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In November 2023, the FCA published PS23/16 - Sustainability Disclosure Requirements (SDR) and Investment Labels. This outlined the regulator’s suite of initiatives aimed at providing consistency in the UK financial sector when it comes to sustainable products.

The EU had already implemented a similar regime in the form of the Sustainable Finance Disclosure Regulation (SFDR) However, following Brexit, this piece of regulation was not implemented in the UK, so the FCA decided to step in to fill the gap.

The FCA summarised the goals of the new rules as follows:

“The regime will support consumers in navigating their investments with trust that the products they are buying do as they say they will. The disclosure requirements will help to overcome information asymmetries, and the anti-greenwashing rule will apply to all FCA-authorised firms”

For clarity, the investment labels, disclosure, and naming and marketing rules discussed below apply only to UK asset managers (mainly fund management groups such as Fidelity, Blackrock, etc.) at present. However, portfolio managers (including DFMs and advice firms running advisory and white labelled model portfolios) will be brought into scope in December 2024. We await further guidance from the regulator, but the portfolio manager consultant closed in June, and a policy statement is likely to follow soon.

The measures include the following (it gets quite complicated from here on in, so we’ve tried to simplify the explanations as much as possible – for further reading, please see here):

1. A new Anti-Greenwashing rule – this came into effect on 31^st May 2024 and is touched upon below. This applies to all FCA authorised firms.

2. Four opt-in sustainable labels (more than one can apply where applicable) for products with sustainability objectives. The use of labels is intended to signpost to consumers so they can navigate the market effectively – these come into effect on 31^st July 2024. The high-level FCA criteria are:

- Sustainable Impact

This is for products with a sustainability objective consistent with an aim to achieve a predefined positive, measurable impact in relation to an environmental and/or social outcome (and invest at least 70% of their assets in accordance with that aim).

Sustainable Improvers

This is for products with a sustainability objective consistent with an aim to invest at least 70% in assets that have the potential to improve environmental and/or social sustainability over time and that are determined by their potential to meet the robust, evidence-based standard of sustainability. Firms must obtain robust evidence for selecting those assets.

Sustainable Focus

This is for products with a sustainability objective consistent with an aim to invest at least 70% in assets that are environmentally and/or socially sustainable, determined using the robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability.

Sustainable Mixed Goals

This is for products with a sustainability objective to invest at least 70% in accordance with a combination of the sustainability objectives for the other labels. Firms must identify (and disclose) the proportion of assets invested in accordance with any combination of the other labels. However, requirements for each of the other labels must be met.

The FCA has set out the specific qualifying criteria that asset managers looking to use a label with their products must meet, which can be separated out into various themes (we haven’t gone into detail here):

For example, if we apply the FCA criteria to the Sustainable Impact Label, you will get an idea of how these may work in practice:

Sustainability objective: To achieve a predefined, positive, measurable environmental and/or social impact.

Investment policy and strategy: Can be used to select assets that have the potential to contribute to positive, measurable impact.

KPIs: measure the positive impact (both the impact of the assets and the investor's contribution).

Stewardship: To support assets in delivering positive impact.

3. Naming and Marketing Rules – these come into effect 2^nd December 2024. We will publish further material nearer the time on the naming and marketing rules, but at a high level, they can be summarised as follows:

- Sustainability-related terms such as ‘green’, ‘transition’, or ‘environmental’ 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
• They do not use a label but comply with the ‘Product name’ and ‘Marketing’ sections.

4. Consumer-facing information - these new documents will be produced by fund managers and are intended to provide clients with a succinct document to help them understand the key sustainability features of a product. The FCA has not mandated a template but has laid out the minimum expectations and confirmed the documents must not exceed two pages.

The new consumer-facing disclosure applies to labelled products and products using sustainability-related terms in their naming and marketing and comes into effect 31^st July 2024.

5. Detailed information in pre-contractual, ongoing product-level, and entity-level disclosures – these will also be produced by the fund managers and are targeted at institutional investors and consumers seeking more information.

• Pre-contractual disclosures come into force from the date a label is first used or by 2^nd December 2024 if a sustainable term is used without a label.
• Ongoing product-level disclosures are produced annually thereafter (after 12 months from either the date the label or sustainable terms are used).

6. Requirements for distributors (advice firms, DFMs and platforms mainly) – these requirements aim to ensure that product-level information (including the labels) is made available to consumers to enable them to make an informed decisions. Distributors are expected to be ready to provide their clients with the relevant information from 31^st July 2024 onwards.

Our view

This stuff isn’t straightforward and there are many facets to the Sustainable Disclosure Regime, resulting in a steep learning curve for not only asset managers looking to opt in to use the labels, but also for advice firms and other distributors when it comes to explaining the new regime to clients.

What will be critical is how firms establish client preferences when it comes to ethical investing. The FCA seems to think that there is a high demand for these arrangements and has placed a great deal of emphasis on SDR as is evident, but few firms have adopted much more than a largely generic approach to this in the past, but many will need to reconsider this in light of SDR.

There is still much yet to be made clear and most fund management groups are keeping their cards close to their chests at this stage. Some have also failed in their attempts to align with one or more of the four labels, so it’s not just the firms we deal with that are struggling to come to terms with this.

Matters are likely to become clearer as time elapses, but if the FCA’s view is proven to be correct, there are a lot of changes coming down the line.

Firms are understandably weary when it comes to regulatory change, particularly with the two phases of Consumer Duty and the knock-on effects of these, but the regulator shows no sign of slowing down, so whether we like it or not, we have to adapt.

Author - Thomas Purcell - Compliance Consultant

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