The FCA SDR Policy Statement: Some of the headlines

Introduction

On 28 November 2023, the Financial Conduct Authority (FCA) published its final rules and guidance on Sustainability Disclosure Requirements (SDR) and investment labels. The intention behind these measures is to ensure that financial products which are marketed as sustainable do as they claim and have the evidence to back it up.

The measures, set out in FCA Policy Statement PS23/16 (PS23/16), include an anti-greenwashing rule, four investment labels, and new rules and guidance for firms marketing investment funds on the basis of their sustainability characteristics.

Without doubt there is a lot packed away in PS23/16 and as aways the devil will be in the detail, meaning that there is no substitute to reading the whole paper. The paper itself is quite user friendly in the sense that feedback is contained in tables and most chapters have a short summary setting out the key features. PS23/16 also contains an overview of the SDR and labelling regime (Annex 2), which is a useful starting point as it provides illustrative examples on how certain areas of the regime might apply.

Anti-greenwashing rule

The anti-greenwashing rule will apply to all FCA-authorised firms and will be located in ESG 4.3.1R of the FCA Handbook. It requires all FCA-authorised firms to ensure that any reference they make to the sustainability characteristics of their financial products and services are consistent with the sustainability characteristics of the product or service and are fair, clear and not misleading. The timing for when the rule comes into force has changed to that consulted on. Instead of applying immediately, it now comes into force on 31 May 2024. In addition, the FCA has published a guidance consultation on the anti-greenwashing rule which closes for comment on 26 January 2023.

Scope

The investment labels, disclosure and naming and marketing rules apply to ‘UK asset managers’ (summarised in Table 15 of PS23/16). The disclosure requirements cover consumer-facing disclosures pre-contractual disclosures, ongoing product-level disclosures and entity-level disclosures. All of the new rules focus on products offered by UK funds to retail investors in the UK, although pre-contractual, ongoing product-level and entity-level disclosures apply to products offered to both retail and institutional investors in the UK. In relation to overseas funds offered by FCA regulated firms, the FCA states that it will continue to work with HM Treasury. In perhaps the most surprising change, except for the anti-greenwashing rule UK portfolio management is excluded from the rules, although a consultation is expected in early 2024.

Investment labels

In its consultation the FCA proposed three investment labels, which firms could choose to use if their products met qualifying criteria. These labels were ‘Sustainable Focus’, ‘Sustainable Improvers’ and ‘Sustainable Impact’. The final rules largely follow the consultation proposals albeit with some amendments like, for instance, some of the detail being removed from the Sustainable Improvers category. There is also now a new fourth label called ‘Sustainability Mixed Goals’ which is designed to accommodate products with mixed strategies that meet the criteria for a label. The FCA considers this will increase overall label uptake and, with more funds using labels, there will be an increased provision of standardised sustainability-related information. Firms will need to identify and disclose the proportion of assets invested in accordance with any combination of the other labels.

To use a label, products need to meet the general and specific qualifying criteria for each label. Also, firms need to meet specific requirements under the criteria and make associated disclosures.

In terms of general qualifying criteria, there remains the five overarching themes of sustainability objective, investment policy and strategy, key performance indicators (KPIs), resources and governance, and stewardship. The FCA has made some changes to these in light of the feedback to its consultation, in particular that the 70% minimum threshold (at least 70% of the products 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) applies to all labels. The FCA is also not prescribing the KPIs that demonstrate progress towards achieving the sustainability objective, leaving it to firms themselves to determine which are the most appropriate for their products.

As for label specific criteria, there have been some changes too. For instance, on the Sustainable Improvers label, which has the objective of investing in assets that have the potential to become more sustainable over time, the FCA has added a new rule. This is intended to clarify that the potential to become more environmentally or socially sustainable over time means the potential to meet a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability over time. The thinking behind this is to place greater emphasis on the firm’s asset selection process.

Naming and marketing rules

The purpose of the naming and marketing rules is to help consumers differentiate between products that have sustainability objectives and use a label and those that have sustainability characteristics but do not use or qualify for a label.

Sustainability related terms can be used in product names and marketing alongside a label. However, if the ‘Sustainability Focus’, ‘Sustainability Improvers’ or ‘Sustainability Mixed Goals’ labels are used the word ‘impact’ must not be used in the product’s name. Where a label is not used, sustainability-related terms can be used in product names and marketing if the product name and marketing rules are followed.

