Unlocking the UK SDR and future investment labels

Associate Director, Real Estate

Published: 10th Jul 2023

Transparency for tomorrow

In today’s ever-evolving landscape, sustainable investing has taken centre stage as individuals, companies, and governments increasingly recognise the urgent need for environmentally conscious practices. With this growing emphasis on sustainability, the United Kingdom has introduced the ground-breaking Sustainability Disclosure Requirements (SDR), backed by a promising framework of associated investment labels for sustainable investment products.

What does this mean for you?

The Financial Conduct Authority (FCA) has been diligently crafting a competitive framework aimed at bolstering the UK’s asset management sector. With a core focus on raising standards and improving access to vital sustainability information, this initiative is set to revolutionise the industry.

Aligned with the ambitious goals outlined in the Paris Agreement (originally adopted in 2015), the UK government’s “Greening Finance: A Roadmap to Sustainable Investing” policy highlights the pivotal role of this step in advancing the nation’s financial sector. It underscores the commitment to creating a robust foundation for sustainable investment practices.

Based on recent communications from the FCA, we do not expect to see SDR coming into force until 2024, with the first set of guidance forecasted to be released sometime in Q3 2023 and the regulation coming into force 12 months thereafter.

Anticipating the full implementation of the SDR may still be some time away. The key message for asset managers is to proactively prepare for the impending implementation to avoid penalties.

Below we have prepared an overview of the key considerations gathered based on our participation in the consultation period:

Objectives

Protect consumers from greenwashing (false/misleading claims of sustainability)
Help consumers to make informed investment decisions and navigate suitability approaches
Allows the FCA scope to take action against non-compliance

Timings

Q3 2023 – Initially targeted to come into effect from the end of H1 2023, however, the FCA recently confirmed that the first policy statement would be released in Q3 2023, pushing back the expected implementation date to 2024. All proposed effective dates listed here will therefore be adjusted accordingly on the back of the FCA’s policy statement .
Q3 2024 – Rules on product labels, consumer-facing and pre-contractual disclosures, product naming and marketing expected to come into force.
Q3 2025 – First ongoing product level disclosures required. Largest in-scope firms with more than £5bn AUM (Assets Under Management) are caught by this.

Who will this apply to?

SDR applies only to UK asset managers. The exception is anti-greenwashing which applies to all FCA regulated firms.
In-scope products include authorised funds, unauthorised alternative investment funds (AIFs) and portfolio management services.
Labels are utilised via a voluntary “opt-in” process.
Most of the rules only apply where a UK manager chooses to make use of one of the prescribed “sustainability labels”.
Many of the rules only apply where retail investors are involved, however, it is worth checking this point given how easy it is for an individual UK investor to technically fall short of the professional investor criteria and trigger retail investor protections.
The ‘sustainability entity report’ requirements do not apply where the UK manager’s AUM is under £5 billion (on a three-year rolling basis).
Naming and marketing rules will apply even if you are not using the labels.

Key rules

Anti-greenwashing rule

Any reference to sustainability characteristics of a product or service in financial promotions must align with the sustainability profile of the product or service. It should also be clear, fair, and not misleading. This requirement applies to all FCA regulated firms starting from a date to be confirmed in Q3 2023.
Anti-greenwashing compliance must be embedded within a firm’s product governance and marketing functions.

Sustainability labels

Labels can be used for products marketed to retail and institutional investors if the product meets the qualifying criteria. If you are not using a label, products must comply with the naming and marketing rules.
Under SDR, financial products will be labelled based on intentionality and on the level of sustainable investments. The three labels are:

i) Sustainable Focus – assets that have mainly (70%+) environmentally or socially sustainable focus.
ii) Sustainable Improvers – assets that may not be sustainable now but are aiming to have a positive environmental or social impact in the future.
iii) Sustainable Impact – assets that invest in real-world problems and are achieving real-world measurable contributions to environmentally or socially sustainable outcomes.

Applies to
i) firms marketing in-scope products; and
ii) firms providing portfolio management services if 90% or more of the value or the constituent products qualify for a label.

Restricting the use of ESG-related terms in naming and marketing of products

A firm must not use any ESG-related terms (e.g., ESG, green, responsible, sustainable, net zero, climate etc.) in the naming or marketing of a product that does not use a label. “Impact” should only be used for “sustainable impact” products.
This applies to:

i) firms marketing in-scope products to retail that do not use a label; and
ii) firms providing portfolio management services to retail investors which do not use a label.

Key disclosure requirements

FCA target declarable disclosures that are comparable.
The FCA are not due to provide an official template.
Regulatory guidance is to be issued and adhered to closely to avoid non-compliance.
Managers will require different reporting depending on jurisdictions where exposures are. The choice is whether you look at standardising them to apply with all or do separate reporting in each jurisdiction to ensure compliance.

Navigating what comes next

Pension providers will have a separate consultation rolled out in respect of SDR.
The International Sustainability Standards Board (ISSB) standard is expected to be incorporated into SDR.

o The ISSB issued its inaugural standards — IFRS (International Financial Reporting Standards) S1 and IFRS S2 — which has led the way in a new era of sustainability-related disclosures in capital markets worldwide. The standards will help to improve trust and confidence in company disclosures about sustainability to help inform investment decisions.

UK Green Taxonomy, a revised Government Green Finance Strategy was issued in Q1 2023 which (among other things) committed to consult on for the roll out of the UK Green Taxonomy in Q3 2023.

o Practical next steps: By 30 June 2023 (to be adjusted) anti-greenwashing is key to ensure people apply and have measures in place to enforce.

Further considerations

Although overseas funds have not been caught by this or mentioned, the market expects them to be looked at soon, with a number of responses to the consultation requesting that they are addressed as a matter of priority.

Brown to green strategies could be caught in between labels and there is a risk that there will be a market perception that impact is “better”, but the FCA has been clear that these are not hierarchical labels. Brown to Green comes down to qualifying criteria.
The labels, although voluntary, are expected to be popular even if the bar is set “too high” due to the marketing power. If anything, this will force an improvement in products to rise to new standards.
There seem to be no real Sustainable Finance Disclosure Regulation (SFDR) links to SDR (other than disclosures). If anything, the criteria is seen to be easier to meet under SDR in comparison to SFDR.

Considerations for any index linked strategies

Purely exclusion strategies no longer acceptable by themselves.
Could cause issues for existing funds based on historic documentation.
Firms likely to use consultation firms or reposition assets.

How can we help?

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