Sustainability Disclosure Requirements (SDR) – What the FCA’s new regulation means in practice

Much like nutrition labels that indicate the amount of salt, sugar and fat in a food product, the investment labels should help consumers cross-compare products. Ultimately, the SDR is about improving the consumer investment journey by refining the way firms market their products, more than it is about the investment process itself. 

Key information

The SDR consists of five main measures that will affect firms at different intervals. 

Anti-greenwashing rule

A growing number of firms are making sustainability-related claims in relation to their products. The anti-greenwashing rule looks to ensure that any sustainability-related claim, including but not limited to, “statements, assertions, strategies, targets, policies, information and images” must be “clear, fair and not misleading”. In connection to the SDR, the FCA has also published a Guidance on the Anti-Greenwashing rule (GC23/3) that details greenwashing examples including misusing images of rainforests and featuring ESG ratings without reference to the wider scale used. The final parameters of the rule will be shared at a later date following conclusion of feedback from stakeholder groups by 26th January 2024. The rule will come into force for all firms on the 31st May 2024. However, firms should start thinking about how they can implement anti-greenwashing controls, if they haven’t already. 

Investment labels

Investors may struggle to link investment choices to their sustainability priorities when there is a lack of standardised markers to help differentiate between products. To meet this gap, the SDR introduces four investment labels, to identify products according to their sustainability objectives and approaches, and to make comparisons easier. 

Figure 2: Investment labels

• Sustainability Focus: Investment products that “aim to invest in assets that are environmentally and/or socially sustainable”.
• Sustainability Improvers: Investment products “aim to invest in assets that have the potential to improve environmental and/or social sustainability over time”.
• Sustainability Impact: Investment products that have a “aim to achieve a pre-defined positive measurable impact in relation to an environmental and/or social outcome”.
• Sustainability Mixed Goals: Investment products that include a mix of assets which “are already sustainable, have the potential to improve their sustainability over time, and/or aim to achieve a positive impact”.  

Firms may choose to use the Sustainability Focus label for products with a sustainable investment objective and a minimum of 70% of assets invested in sustainable investments. We consider this relatively similar to the  European SFDR’s Article 9 status, and as such it may well be that firms seek to interpret sustainable investments as (among other things) ones that represent less risk of harm to environmental and social objectives.  

The Sustainability Improvers label is for products investing in assets that offer a higher potential for improvement, but also likely representing more ESG risk prior to this improvement.  One example of this balance between ‘ESG risk and return’, might be a power company that uses fossil fuels today, but stands to transition to renewables. In other words, could be potential for large ESG improvements, if you are willing to accept the risk of harm in the immediate term. 

If we use a very broad analogy to financial terms, then the sustainable investments may appear more ‘investment grade’ and improving investments may appear more ‘high yield’, so it may well be that firms wish to combine the two approaches as part of getting the right balance between the risk and reward label.  

That is one possible use where the Sustainability Mixed Goals label comes in. This could capture funds that aim to invest in a mix of sustainable and improving assets, as long as the fund sets out the proportions to be held in each category.  

Finally, the Sustainability Impact label covers funds aiming to generate positive societal impact, which have implemented a robust method for measuring and demonstrating the impact from both the underlying assets and the firm’s investment activities.   

We also think there may be a role for the Sustainable Mixed Goals label for multi asset funds as that might allow them to allocate to sleeves of impact investments within a wider investment universe of other types of ESG investing. 

For each label, there is a 70% minimum threshold that must be invested in line with the sustainable objective. This threshold is compared to the funds’ gross assets, rather than net asset value. One example of why this is not set higher is the potential need for liquidity and derivatives to sit outside of the 70%. 

The FCA has also clarified that the labels are not designed to be used or perceived as hierarchical. Rather than attempting to indicate a sustainability grade, the labels are meant to convey a particular sustainability objective and strategy. Firms can begin to use labels from 31st July 2024, with accompanying disclosures and statements. In order to do so, we expect all products will need some form of change, at least to introduce the 70% commitments, but some products may need more changes than others. The SDR notes that unlabelled funds will be required to state why their product does not have a label.

Naming and marketing rules

Terms like ‘social’, ‘green’ and ‘impact’ are increasingly featured in the naming and marketing of products to suggest that it bears certain sustainability characteristics, when this may not always be the case. The SDR’s naming and marketing rules look to regulate the language used to present and describe both labelled and unlabelled products.  

From 2nd December 2024, UK domiciled unlabelled funds will not be allowed to use ‘sustainable’, ‘sustainability’, ‘impact’ or variations of those terms in their product name. Distributors will need to ensure consumers understand that overseas funds are not subject to SDR, especially as these funds may still have these terms in their name. However, firms can continue to use these terms in their marketing, provided that the anti-greenwashing rule is met, and the relevant disclosures and statements are made.  

Disclosures 

To help investors understand and compare products’ sustainability characteristics, the SDR requires firms to issue new standalone disclosures for all labelled and unlabelled products. The proposed disclosures include:

• Consumer-facing disclosures: Labelled products must be accompanied with a disclosure that summarises their sustainability characteristics. As a two-page disclosure in consumer-friendly language, some have referred to this as a ‘ESG Key Investor Information Document (KIID)’ – however, this does not involve numbers like costs or charges, and it is fund level rather than share class level. Distributors will be obliged to deliver this to investors though, which may require some changes to systems and processes. Unlabelled products that do or do not use sustainability-related terms must explicitly state that they are not labelled.
• Detailed product-level disclosures: Labelled products must include sustainability information in pre-contractual disclosures from when the label is first used; and then there will be reporting starting from the twelve-month anniversary after the label is first used. Unlabelled products using sustainability-related terms must include sustainability information in pre-contractual disclosures by 2nd December 2024; and again, a reporting obligation kicks in from the twelve-month anniversary. As a result, across all products, firms are required to provide on-demand information to eligible clients from 2nd December 2025 at the latest.
• Entity-level disclosures: From 2nd December 2026, all firms with over £5 billion AUM must make disclosures annually in a sustainability entity report, which builds on the Task Force on Climate-Related Financial Disclosures (TCFD) report.

Distributors 

The FCA highlights the role of distributors, namely financial advisors and platforms, in facilitating easy access to sustainability-related information for investors throughout their investment journey. According to the SDR, distributors “must ensure the labels and consumer-facing disclosures are made available to retail investors” through the appropriate channels from 31st July 2024.  

The proposal also stipulates that all labels and disclosures must be kept up to date and displayed prominently, along with a link to the FCA webpage. Firms will also be required to issue a notice on all overseas products to highlight their exemption from UK labelling and disclosure requirements from 2nd December 2024.