In our previous alert, The Sustainability Disclosure Requirements and Investment Labels Rules: Tougher ESG Standards for UK Private Fund Managers, we discussed the Financial Conduct Authority (FCA) October 2022 consultation (CP 22/20) on sustainability disclosure requirements and investment labels (SDR). After 10 months, longer than expected due to the volume of feedback, the FCA has now published its response and final SDR rules in its Policy Statement (PS 23/16), along with a guidance consultation for the anti-greenwashing rule.
The final framework for those FCA-authorised managers in scope is different from that proposed in CP 22/20, although the broad policy approach is unchanged. Private fund managers will find the SDR requirements are not dissimilar from those under the EU Sustainable Finance Disclosure Regulation (SFDR), although the SDR will not (yet) apply to foreign funds marketed into the UK. As under the SFDR, a fund’s “green” categorisation, albeit that the SDR categorisation is more precise, will determine the specifics of the fund disclosure.
The obligation to publish an annual sustainability entity report, which is separate from the reports under the FCA Rules implementing Articles 22 and 24 of the Alternative Investment Fund Managers Directive, will be new. There will also be special disclosure requirements and restrictions for managers who wish to offer their funds to retail investors and the distributors they employ for this purpose, which are not currently imposed under UK or EU law.
Although it imposes new obligations, the SDR provides clarity and flexibility. For example, the SDR contains rules for those managers who prefer not to use a sustainability label but whose products have sustainability features. It also responds to industry concerns by, for example, accommodating investment in assets in transition to become more sustainable in the “sustainable improvers” category, although the EU is revisiting this (as we noted in our recent alert The Seeds for SFDR II? Two EU Commission Consultations).
Many existing UK-managed ESG funds are unlikely to fall within the scope of the framework, either because their funds have EU managers and UK delegated advisers/portfolio managers or because they do not qualify for a sustainability label. However, the FCA approach to implementation will give UK managers time to achieve compliance as well as consider if and how they want to use a label for future funds.
Summary Overview Table and International Compatibility
We have produced a summary overview table that sets out the various elements of the regime, which firms and products are caught, the main impact, and dates of (staggered) implementation. We have highlighted particular features of interest in this briefing, too.
The extent of any alignment of product categorisation across international frameworks will involve a case-by-case analysis, and there may not be obvious “equivalents” under comparable regimes — in which case multijurisdictional compliance is likely to be an involved and delicate exercise of assessing and disclosing in parallel on a case-by-case basis. We have produced a mapping table to set out an illustration of how the EU (current and proposed), the SEC ESG proposals, and the UK SDR frameworks may map.
What’s in Scope and Not in Scope
As we note in the summary table, the SDR will apply to full-scope and small authorised alternative investment fund (AIF) managers whose business is carried out from an establishment maintained by the firm in the UK and in relation to authorised and unauthorised AIFs, including unlisted AIFs and feeder funds.
Social entrepreneurship funds (SEFs), qualifying venture capital funds (RVECAs), and those funds that made no additional investments after 22 July 2013 are not in scope of the SDR.
The SDR will also not apply to segregated accounts and other portfolio management products and services.
The SDR, apart from the anti-greenwashing rule, will also not apply to non-UK funds marketed in the UK.
The FCA has indicated that the scope of the SDR will be expanded to include portfolio management services and overseas funds as well as pension and insurance-based products and financial advisers.
It will also be used as a building block as the toolkit develops, to include transition plan disclosures, requirements under the UK Green Taxonomy, and in line with future International Sustainability Standards Board standards.
Therefore those in the funds industry, even if they are not immediately affected, will want to take stock of the rules now, how they are likely to impact their structures and products, and what actions are needed to be ready to comply as and when SDR is broadened.
The key elements of SDR provide for:
- General content requirements and restrictions in the form of a general anti-greenwashing rule, with supporting guidance on which the FCA is consulting, that requires that sustainability-related claims must be consistent with the sustainability characteristics of the product or service and be clear, fair, and not misleading.
- Product disclosure requirements, including rules on the use of four sustainable-investment-branded labels for managers who wish to use these labels. The labels are: Sustainability Focus, Sustainability Improvers, Sustainability Impact, and (new since CP 22/20) Sustainability Mixed Goals. For each label, the product must have a sustainability objective as part of its investment objective, and at least 70% of product assets, subject to some exceptions, must be invested in accordance with the product’s sustainability objective, with reference to a robust, evidence-based standard that is an absolute measure of environmental (E) or social (S) sustainability. The FCA states, “There is no hierarchy between the proposed labels: each is designed to deliver a different profile of assets and consumer preferences.”
- Product disclosure requirements, including pre-contractual disclosures to investors as part of a private placement memorandum or prospectus; and ongoing disclosure information to be provided to investors on demand on an annual basis.
- Entity reporting requirements for those managers in scope of ESG2 (the public Task Force on Climate-related Financial Disclosures (TCFD) entity and TCFD product reports) will be combined and additive, so that the TCFD reports will be included or referred to in new sustainability entity and public product-level sustainability reports.
- Retail investor/client-specific content requirements/restrictions, including naming and marketing rules to ensure that the use of sustainability-related terms are accurate. A manager not using a label but still in scope will have to produce the same disclosures as for funds that have a label, alongside a prominent statement to clarify that its product does not use a label and why.
The FCA acknowledges that there may be issues with data gaps and methodological challenges. Metrics should be disclosed, along with an explanation, only if a firm can address these by using proxy data or assumptions. Otherwise, where metrics may still mislead, a firm must explain the gaps, why it has been unable to address them, and steps it will take to address the gaps or challenges in the future. Data relied on for labels must be accurate and complete (including through use of proxies and assumptions where appropriate) and are not subject to this proviso.
The rules will come into force in phases, as set out below.