On 28 November 2023, the Financial Conduct Authority (FCA) — the British regulator that oversees services, companies, and financial markets — unveiled a highly anticipated set of regulations targeting ESG funds. This comprehensive framework, known as the Sustainability Disclosure Requirements (SDR), introduces a labelling system for investment products which encompasses a robust set of measures to enhance trust and transparency in sustainable investments, while mitigating the phenomenon of greenwashing.
Effective from 2024 onwards, the SDR will apply to an estimated 50,000 financial entities in the UK. Moreover, the FCA has signalled its intent to expand the regulatory ambit to include a broader spectrum of companies in the future, indicating potential growth in coverage beyond this initial phase.
The SDR encompasses several key provisions that collectively aim to fortify the integrity and effectiveness of sustainable investment practices within the UK market.
- An anti-greenwashing rule aimed at guaranteeing that statements are accurate, transparent, and free from misleading information. This rule will be the first to come into force in May 2024 and requires that information supplied about the environmental and/or social nature of financial products or services align with their actual traits. This rule applies to all FCA-authorised firms.
- The implementation of four sustainability labels, designed to empower consumers in navigating the product landscape and foster greater trust. These four labels are: 1) Sustainability Focus, 2) Sustainability Improvers, 3) Sustainability Impact, and 4) Sustainability Mixed Goals.
The Sustainability Focus category refers to funds that prioritise sustainable investing, directing investments towards assets that promote the sustainability of both people and the planet. In contrast, the Sustainability Improvers label acknowledges funds that predominantly invest in assets that may currently lack sustainability but are committed to enhancing their sustainability practices progressively. The third category, Sustainability Impact, corresponds to funds that wield a substantial positive influence on sustainability, through their core business model. Lastly, the Sustainability Mixed Goals descriptor involves funds which employ a multifaceted strategy, incorporating diverse sustainability objectives. Here, at least 70% of the product’s assets are sustainable, with reference to an evidence-based standard and progress towards the outcome to be measured via key performance indicators (KPIs).
- The usage of sustainability-related terminology in naming and marketing rules for investment products. This supplements the greenwashing provisions and allows asset managers to promote non-labelled funds with ESG characteristics, but no fund may include the word “sustainable” or “impact” in its name if it does not use a label.
- A series of disclosures to enhance undersatanding of the traits of sustainable products, whether they have a label or use sustainability-related terms without a label. Disclosure documents should include sustainability objectives, investment strategy, metrics, access points for additional information, and should be annually updated. They span from consumer-facing to more detailed, product-level disclosures targeted at institutional investors and consumers seeking detailed information.
The anti-greenwashing rule will take effect on 31 May 2024, then the use of product labels and related disclosures will start from 31 July 2024. Naming and marketing rules with reference to sustainability-related terminology, come into force on 2 December 2024, with accompanying disclosures.
Implications for governments
- International commitments: the current alignment to international standards signifies a commitment to global efforts in promoting sustainable development. Additionally, governments should remain vigilant in continuously updating their regulatory frameworks to reflect evolving international standards and best practices in sustainable finance. Failure to do so could lead to discrepancies in regulatory approaches, potentially hindering cross-border investments and collaborations in sustainable finance initiatives.
- Evidence-Based Policy Development: policymakers can leverage the wealth of data collected by firms under these new rules for evidence-based policy development. Analyzing this data helps identify trends and challenges, guiding policy and decision-making on regulatory interventions or incentives.
Implications for private firms
These new rules are especially relevant for private firms in the UK, whichever industry or sector they operate in.
- Compliance: To comply with the SDR, firms need to establish a thorough understanding of the regulatory framework and its implications for their business operations, investment products, and marketing strategies. Firms must allocate resources to adapt their processes and procedures to meet the requirements outlined in the SDR, including implementing anti-greenwashing measures, obtaining sustainability labels for applicable products, and enhancing disclosure practices.
- Marketing and labelling: With the introduction of sustainability labels and stricter rules on the usage of sustainability-related terminology, firms will need to reconsider their product labelling and marketing strategies. Those offering sustainable investment products may leverage the designated labels to distinguish their product or service offerings in the market and appeal to environmentally and socially conscious investors. Conversely, firms offering products without sustainability labels should carefully review their terminology.
- Disclosure efforts: Private firms may thus focus on streamlining their reporting efforts and integrating ESG data into their existing financial and disclosure reporting.