Sustainability disclosure requirements: weighing up the proposals

The Financial Conduct Authority has published a long-awaited consultation paper on sustainability disclosure requirements and investment labels. The consultation sets out proposed rules for the UK’s equivalent to the EU’s Sustainable Finance Disclosure Regulation, which has been in place for some time. The aim of the new rules is to make the UK “a trusted centre for sustainable investment and place the UK at the forefront of sustainable investment internationally”. The SDRs aim to do this by “setting robust regulatory standards to protect consumers that raise the bar and build a strong foundation for sustainable investment products”. In the consultation, the FCA states: “We are proposing to introduce a package of measures aimed at clamping down on greenwashing. This includes sustainable investment labels, disclosure requirements and restrictions on the use of sustainability-related terms in product naming and marketing.” The FCA says it hopes to “provide greater transparency, consistency, and in turn, trust, in the market for sustainable investment products”. The consultation paper sets out core elements of the SDRs, with the focus on asset managers and their UK-based fund products and portfolio management services. Key dates and what is coming The FCA is inviting responses by 25 January. We can see a significant impetus to get this regime in place, as the FCA states that it intends to publish the final rules and guidance in a policy statement by the end of June. This is clearly a tight timescale, indicating the importance of ESG on the government’s agenda. The FCA acknowledges: “While we need to move quickly to address potential harms in the market today, we recognise that firms will need time to apply the new rules.” As the labelling, naming and marketing and initial disclosure requirements will require some adjustments by firms, these rules are not expected to come into effect until at least 30 June 2024. A further consultation is expected which will look at extending the scope of the new rules to overseas products. Additional consultations will follow to expand and evolve the regime over time. Objectives of the UK SDRs The key objectives of the SDRs include: Protecting consumers and improving trust in the ESG and sustainable investment products market; Enhancing transparency for end consumers; Meeting the information needs for institutional investors; and Helping to combat potential “greenwashing” by requiring firms to evidence the ESG claims they make. Tackling greenwashing is a core regulatory priority for the FCA. It sets out its concerns regarding the growth in the number of investment products marketed as “green” or making wider sustainability claims. By proposing new rules in this area, the FCA wants to ensure that consumers and firms can trust that products have the sustainability characteristics they claim to have. Key takeaways from the consultation The FCA is proposing to introduce: Sustainable investment product labels that will give consumers the confidence to navigate the investment product landscape more easily. There will be three categories for sustainable investment products: 1. Sustainable focus (for products investing in assets that are environmentally or socially sustainable); 2. Sustainable improvers (for products investing in assets to improve the environmental or social sustainability over time); and 3. Sustainable impact (for products investing in solutions to environmental or social problems to achieve positive, measurable real-world impact). The labels are all underpinned by objective qualifying criteria and assess products on the sustainability objectives they are trying to achieve. The FCA makes clear that there is no hierarchy between the proposed labels: each is designed to describe a different profile of assets and consumer preferences. They propose that firms can choose whether or not to label their products. Firms will, however, need to meet the proposed qualifying criteria to use the labels. Naming and marketing rules to restrict how certain sustainability-related terms – such as ESG, green and sustainable – can be used in product names and marketing materials for products that do not qualify for sustainable investment labels. A general anti-greenwashing rule which will reiterate requirements for all regulated firms that sustainability-related claims must be clear, fair and not misleading. This rule will come into effect immediately once the FCA publishes the final rules by 30 June 2023 given that it aims to clarify existing rules. Consumer-facing product disclosures to help consumers understand the key sustainability-related features of an investment product – this includes disclosing investments that a consumer may not expect to be held in the product. Detailed disclosures, targeted at a wider audience (for example, institutional investors or retail investors) that want to know more, including the following: 1. Pre-contractual disclosures (for example, in a fund prospectus), covering the sustainability-related features of investment products; 2. Ongoing sustainability-related performance information, including key sustainability-related performance indicators, in a sustainability product report; 3. A sustainability entity report covering how firms are managing sustainability-related risks and opportunities. Requirements for distributors of products, such as investment platforms, to ensure that the labels and consumer-facing disclosures of products are accessible and clear to consumers. Divergence from other regimes The FCA recognises that many firms and products that may be in scope of these new rules operate internationally. It has tried, as far as possible, to achieve international coherence with other regimes – notably the SFDR in the EU and proposals by the Securities and Exchange Commission in the US.  