Background to why the SDR is needed

In a  wide-ranging FCA Policy Statement (PS23/16), the FCA has confirmed the final rules and guidance for the Sustainability Disclosure Requirements and a consumer-focussed investment labelling regime (SDR).  This follows a consultation (CP22/20) issued in October 2022 and a  discussion paper (DP21/4) issued in November 2021 which involved feedback from various stakeholder groups including the asset management industry, the Disclosure and Labels Advisory Working Group (DLAG), consumer groups and other regulators (see our previous Engage article on the background to those here). The publication of PS23/16 has been long-awaited given that it was originally scheduled for Q2 2023, then delayed to Q3, and finally pushed back again to Q4 2023 before publication on 28 November 2023.

The FCA has set out that with an estimated $18.4 trillion of ESG-orientated assets now being managed globally, which is expected to rise to $34 trillion by 2026, there is clearly a demand for investments with some positive environmental or social impact.  The SDR aims to support the UK’s position as a world-leading, competitive centre for asset management and sustainable investment. 

In terms of why the SDR is being introduced, the FCA highlights that the SDR is designed to support and protect consumers by helping them to make more informed decisions when investing and enhance the credibility of the sustainable investment market.  The FCA’s consumer protection mandate requires it to ensure that those products that are marketed as being sustainable should be able to meet those objectives and have evidence to back up those claims Consumer trust is vital for the viability of the market. 

The FCA is concerned that some firms may have been making misleading or exaggerated sustainability-related claims about their investment products which is damaging market integrity.  FCA research has shown that investors are not confident that sustainability-related claims made about investments are genuine.  The FCA highlights that firms have not used terms such as 'green', 'ESG' or 'sustainable' consistently which has led to confusion amongst consumers about what those terms mean.

The SDR also aims to support leading the UK to a more sustainable future and reaching the UK’s target of net zero by 2050. The SDR is designed to lead to a virtuous circle of better industry standards leading to improved market integrity helping to consolidate the reputation of the UK as a leading international hub for sustainable finance, thereby attracting more credible sustainability-orientated investment opportunities.

What does the SDR introduce?

The final SDR package includes the following:

• An anti-greenwashing rule for all authorised firms to reinforce that sustainability-related claims must be fair, clear and not misleading (FCNM).  The FCA is also consulting on the supporting guidance around this in a Guidance Consultation 23/3 (GC23/3) open until 26 January 2024.
• Four product labels to help consumers navigate the investment product landscape, understand what their money is being used for and enhance consumer trust.  The four labels aim to meet clear criteria on their sustainability goals as further set out in the labelling section below and in this new FCA webpage.
• Naming and marketing rules for investment products so products cannot be described as having a positive impact on sustainability when they do not.  The use of sustainability-related terms will only be permitted where these are accurate.
• Consumer-facing information to provide consumers with better, more accessible information to help them understand the key sustainability features of a product.
• Detailed information in pre-contractual, ongoing product-level and entity-level disclosures, targeting institutional investors and consumers seeking more information.
• Requirements for distributors to ensure that product-level information (including the labels) is made available to consumers.

As well as building on feedback to DP21/4 and CP22/20 (to which the FCA received 240 responses), the FCA states that the final measures have also been informed by:

• The findings from the FCA’s multi-firm review published on 16 November 2023 on the application of the Guiding Principles set out in this AFM chair letter from 19 July 2021. The review found that whilst some progress had been made, more need to be done to ensure firms were embedding the Guiding Principles into the design and delivery of ESG and sustainable investments. 
• Feedback from the Treasury Sub-Committee’s inquiry on Greenwashing: sustainability disclosure requirements (see our Engage article on that here).
• Engagement with the FCA’s independent statutory panels including the Financial Services Consumer Panel, the Practitioner Panel and the Smaller Business Practitioner Panel.
• The FCA's Financial Lives Survey which highlighted that a significant majority of adults in the UK would like to invest in a way that protects the environment and has a positive social impact.

What is the anti-greenwashing rule and is there any guidance on it?

The anti-greenwashing rule is summarised in Chapter 4 of PS23/16 and is included in the SDR measures to help ensure that sustainability-related claims made by all authorised firms about their products are not only fair, clear and not misleading but also consistent with the sustainability profile of the product or service.  The rule applies to all communications about financial products or services which refer to the environmental and/or social (i.e. ‘sustainability’) characteristics of those products or services. Sustainability-related references can be present in, but are not limited to, statements, assertions, strategies, targets, policies, information, and images.

To provide further clarity on the FCA’s expectations, the FCA is consulting on guidance (GC23/3) for the anti-greenwashing rule.  The guidance consultation is open for comments until 26 January 2024.