The anti-greenwashing rule forms the foundation of the product name and marketing rules.

In terms of the product name rules, 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 these terms must not be used. In line with the anti-greenwashing rule and proposed guidance, firms should consider the product name as a whole and how it may be interpreted by a consumer. Firms must also produce the same types of disclosures as required for labelled products. Furthermore, firms need to publish a statement which clarifies that the product does not have a label and the reasons why. As for the marketing rules, firms must produce the same disclosures and statement as those required when sustainability-related terms are used in the name of the product.

Disclosures

The FCA consulted on four types of disclosures: consumer-facing, pre-contractual, on-going product-level and entity-level. The FCA confirms in PS23/16 that consumer-facing disclosures, which will summarise the product’s key sustainability characteristics, will be a standalone document, presented in a prominent place on the product webpage, app or other digital medium, alongside other key investor information. However, the final rules for consumer-facing disclosures have been adjusted so that they apply only to labelled products and products using sustainability-related terms in their naming and marketing (with the exception of where terms are used to make short, factual, non-promotional statements in marketing materials). Also, firms will need to review and update consumer-facing disclosures at least every twelve months.

There have also been some further changes to ongoing product-level disclosures but its noticeable that the FCA has not amended its requirements relating to data. Firms using labels will need to take reasonable steps to ensure the data used for KPIs is accurate and complete. As for entity-level disclosures, the FCA has referenced the ISSB, SASB and GRI standards as documents to consider when firms are determining the content of their disclosures but, given that the ISSB and GRI standards are designed for corporate reporting, these are envisaged as a starting point when considering the types of sustainability-related information that would be useful to clients and consumers.

Distributors

Distributors will be subject to the anti-greenwashing rule. They are also required to communicate the label and provide access to consumer-facing disclosures (both for labelled and unlabelled funds) to retail investors, either in a relevant digital medium for the product or using the channel they would ordinarily use to communicate information. Distributors must also provide a notice on overseas products clarifying that they are not subject to the UK sustainability disclosure and labelling regime. The FCA will be establishing an independent working group for the advice industry to help build on capabilities in sustainable finance, including how the sustainability disclosure rules and labels support their role.

Timing

As mentioned above, the anti-greenwashing rule is not coming into immediate effect as originally expected but on 31 May 2024. The FCA has opted for a staggered implementation timeline for the other requirements with some key milestones being:

• 31 July 2024 – Firms can begin to use labels, with accompanying disclosures.
• 31 July 2024 – Rules on distributors regarding labels, consumer-facing disclosures and notice on overseas funds come into force where firms are using labels.
• 2 December 2024 – Rules on distributors regarding notice on overseas funds.
• 2 December 2024 – Naming and marketing rules come into force, with accompanying disclosures.
• 2 December 2025 – Ongoing product-level and entity-level disclosures for firms with assets under management (AUM) greater than £50bn.
• 2 December 2026 – Entity level disclosure rules extended to firms with AUM greater than £5bn.

A more detailed implementation timeline can be found in Table 17 of PS23/16.

Next steps

On page 19 of PD23/16, the FCA sets out a summary of next steps for firms. In addition, as mentioned above, there is a lot packed away in the paper and therefore it needs to be thoroughly reviewed. No doubt firms will focus on the anti-greenwashing rule which comes in first on 31 May 2024. However, given all it entails to operationalise the regime, six months seems tight. There is also the matter of developing the regime further and on page 18 of PS23/16 the FCA sets out a list of areas that it will focus on, with the first being UK portfolio management. The FCA will also carry out a post implementation review of its rules after three years.

International

As with the previous consultation, the FCA has produced an annex regarding international compatibility noting that its assessment of its rules against the EU Sustainable Finance Disclosure Regulation (SFDR) and the US Securities and Exchange Commission’s (SEC) proposals broadly remain the same. There is updated mapping of the labels’ criteria against the SFDR as the SEC has not yet finalised its approach. However, the mapping takes into account the SFDR as it currently is. The European Commission issued a targeted consultation questionnaire on the SFDR which runs until 15 December 2023.

This briefing was first published on Thomson Reuters Regulatory Intelligence on 12 December 2023.