However, the FCA notes that the starting point for its proposals is actually very different, as they are introducing a consumer-focused labelling regime as well as disclosure requirements. So, although they have tried to complement the approaches taken in other jurisdictions, the FCA’s proposals differ quite significantly in some areas. Because of this, it has not been able to simply map to the same product categories used in the EU SFDR. In the consultation paper, the FCA sets out how its proposals differ from these international regimes, and it appears the FCA’s approach is likely to differ significantly.  Notably, the FCA states that the UK framework is designed as a labelling regime with detailed criteria to determine eligibility. Therefore, the regime differs to both the EU SFDR (which is positioned as a disclosure regime) and the SEC’s proposals. The FCA confirms that products that do not meet the qualifying criteria under its proposals will not be able to use any of the sustainable investment labels under the proposed SDRs. Firms will need to consider how a product categorised under the EU SFDR or under the SEC’s proposals would be treated under the FCA’s SDRs. Areas of divergence include proposals around classification and labels. Classification and labels The fundamental aim of the FCA’s classification and labelling regime is to: Help consumers distinguish between products on the basis of their sustainability characteristics, themes and outcomes; and Help them distinguish between different types of sustainable investment product. One of the key attributes of a sustainable investment product is an explicit environmental and/or social objective. This sustainability objective must be part of the product’s investment objectives (sitting alongside the product’s financial return objective) and expressed in specific and measurable terms. A sustainability objective may target either: A particular sustainability profile for the product’s assets, where it can be shown that this profile has a plausible, purposeful and credible link to positive outcomes for the environment and/or society; or Directly positive outcomes for the environment and/or society. The EU SFDR introduced the three disclosure categories of products set out below. These have become a de facto classification and labelling system despite the EU SFDR Regulatory Technical Standards explicitly stating that the SFDR is “not a labelling regime”. As a recap: Article 6: funds that do not integrate sustainability into the investment process; Article 8: funds that promote, among other characteristics, environmental or social characteristics, or a combination of those, provided the companies in which the investments are made follow good governance practices; and Article 9: funds that have sustainable investment as their objective. In the SDRs, the FCA sets out a method for considering how to treat a product that discloses under one of the above categories under the EU SFDR for its proposed regime as follows: Article 6: products will not be eligible for an SDR sustainable label; and Article 8 or Article 9: products that meet the FCA cross-cutting criteria and category-specific criteria may be eligible for one of the three SDR sustainable labels. The consultation paper also sets how to categorise a product under the FCA’s proposals that already falls within the SEC’s proposals. Disclosures The FCA’s proposals on entity-level disclosures, in respect of how the firm takes sustainability-related matters into account in managing investments on behalf of clients and consumers, are built from the framework devised by the Task Force on Climate-related Financial Disclosures. This is so that they remain consistent with the International Sustainability Standards Board standards. The FCA acknowledges that this approach means that the entity-level disclosure requirements are not fully aligned with EU SFDR or US requirements for fund advisers. The key difference is that the FCA does not require disclosure of principal adverse impacts. Rather, it intends to update disclosure requirements, as appropriate, to be in line with the development of more specific ISSB standards. To reduce the burden for firms in relation to disclosures, the FCA proposes that firms can make entity-level disclosures in a group or affiliate report that includes other sustainability-related disclosures, provided that the cross referencing and other requirements set out in the consultation are met. They must also include a compliance statement confirming that a firm’s disclosures comply with FCA requirements. Unlike the EU SFDR, the FCA is not proposing to introduce pre-contractual, website and periodic template disclosures for the SDRs. Instead, it “encourages” each industry to do so if helpful for firms. There are also some disclosure items required under the EU SFDR disclosures that the FCA is not proposing for the new regime in the UK.  Next steps The FCA has asked for comments on the proposed new regime by 25 January. It intends to review feedback and will set out the final rules in a policy statement by the end of June. The FCA also intends to expand the regime with further consultations on overseas and pension products in due course. Watch this space as it is clearly a fast-moving area, where change is inevitable. Click here to view the consultation.  Rita Hunter is a partner, Melanie Johnson and Ingrid Stables are senior knowledge lawyers and Stella Bliss is a counsel knowledge lawyer at Hogan Lovells Photo © Jacek Bilski/imageBROKER/Shutterstock