The effective date for the anti-greenwashing rule coming into effect is 31 May 2024.  The FCA has decided on an earlier implementation date for the anti-greenwashing rule and guidance as this will apply to all authorised firms, in contrast to the remaining SDR and labelling rules which will apply to UK asset managers only at this stage.

Labelling regime - what are the new labels?

Chapter 5 of PS23/16 sets out the principles of the labelling regime and general criteria. The FCA received significant feedback on the detailed criteria to qualify for a label and part of the response to that feedback has been to add a fourth label, ‘Sustainability Mixed Goals’.  This label will be suitable for those funds that have a mix of assets that might meet the attributes of the Focus, Improvers and/or Impact labels and “have the potential to improve their sustainability over time”.  

From 31 July 2024, consumers will start to see labels on investment funds that have a specific environmental or social goal.  The four labels (set out below) are designed to help consumers differentiate between the different sustainability objectives and different investment approaches to achieve those objectives.  The aim is to provide consumers with clear and simple information on what that goal is and the approach to achieving it and there is a requirement to provide annual updates on progress towards those goals. 

The labels are as follows:

• Sustainability Focus: invests mainly in assets that focus on sustainability for people or the planet.
• Sustainability Improvers: invests mainly in assets that may not be sustainable now, but have the potential to improve their sustainability in time.
• Sustainability Impact: invests mainly in solutions to sustainability problems with an aim to achieve a positive impact for people or the planet. References to “real world impact” as seen in the previous CP22/20 definition of this label have been removed.
• Sustainability Mixed Goals: invests mainly in a mix of assets that either focus on sustainability, aim to improve their sustainability over time, or aim to achieve a positive impact for people or the planet.

Firms can choose to use labels for products seeking to achieve positive sustainability outcomes, provided that they meet the qualifying criteria set out above.  

The general qualifying criteria for a product with any of the sustainability labels align under the following 5 key themes:

• Sustainability objective - all products using a sustainability label must have a sustainability objective to improve or pursue positive environmental and/or social outcomes as part of their investment objectives. Firms must identify and disclose whether pursuing the positive sustainability outcomes may result in material negative outcomes.
• Investment policy and strategy - ordinarily, at least 70% of the product’s assets must be invested in accordance with its sustainability objective, with reference to a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability. Firms must also identify and disclose any other assets held in the product for other reasons (eg, cash, derivatives), including why they are held.  In the final rules the FCA has removed a previous proposal to have an investment strategy assessed as ‘credible’ by an independent party.  That assessment can now be done in-house.
• KPIs - firms must identify KPIs to measure progress against the sustainability objective (these can measure the progress of the whole product or individual assets).
• Resources and governance - firms must ensure there are appropriate resources, governance and organisational arrangements to support delivery of the sustainability objective.
• Stewardship - firms must identify and disclose the stewardship strategy needed to support the delivery of the sustainability objective for all labels, including activities they expect to take and outcomes they expect to achieve. Firms must also set out an escalation plan to be able to take action when assets do not demonstrate sufficient progress towards the sustainability objective and/or KPIs. Assets subject to such action should remain within the 70% threshold. The FCA states that it has not been prescriptive as to the form in which stewardship would take place or whether the strategy is at firm or product level.  In the final rules it has removed previous references that may imply a certain approach. The FCA refers to added disclosures which might help with stewardship approaches including referencing the UK Stewardship Code or other stewardship-related reporting.

The FCA confirms that the labels are not designed to be in a hierarchy (perhaps in contrast to approaches that have been taken to the disclosure requirements under Articles 6, 8 and 9 of the EU SFDR).

Funds that have labels will also need to be accompanied by clear and simple information setting out what the sustainability goal is, the approach to achieving it and annual updates on progress towards the goal (further detailed below).

Does the FCA provide further information on the 70% threshold that needs to be reached to meet the criteria for a sustainability label?

As noted above, sustainability labelled products will need to have a minimum of 70% of assets aligned with the relevant label. In addition, the FCA has said that unlabelled products with sustainability characteristics (discussed further below) should also ensure that those characteristics will be "material to the fund’s objectives and/or investment policy and strategy" which they clarify means "for example, that at least 70% of the assets have sustainability characteristics”. Alternatively, managers may need to include a qualification of any sustainability-related terms used in relation to its product in order to "accurately reflect a product’s sustainability characteristics, eg, ‘low-carbon tilt’ rather than ‘low carbon’. This may help to clarify that the majority of the product may not necessarily have sustainability characteristics”.   

What about those funds that make sustainability claims but do not meet the requirements for the new labels- are there disclosure rules for unlabelled products?

