) different types of sustainable products. The FCA considers an explicit environmental and/or social objective that is part of the investment objectives (sitting alongside the financial return objective) and expressed in specific and measurable terms to be a key attribute of any sustainable investment product.
Firms offering sustainable investment products that wish to rely on a label and meet the associated criteria can choose from three mutually exclusive labels:
Sustainable focus products will be those which invest in assets that a reasonable investor would regard as being environmentally and/or socially sustainable. At least 70% of the product’s assets would need to meet a credible standard of environmental and/or social sustainability, or align with a specified environmental and/or social sustainability theme.
The FCA considers that the key features of this category are (1) a credible sustainability objective and (2) sustainability goals pursued primarily via the market-led channel of influencing asset prices, thereby reducing the relative cost of capital of sustainable economic activities, and secondarily through investor stewardship activities that pursue improvements in the sustainability performance of assets.
Sustainable improver products will be those which invest in assets that, while not objectively environmentally or socially sustainable at present, have the potential to deliver measurable improvements in their environmental and/or social sustainability over time. Products may be invested broadly across sectors, with the firm playing an important role in embedding and accelerating improvements in the sustainability profile of assets.
The FCA considers that the key features of this category are (1) an objective to deliver measurable improvements in the sustainability profile of the product’s assets over time and (2) sustainability goals pursued primarily via the channel of investor stewardship and secondarily through portfolio construction and asset selection of products best placed to improve their sustainability over time. This label will accommodate investment in assets that are in transition to becoming more sustainable.
Sustainable impact products will be those which aim to achieve a positive, measurable contribution to real-world sustainability outcomes. A firm using this label would commit to deliver and report on its contribution to a positive environmental and/or social sustainability outcome through financial as well as other types of investor additionality.
The FCA considers that the key features of this category are (1) an objective to achieve a pre-defined, positive, and measurable environmental and/or social impact and (2) sustainability goals pursued primarily by directing typically new capital to projects and activities that offer solutions to environmental or social problems, often in underserved markets or to address observed market failures, and secondarily through investor stewardship activities. The FCA expects these products to feature a description and illustration of how and why a desired change is expected to occur in a particular context.
Products which consider ESG risks, opportunities, and impacts but without a sustainability objective would not qualify for a sustainable investment label. However, firms would still need to ensure those features are communicated in compliance with the anti-greenwashing rule and applicable sustainability disclosure requirements.
The FCA recognises that UK firms operate in global markets and has provided guidance on mapping product classifications to the EU Sustainable Finance Disclosure Regulation (SFDR) and the US Securities and Exchange Commission (SEC) proposed regime. The FCA states that products without a sustainability objective but which may use strategies such as “ESG integration,” “exclusion/negative screening,” or so-called “basic ESG tilts” would not qualify for a label.
The investment classification and labelling rules would come into effect provisionally from 30 June 2024 for in-scope firms (other than portfolio managers) and 30 December 2024 for portfolio managers that satisfy the 90% test: where 90% or more of the value of the constituent products qualify for a label.
Notably, the use of labels is optional even for funds targeting retail investors, and may be used for funds targeting institutional investors.
The FCA has set out proposals for disclosures initially by asset managers, with a view to extending them to certain FCA-regulated asset owners. The focus is on delivering information on the sustainability-related features of investment products in an accessible way, and providing more detailed information to institutional investors and others that want to know more.
Consumer-Facing Disclosure Rules
These will apply to in-scope firms (other than portfolio managers) marketing sustainability products to retail investors whether or not a label is used. The proposed rules require in-scope firms to provide a summary of their products’ key sustainability-related features, helping consumers to better understand those features, compare similar products or the same product over time, and hold providers to account for sustainability claims.
Consumer-facing disclosures should be made in a prominent place, such as the product webpage, alongside other key investor information such as the so-called PRIIPs Key Information Document. The disclosures have no set format, but must be clear and concise, not exceed two A4 pages when printed, and address basic information, a product label (if any), the sustainability goal and approach, a summary of unexpected investments, sustainability metrics, and signposting to other regulatory disclosures. The disclosures must be reviewed and updated annually and before any proposed change is made to a product.
These rules come into effect provisionally on 30 June 2024.
