Sustainability Disclosure Requirements (SDR) – Five Things to Look Out for in the FCA’s Policy Statement

Following the Consultation Paper (CP22/20) on SDR and investment labels in October 2022, the FCA confirmed this July it has delayed the publication of the subsequent Policy Statement to Q4 2023.

While this may provide temporary relief to those already undertaking substantial ESG regulatory change initiatives, firms would do well to not let SDR slip off the radar. The rules are expected to bring about significant change to naming, marketing and disclosure requirements, at entity and product level and for both sustainable and non-sustainable focused products.

As we await the final Policy Statement, here are five key things we are looking out for which may require focus for our asset and wealth management clients. (Please note, this is not intended as a summary of the proposed rules).

Central to the FCA’s policy objective of SDR is the generic anti-greenwashing rule, which will come into force immediately once the Policy Statement is published. While there is no further prescription around this rule, firms must ensure their ESG claims are fair, clear and not misleading, as per the FCA’s wider handbook rules. Given the growing scrutiny around greenwashing and other ESG regulatory efforts, this is something firms should already be complying with, but it is worth considering how you would evidence compliance with this rule, should this be requested.

What can you do now? Understand where your greatest exposures to ESG-related investments and operational risks are and review the governance and controls you have in place to mitigate them.

Unlike the EU’s Sustainable Finance Disclosure Regulation (SFDR), which was never intended to be a labelling regime, SDR proposes three mutually exclusive, non-hierarchical product labels. There is no direct mapping between these labels and SFDR classifications, although approximate comparisons can be drawn. This may present practical challenges and operational complexity for firms operating and marketing funds with similar sustainability-focused investment processes across multiple jurisdictions. Fund documentation is required to be increasingly bespoke to new rules in the country in which funds are available, as per for example the AMF Doctrine in France or BaFin’s proposed sustainable fund guidelines in Germany. SDR will introduce additional product-specific criteria which will need to be rapidly integrated by Distribution, Marketing and Compliance functions to ensure product governance processes evolve accordingly.

What can you do now? Identify any in-scope funds that mirror the strategy of sustainability-focused EU-domiciled funds and plan for possible changes to investment policies or disclosures.

A key point of debate around the Consultation Paper was the minimum thresholds proposed for certain labelling criteria – for example, the 70% minimum of sustainability aligned investments for the Sustainable Focus label, or that Portfolio management services can only use a label if 90% or more of the value of all constituent products in which they invest qualify for the same label. It will be interesting to see whether these are maintained in the Policy Statement, and how the appetite for labelling responds as a result. Meanwhile, the FCA has indicated that some Article 8 funds will need to ‘level up’ to meet labelling criteria by specifying a sustainability objective. Managers will need to determine what this means in practice for their Article 8 funds and consider additional measures that may be necessary to meet the labelling requirements.

What can you do now? Conduct a high-level mapping between in-scope funds and the proposed labels to identify which funds are most likely to be eligible for a label.

One of the key labelling criteria is the identification of ‘credible, rigorous and evidence-based KPIs’ to measure a product against its sustainability objective(s). There are no prescribed metrics, so firms will need to determine the most suitable metrics for their products, review their existing datasets, and make plans to source new data where needed. KPIs will need to be tailored to each label – for example, how will an ‘improvement in the sustainability profile’ be defined and measured for the Sustainable Improvers label? How will Stewardship be approached and measured in a way that is specific to the sustainability objectives?

What can you do now? Work with investment teams to identify possible relevant metrics for in-scope funds, and reassess your current and planned ESG data sources.

There are some interesting practical considerations behind SDR’s objectives of greater transparency and comparability for end investors. The top-level consumer-facing disclosures should provide factsheet-style snapshots of the products’ ‘ESG profile’. As with the other proposed disclosures (and unlike SFDR), a template for these disclosures is not prescribed, though the FCA encourages a market-led approach towards templates. Firms will need to keep the perspective of retail investors in mind when writing new disclosures and use appropriate language. Meanwhile, the concept of ‘unexpected investments’ to be covered in consumer-facing disclosures may present interesting interpretations across firms and products, given the wide spectrum of sustainability preferences consumers may have.

What can you do now? Plan ahead for how your disclosures will ‘look and feel’ and how you will ensure fund documentation remains retail-friendly.