From the original proposals set out in CP22/20, the FCA appears to have amended the naming and marketing rules to allow some flexibility for firms that do not meet the requirements for each type of sustainability label but that still have ESG characteristics (similar to funds disclosing in line with the requirements of Article 8 of the EU’s Sustainable Finance Disclosure Requirements (SFDR)).  For example funds without a label may still make some ESG-related claims such as including ‘green’ or ‘low carbon’ in the name of the fund.  The circumstances where a label is not featured might include:

• The provider might have chosen not to feature a label;
• The fund does not meet the criteria to feature a label; or
• The fund is not in scope of the regime because it is based outside of the UK or is a different type of fund such as a pension fund. 

Where this is the case, those funds will still need to disclose clear and simple information about what the fund is investing in meaning that unlabelled funds making sustainability claims will be required to make the same types of disclosures as those required for a labelled product.  There must also be a statement clarifying that the product does not have a label and explaining the reasons why.  

What are the key features of the naming and marketing rules within the SDR?

All FCA-authorised firms are subject to the anti-greenwashing rule which requires that sustainability-related claims must be clear, fair and not misleading. This is consistent with the Consumer Duty’s ‘consumer understanding’ outcome and forms the foundation of the FCA’s naming and marketing rules for asset managers as well.

Sustainability-related terms can only be used in product names and marketing if:

• they use a label – provided that, where the ‘sustainability focus’, ‘sustainability improvers’ or ‘sustainability mixed goals’ labels are used, the word ‘impact’ is not used in the product’s name; or
• they do not use a label but comply with the ‘Product name’ and ‘Marketing’ sections further detailed in Chapter 7 of PS23/16 including the following:
  • The product must have sustainability characteristics and the product’s name must accurately reflect those characteristics but the terms ‘sustainable’, ‘sustainability’, ‘impact’ and any variation of those terms must not be used.
  • Firms should be able to accurately describe their products so that consumers are able to navigate to those that meet their needs and preferences. 
  • The naming and marketing rules only apply when the sustainability related terms are being used for products marketed to retail investors.
  • Additionally they only apply when referring to sustainability characteristics and do not preclude firms from using the terms in other contexts, such as to describe the ‘economic climate’ or ‘financial impact’.
  • The naming and marketing rules do not apply when firms are making short, factual, non-promotional statements about a product, such as when making a statement about who is ‘responsible’ for providing services in relation to a product, or stating that ‘Firm X produces its sustainability product reports annually’.

What are the key features of the consumer-facing, detailed product-level and entity-level  disclosures?

Consumer-facing disclosures

Further detailed in Chapter 8 of the PS23/16, the FCA summarises that:

• Firms must produce a clear, concise consumer-facing disclosure for i) products with a label and (ii) or products using sustainability-related terms without a label.
• It must be located in a prominent place on the relevant digital medium (eg, webpage, mobile app) through which the product is offered, and hard copies must be made available on request. It must not exceed 2 pages.
• The disclosure must include the following information:
  • either the product’s sustainability objective and label, or the statement to clarify that the product does not have a label;
  • the investment policy and strategy (including what the product will and will not invest in);
  • relevant metrics;
  • details of where a consumer can access other relevant sustainability and non-sustainability information; and
  • for the ‘Sustainability Mixed Goals’ label only, the proportion of assets invested in accordance with each of the other relevant labels.
• It must be reviewed and updated annually as appropriate. Disclosures for products with labels must, at a minimum, be updated to reflect progress towards achieving the sustainability objective.

Product-level disclosures

• All products using a label or using sustainability-related terms in their naming and/ or marketing without a label must include sustainability information in:
  • pre-contractual disclosures (from the date the label is first used or by 2 December 2024 for products using the terms without a label); and
  • ongoing product-level disclosures annually (after 12 months from either the date the label or terms are used)
• For products using a label, the information that must be disclosed is broadly associated with the qualifying criteria for the labels.
• For products not using a label, the pre-contractual and ongoing product-level disclosures must, at a minimum, include information relating to the investment policy and strategy and any relevant metrics.
• For the ‘Sustainability Mixed Goals’ label only, the disclosures must include the proportion of assets invested in accordance with each of the relevant labels, and the information required in relation to those labels.

Entity-level disclosures

• Consistent with the TCFD’s (and ISSB’s) 4 pillars, firms are required to disclose their governance, strategy, risk management, and metrics and targets in relation to managing sustainability-related risks and opportunities.
• The TCFD’s supplementary guidance for asset managers, IFRS sustainability disclosure standard (IFRS S1), the SASB Standards and GRI Standards are documents that may be relevant for firms to help determine what to disclose.
• Where firms use labels or sustainability-related terms in their product names and marketing, they must also include details on their resources, governance and organisational arrangements in relation to those products.
• All firms with over £5 billion AUM must make these disclosures annually in a sustainability entity report, which builds from the TCFD entity report.
• Firms can cross-refer to disclosures made in a group, parent-level or other relevant report, provided the information is clearly signposted and other cross-referencing requirements are met.

