SDR brings long-awaited answers but raises pressing questions

16 November 2022 | UK & Europe | Articles

The SDR consultation is certainly weighty, outlining proposed sustainability labels and detailed disclosure requirements for investment products, as well as anti-greenwashing rules which apply to all regulated firms.

But the proposals are controversial in their use of ‘voluntary’ labels, and there are fundamental elements which are not yet addressed, for example how firms deal with lack of available data and how often they should be reviewing portfolios. There are also firms for whom the labels are not available, for example those with discretionary managed segregated portfolios investing directly in companies with sustainability features. And for those already having to comply with SFDR in Europe, there is little alignment when it comes to product labelling.

While it’s likely there will be more changes than usual between publishing the proposals and final policy statement – not least because of the FCA’s wider research on the topic – some elements will come into effect as early as June and others which will require considerable time to prepare. For some firms, reviewing all potential ESG-related terms across all marketing materials will be a real challenge. “Wait and see” does not look like an option.

The next step in the “Roadmap to Sustainable Investing”

The FCA published CP22/20: Sustainability Disclosure Requirements (SDR) and investment labels last month, outlining the proposed next steps in the UK Government’s Roadmap to Sustainable Investing to support the UK’s overall transition to a net zero economy.

The proposals build on the new ESG sourcebook, applying the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) and expanding on the Dear AFM Chair letter which outlined the regulator’s guiding principles for authorised funds. There are also links throughout to other regulatory initiatives such as the FCA’s new Consumer Duty. Comments are invited up to the 25^th January.

This consultation covers six key areas:

• Sustainable investment labels for investment products based on the nature of the product’s investment objective and how it will promote positive sustainability outcomes.
• Consumer-facing product-level disclosures summarising the sustainability characteristics of products with a focus on retail investors.
• More detailed sustainability disclosures for a range of stakeholders, including pre-contractual and ongoing performance disclosures at product level, and entity-level disclosures.
• Product naming and marketing rules to prevent firms using sustainability-related terms in product names and retail-facing marketing materials unless the product in question qualifies for one of the sustainable labels.
• Requirements for distributors to provide sustainability information to consumers.
• A general “anti-greenwashing rule” for all regulated firms.

The FCA also states its intention to consult further on requirements for marketing overseas funds in the UK, and the obligations on FCA regulated asset owners and advisers seeking to address the sustainability preferences for investors.

Which firms are in scope?

All firms

The FCA have proposed a new anti-greenwashing requirement, that will impact all FCA regulated firms, and which reasserts existing requirements that information provided on products and services must be clear, fair, and not misleading and should be linked directly to sustainability claims. This requirement will necessitate an updated financial promotion approval process to avoid unwarranted ‘green’ language and in some cases a review of all current marketing material to confirm it is compliant.

“In-scope” firms and products

The product labelling and disclosure rules will capture all fund and asset managers, including UK AIFMs, UCITS Man Cos, self-managed UCITS ICVCs, and UK portfolio managers (‘in-scope firms’). The products that are in scope include all authorised funds and unauthorised AIFs, including investment trusts (‘in-scope products’). With regards to authorised funds, this excludes feeder funds and funds in the process of winding up or termination. Those firms that provide portfolio management services will not be required to produce product level disclosures but will be required to provide access to the relevant disclosures for the underlying products where these are funds. Currently the consultation paper is silent on portfolio management services which invest directly into companies that have sustainable credentials.

Distributors

Distributors who offer in scope products to retail investors, such as financial advisers and investment platforms, will be subject to more limited requirements, namely displaying sustainable product labels and making consumer facing disclosures.

Overseas

The FCA will follow up with a separate consultation on how its proposals may apply to overseas products. Meanwhile, where prohibited sustainability‑related terms are used in relation to the naming and marketing of overseas products, distributors of those products to retail investors must place a notice on that product, alerting retail investors that the product is based overseas and is not subject to FCA sustainable investment labelling and disclosure requirements.

Investment labels

In the earlier Discussion Paper, the FCA had originally proposed five non-hierarchical mutually exclusive product labels; now there are three, set out in the SDR Consultation Paper as follows:

1. Sustainable focus: Products with assets that are environmentally and/or socially sustainable, by ensuring at least 70% of the portfolio meets a “credible standard of environmental and/or social sustainability” or aligns with a specified environmental and/or social sustainability theme.
2. Sustainable improvers: Products that seek to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm.
3. Sustainable impact: Products that have a clear objective to achieve a positive and measurable real-world impact to sustainable outcomes.