Detailed Disclosures at Product Level and Entity Level
These are aimed at institutional investors and other stakeholders or retail investors that may be interested in receiving more information. The disclosures are intended to provide greater transparency on a product’s sustainability objective, strategy, progress, and ongoing performance metrics.
The FCA proposes that the disclosures be made in two forms of existing documentation to reduce the burden on firms:
Pre-contractual disclosures associated with the qualifying criteria must be made by in-scope firms (other than portfolio managers) in relation to products bearing a sustainable investment label. For these products and those without a sustainable investment label that nevertheless adopt sustainability-related features integral to their investment policy, the disclosures should cover those features, the investment policy, and the strategy in a manner proportionate to the sustainability profile of the product.
Sustainability product reports will be required only for products that qualify for a sustainable investment label in the first instance. The report must include how the product invests, its performance against the selected key performance indicators, and, where relevant, stewardship-related information and any other metrics that a client or consumer might find useful in understanding the firm’s approach to meeting the sustainability objective or deciding whether to invest in a particular sustainability product.
The FCA proposes that the product report be published on the firm’s website. The FCA has helpfully recognised that in some client relationships, public disclosures are not helpful. Accordingly, portfolio managers and UK AIFMs managing unauthorised AIFs not listed on a recognised exchange that use a label will instead be subject to on-demand annual non-public reporting.
The pre-contractual disclosures, sustainability product reports, and on-demand regime come into effect provisionally from 30 June 2024, 30 June 2025 and 1 July 2025, respectively. An entity-level sustainability report covering how firms are managing sustainability-related risks and opportunities will also need to be made by all in-scope asset managers with more than £50 billion in assets under management from 30 June 2025, and all firms with more than £5 billion (but less than £50 billion) in assets under management from 30 June 2026. Accordingly, firms with less than £5 billion will be exempt from the entity-level report requirement. Such firms are currently exempt from the FCA climate-related disclosure regime in ESG Chapter 2.
The FCA proposals introduce restrictions around names and marketing to retail investors of investment products that do not qualify for a label. Firms providing in-scope products to retail investors that do not qualify for and use a sustainable label will be prohibited from using sustainability-related terms, including but not limited to ESG, climate, impact, sustainable, sustainability, responsible, green, sustainable development goals (SDG), Paris-aligned, or net zero in their product names and marketing.
The naming and marketing rules (other than the anti-greenwashing rule) would come into effect provisionally from 30 June 2024; however, portfolio managers will have until 30 December 2024 to come into compliance and will be exempt where 90% or more of the value of the constituent products qualify for a label.
The FCA regards distributors as those that offer, sell, recommend, advise on, arrange, deal, propose, or provide a product. This would include investment platforms through which investors can compare and invest in multiple investment products.
Distributors would be required to display prominently a sustainable investment label on the relevant digital medium and provide access to the accompanying consumer-facing disclosures. Distributors will also be prohibited from using a sustainable investment label for a product other than that which has been assigned by the firm.
The rules for distributors come into effect provisionally from 30 June 2024.
The FCA and HM Treasury will address how to expand the scope of the regime to overseas products in due course since the FCA intends to protect UK investors from potential greenwashing arising in non-UK as well as UK products. Pending that development, the FCA recognizes the need for an interim measure to help retail investors understand that some overseas products using sustainability-related terms in their names and marketing materials may not have an associated sustainable investment label.
The FCA proposes to require distributors of such products to UK retail investors to note, “This product is based overseas and is not subject to FCA sustainable investment labelling and disclosure requirements.”
The FCA judges its proposals to be consistent with the International Organization of Securities Commissions (IOSCO) recommendations on Sustainability-Related Practices, Policies, Procedures and Disclosure in Asset Management and to take into account sustainability regimes in similar jurisdictions such as the EU SFDR and the US SEC’s proposed regime. However, SDR is UK specific, materially very different from the SFDR and the SEC’s proposals, and regarding permissible use of labels, it sets a high barrier to entry. Once the FCA publishes its consultation on overseas funds, there will be a better sense of the FCA’s approach to cross-border interoperability. Notably, the FCA has not proposed mirroring the SFDR approach to principal adverse impacts and to do no significant harm.All types of FCA-regulated firms will need to address the advent of the anti-greenwashing rule provisionally by June 2023, whether or not they rely on labels. Firms potentially subject to SDR should start contemplating whether they will deploy labelled products and analysing potential issues in such use and compliance with SDR.
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