How will the FCA supervise and enforce the SDR?

If a firm chooses to label a product, the firm remains responsible for its classification and ensuring the label is appropriate. The FCA’s Fund Authorisation team will review, and may challenge, the application of any new fund submitted for authorisation, or amendments to existing funds. However, this will not be an approval of the label. The FCA states that it will apply its usual supervisory and enforcement approaches to the SDR responding to compliance issues when they arise and will take action if it sees evidence that a firm may not be meeting the requirements. The FCA will take enforcement action where it has reason to believe that serious misconduct may have taken place. It states that it will continue to provide support to industry on implementation of the regime through stakeholder engagement, including webinars and events.

Has the FCA considered alignment across jurisdictions for example contrasting SDR and SFDR approaches?

The FCA says that it has sought to encourage international interoperability notably with the EU’s SFDR. Annex 3 to PS23/16 includes a mapping of the SDR to the SFDR.  The FCA notes the ongoing review of the SFDR and its consultation published in September 2023 (see our Engage article for further information) and acknowledges that, as the UK is the first to introduce investment labels, it stands ready to work with the EU authorities on this important issue.  The FCA has stated that it is keen to work with other jurisdictions to demonstrate that it is possible to introduce rules that protect consumers but also help the market to grow. The FCA says it will continue to engage with its counterparts across the globe as they develop similar rules, as well as continuing to engage with HM Treasury as it considers its approach to overseas funds. The FCA says that it wants to see a level playing field for all firms operating across the market to maximise the benefits of the regime for consumers.

What should firms to do prepare for the SDR?

All authorised firms should:

• Prepare for the new anti-greenwashing rule if they make claims about the sustainability characteristics of their products or services, to ensure sustainability-related claims are fair, clear and not misleading;
• Read the FCA’s accompanying consultation on further guidance to the anti- greenwashing rule  and decide whether to respond to this by 26 January 2024.

In addition UK asset managers should:

• Decide whether to label products that aim to achieve positive sustainability outcomes, if they meet the qualifying criteria set out above;
• Familiarise themselves with the FCA requirements (summarised in Annex 2 and set out in full in Appendix 1 of PS23/16) and prepare to meet the relevant regulatory requirements within the implementation timeframes. This includes general requirements for use of the label (including notification to the FCA and disclosure publication requirements), qualifying criteria, naming and marketing, disclosures, and ongoing requirements.

All distributors of relevant investment products should:

• Prepare to make the labels and consumer-facing disclosures available to retail investors, and to keep them up to date following changes made by the firm;
• Where relevant, prepare to add a notice on overseas funds to inform consumers that they are not subject to the regime.

SDR: next steps and key timelines

The SDR rules and guidance come into force on the following dates:

• Anti-greenwashing rules and guidance – the FCA has published a consultation on anti-greenwashing guidance on 28 November 2023.  Responses to that are due by 26 January 2024.  The anti-greenwashing rule will then come into effect on 31 May 2024.
• Firms can begin to use labels with accompanying disclosures from 31 July 2024.
• The naming and marketing rules come into force with accompanying disclosures from 2 December 2024.
• Ongoing product-level and entity-level disclosures for firms with AUM greater than £50bn will come into force on 2 December 2025.
• Entity-level disclosure rules will be extended to firms with AUM greater than £5bn on 2 December 2026.

The FCA makes the point that the rules and guidance set out in PS23/16 are a starting point.  It intends to expand and evolve the regime in the future as follows.

• Portfolio management – in early 2024, the FCA will consult on a similar approach for portfolio management with a focus on UK retail clients, including managed portfolios and discretionary wealth management services. 
• Overseas funds are not in scope of PS23/16 but the FCA will continue to work with HM Treasury to understand the options for extending the SDR to overseas recognised funds, including those marketing under the Overseas Funds Regime. 
• Pension products - the FCA will also consider extending the regime to pension products and will provide further details on this in due course. 
• Financial advisers - the FCA plans to set up an independent working group for the advice industry to work together to build on existing capabilities in sustainable finance including how the SDR and labels could support their role.
• Disclosures – the FCA plans to build on disclosure requirements over time in line with UK and international developments.  This includes updating FCA guidance on transition plan disclosures drawing on the outputs of the government’s Transition Plan Taskforce (TPT).  It will also consider updating product-level disclosures requirements once the UK Green Taxonomy is in use and product and entity-level disclosure requirements in line with future ISSB standards.  

Our Sustainable Finance & Investment practice brings together a multidisciplinary global team to support our clients in this mission-critical area. We are following this important development very closely so please get in touch if you would like to discuss further. 

Authored by Rita Hunter, Julia Cripps and Melanie Johnson.