In scope firms will be responsible for their own labelling and will do so on a voluntary basis. It is important that firms ensure they have chosen the appropriate label for each product. The FCA may review and challenge, , labels for new authorised funds.

Products qualifying for a sustainable investment label must meet the following:

• Five overarching principles – these are listed in the appendix of the SDR CP and cover:sustainability objective, investment policy and strategy, KPIs, resources and governance, and investor stewardship.
• A number of ‘considerations associated with each of the overarching principles. For example, for the sustainability objective principle, a firm must determine the product’s sustainability objective in clear, specific and measurable terms as part of its investment objective.
• Certain category-specific key considerations relevant to their particular label.

Firms that provide portfolio management services can only use a label if 90% or more of the value of all constituent products, for example funds, in which they invest qualify for the same label.

All other products will have no sustainability label. Where sustainability-related features are integral to an investment policy and strategy, but the firm chooses not to use a label, or does not qualify to do so, they will need to ensure those features are communicated in a proportionate way to the sustainability profile of the product, in line with the FCA’s naming and marketing rules (see below).

Consumer-facing disclosures

The consumer-facing disclosures will apply to all in scope investment products with or without an investment label that are ultimately offered to retail investors. The disclosures are intended to help retail investors understand a product’s features and its objectives and will need to be provided alongside other existing disclosures, such as the Key Investor Information Document (KIID). The disclosures must be reviewed and updated at least annually. The information available to customers/investors will need to include information on the five principles mentioned above in relation to each relevant product. Notably, if any unexpected investments are made that the consumer may not typically associate with the sustainability objective of the product, then this should be disclosed. Unlike the EU’s SFDR, the FCA have decided to not create a disclosure template, as it wants to encourage the industry to develop its own.

Firms should bear in mind the Consumer Duty rules here, which are effective from July 2023, with a focus on the “consumer understanding outcome”. Firms should consider how they will test, monitor, and adjust communications and disclosures.

Detailed product level disclosures

Product level disclosures that will aim to deliver more granularity will be for all in scope products with an investment label or which adopt sustainability-related policies and strategies. These disclosures will be for both retail consumers who wish to receive more information and for institutional clients. Those products that do not qualify for a label or adopt sustainability‑related policies and strategies are not subject to detailed product-level disclosure requirements.

Two types of product level disclosures have been proposed:

1. Pre-contractual: to be contained in a dedicated section of a fund’s offering documents (for example the prospectus) and should cover the product’s sustainability investment objective, investment policy, approach to stewardship, and on any unexpected investments made.
2. Ongoing ‘sustainability product reports: will follow from the pre-contractual disclosures and inform investors, based on the current TCFD product reports.

Firms providing portfolio management services will not be required to produce their own sustainability product reports but must provide retail investors with easy access to relevant disclosures. Eventually the sustainability product report will also include a baseline of sustainability‑related metrics building from the core climate‑related metrics in the TCFD product report, and firms will be required to disclose these in respect of all in‑scope products (including those without a label).

Entity level disclosures

The entity level disclosures continue from the FCA’s requirements for the TCFD-aligned reporting and will apply to those firms with an AUM greater than £5 billion. As part of SDR, the FCA are proposing to introduce core entity‑level disclosure requirements based on the TCFD’s four recommendations in the areas of governance, strategy, risk management, and metrics and targets. These disclosures will need to be made available on a firm’s website.

Naming and marketing rules

The naming and marketing rules will apply for all in scope products available to retail investors which do not qualify for or use a label. The requirements here will prohibit the use of sustainability-related terms, including ‘ESG’, ‘climate’, ‘impact’, ‘sustainable’ or ‘sustainability’, ‘responsible’, ‘green’, ‘sustainable development goals, ‘Paris‑aligned’ or ‘net zero’ in retail facing marketing materials, apart from factual information in pre-contractual disclosures.

Key timelines

Next steps for firms

Firms should act now to understand the nature of their products in the context of the SDR and determine which disclosure requirements will apply. We would encourage firms to consider the following actions:

• Review sustainability communications and marketing materials to ensure compliance with the anti-greenwashing rule.
• Analyse the impact of the rules on all UK asset management products or services.
• Consider whether you might need to develop sustainability KPIs for any products or entities.
• Look at your stewardship framework to see if it might need improvement to support any labelled or other sustainable-related products.

We can help

Our regulatory specialists are working closely with a wide range of clients to understand how the SDR will impact them and how they need to start preparing.

Our November webinar looks in more detail at the proposed rules under the SDR, implications for firms, and actions to consider ahead of the implementation dates commencing next year. A recording of this session is available on request.