FCA Sustainability Disclosure Requirements (SDR) and Investment Labels

On 25 October 2022, the UK’s Financial Conduct Authority (FCA) issued a consultation paper (CP22/20) (the "Consultation Paper") on Sustainability Disclosure Requirements (SDR) and investment labels. 

The Consultation Paper is a product of the FCA's growing concern that regulated firms may be making exaggerated, misleading, or unsubstantiated sustainability-related claims about their investment products (also known as "greenwashing"), and follows a discussion paper published in November 2021 (DP21/4).

Summary (the "who" and the "what")

The proposals set out in the Consultation Paper are discussed below but, broadly, all FCA regulated firms will have to abide by the "anti-greenwashing rule" that sustainability-related claims, primarily in relation to investment products, must be clear, fair and not misleading.

The more targeted proposals, i.e. rules on labelling and classification, disclosure, naming and marketing and distribution, will affect investment funds (primarily those marketed to retail investors in the UK), and the firms that manage or distribute those ESG focused investment products. 

Initial thoughts

The FCA have taken a belt and braces approach to their concentration on retail customers, ahead of the launch of the Consumer Duty. The Consultation Paper proposes new rules to prevent the erosion of consumer trust in the market for sustainable investment products, help consumers navigate an increasingly complex investment product landscape, and overall protect consumer interests. More specifically, the FCA have outlined that the focus of the new regime is to help consumers distinguish between products based on their sustainability characteristics, themes, and outcomes, and to help them make informed decisions when it comes to sustainable investment products.

That said, although the FCA has sought to make the regime as straight forward as possible, the length of the Consultation Paper alone is suggestive of the complexities that firms will need to navigate, and the extent of work likely to be involved in complying with the detailed requirements (this begs the question, at what cost?). 

The multifaceted proposals also send a strong message to firms that tackling greenwashing is a high priority area for the FCA and that there is nowhere to hide in the ever-evolving ESG regulatory space. After all, among the reasons behind the Consultation Paper, is the FCA's desire to have an explicit rule on which to challenge firms they consider to be greenwashing their products or services, and to take appropriate enforcement action against them. 

The FCA will also be stepping up its supervisory engagement on sustainable finance, meaning that authorised fund managers should expect a "check-in", regarding how they have responded to the action points set out in the "Dear Chair Letter" issued in July 2021. 

In-scope firms should be aware that these new rules are in addition to the FCA's climate related disclosure regime which came into force earlier this year (PS21/24). With an anticipated effective date of 2023/2024 (see timeline below), firms will already be busy preparing to make their TCFD disclosures, so only time will tell how aligned these regulatory changes truly are and how easily the new requirements "bolt on" to the already high expectations set by the FCA. 

Proposals

The FCAs proposals set out in the Consultation Paper seek to address the following five main areas: 

1.   Sustainable investment labels

Product labels will be based on "intentionality" and focus on the particular sustainability objective the product is seeking to achieve. Broadly, the labelling regime distinguishes between three types of sustainable products:

• Sustainable Focus – investments in assets that are environmentally and/or socially sustainable;
• Sustainable Improvers – investments to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm; and
• Sustainable Impact – investments in solutions to environmental or social problems, to achieve positive, real-world impact.

The FCA have developed a set of threshold criteria that a firm must meet for the product to qualify for any one of these labels. In particular, the FCA state that the criteria are objective, rigorous and aim to "raise the bar", whilst providing flexibility to accommodate different sustainability objectives for continued evolution and innovation in the market.

Firms will need to decide if they want to apply a sustainable investment label to their products based on an assessment of whether the products meet the relevant qualifying criteria. Products that are not labelled must meet the new naming and marketing rules (set out below).

2.   Disclosures

The FCA intends to introduce a set of consumer-facing disclosures as well as a second layer of more detailed disclosures aimed at institutional investors and other stakeholders.

Consumer-facing disclosures

Disclosure layer 1 will be aimed at consumers and therefore must be consumer-friendly and accessible to help consumers understand the key sustainability-related features of an investment product. The consumer-facing disclosures must be produced for products with or without a sustainable investment label.

Detailed product-level and entity-level disclosures

Disclosure layer 2, aimed at a wider range of stakeholders, will comprise:

• Pre-contractual disclosures – covering the sustainability-related features of an investment product (for example, its sustainability objective and investment policy and strategy), both for products which use a label, and for products that do not use a label, but which have sustainability-related features that are integral to their investment strategy;
• Sustainability product-level report – covering ongoing sustainability-related performance information for products that use a sustainable investment label; and
• Sustainability entity-level report – covering disclosures on how firms are managing sustainability-related risks and opportunities, irrespective of whether an in-scope firm uses a label.

3.   Naming and marketing rules

The Consultation Paper proposes prohibiting firms from using "sustainability-related" terms in the naming and marketing of products offered to retail investors, when them products do not qualify for the use of a sustainable investment label. The FCA has indicated that such terms would include "ESG", "sustainable", "responsible", "green", "net zero", and the like.

Restrictions will also apply to the use of "Sustainable Focus", or "Sustainable Improvers" products, preventing use of the term "impact" in the names and marketing of these products.

4.   Anti-greenwashing rule

The naming and marketing rules also include a general "anti-greenwashing" rule, which clarifies that sustainability-related claims must be clear, fair and not misleading, and will apply to all regulated firms.

The Consultation Paper clarifies that sustainability claims must be proportionate to the sustainability profile of the product or services. This will give the FCA an explicit rule on which to challenge firms that they consider to be potentially greenwashing their products or services, and take enforcement action against them as appropriate. From the FCAs perspective, this will help to ensure better outcomes for consumers, in line with the new Consumer Duty and their overall objective to protect consumers.

5.   Rules for distributors 

Where in-scope products are offered to retail investors, and have a sustainable investment label, the Consultation Paper proposes that distributors must display the label prominently on a relevant digital medium and provide access to the accompanying consumer-facing disclosures. 

When?

Subject to the outcome of the consultation period, the FCA has provided the following timeline: