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With the consultation on the FCA’s new Sustainability Disclosure Requirements now closed, the industry waits to see what the final rules will look like. Although the general direction travel – supporting sustainable investing – has support, our research indicates that the path to get there may need some adjustments.
The Sustainability Disclosure Requirements – or SDR – will introduce labels to help consumers understand sustainable investment products and ensure that claims on sustainability are proportionate to the sustainability profile of the product.
The FCA proposed that product providers from mid-2024 will be able to use investment labels for their sustainable products. The labels will not be mandatory, in contrast to the EU’s Sustainable Finance Disclosure Regulation (SFDR) regime where all products are required to be categorised. The FCA have suggested three categories: those investing in a majority of assets that have a sustainable objective, “sustainable focus”; products looking to improve the sustainability of assets over time, “sustainable improvers”, and those that aim to invest in real world solutions to sustainability problems “sustainable impact”. The regime will initially focus on asset managers and portfolio management service providers, before expanding to other sectors over time.
The FCA’s drive to create a robust framework for sustainable investing is broadly supported across the financial services industry. When we polled attendees at our recent webinar, the majority agreed that the new rules will help to combat greenwashing, and three-quarters agreed that the product labels could be relevant to their products.
The FCA’s consultation on SDR closed at the end of January with the final rules expected at the end of June. If the feedback we have received from our clients is anything to go by the regulator will have received a heavy postbag on this one.
Further distinctions required
While many believe the inclusion of the “sustainable improvers” label is helpful to allow funds to be invested into companies that are committed to ‘transition’ there are concerns that the “sustainable impact” label is too restrictive as it is felt that the criteria do not fit with listed, public markets. This could increase both investment and liquidity risk for retail investors. The “sustainable impact” criteria focus primarily on the impact of the individual investor, which is difficult to claim or to measure, rather than an approach that considers enterprise contribution as having at least equal weight.
There is also concern that in creating a regime where the three product labels cannot be mixed, the labels will be unnecessarily and at times illogically siloed. This could make it difficult for firms to offer products with a ‘diversification of sustainability’. As a solution to this, the regulator could consider allowing firms to disclose the intended split of portfolios between the different label categories.
Where products do not qualify for the use of a label firms will need to be careful about the application of the new product naming rules which propose preventing terms such a ‘sustainable’ ‘green’ or ‘responsible’ being used, notwithstanding that a product may take ESG factors heavily into consideration.
SDR vs SFDR
For firms that also operate or sell products in Europe, how SDR interacts with the SFDR is something that they will need to consider carefully. The fact that the FCA and ESMA are taking very different approaches will only make it more difficult for firms to align both sets of rules. Although both are disclosure regimes, the SDR sets out the requirements for products to be allowed to use its investment labels, whilst the EU’s SFDR obliges firms to categorise all its products and then to determine the level of disclosures required.
Products that are categorised as sustainable under the EU’s rules may not meet the criteria for the SDR – meaning that they could be labelled as sustainable in one jurisdiction but not in another.
And firms that amend their investment strategies to meet SDR requirements will then have to consider the knock-on effects in other jurisdictions, such as the EU. There is a risk that the difficulty of aligning products with more than one regime will mean that fewer sustainable investment products are made available to UK consumers.
What’s next
All of this amounts to a good deal of uncertainty around the adoption of SDR; our poll found that two-thirds of asset managers are unsure of how challenging they will find the proposed requirements to implement.
While firms can expect there to be significant changes between the proposals and the final policy, they cannot afford to wait around. Those that don’t will find that they are playing catch up by the time the final policy paper is out.
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