Where they choose to do so, there will be associated disclosure requirements. If a company decides not to use a label or is not allowed to do so, it must ensure that the product name and product characteristics comply with the naming and marketing rules. Given that much of the current criticism of the EU Sustainable Finance Disclosure Regulation (SFDR) stems from the perception that many “Article 8 funds” lack sufficient sustainability ambition (indeed, the European Commission and the European Supervisory Authorities are considering introducing minimum sustainability standards), the adoption of FCA sustainability labels could prove useful to create a product both in the EU as part of an EU offer as well as in the UK. This applies to both institutional and mutual funds. 2. Naming and marketing rules The FCA intends to restrict the use of certain sustainability-related terms such as `ESG`, `green` and `sustainable` in product names and in the marketing of products that are not eligible for sustainable investment product labels. The FCA also proposes a more general “anti-greenwashing rule” that clarifies that sustainability-related claims must be clear, fair and not misleading. Overall, it is hoped that these restrictions will help to avoid misleading marketing of products. Although the product-level information provided under the FRDS and SDRs contains many of the same information, SDRs require more detailed information in a number of areas, particularly with respect to asset selection procedures and criteria. We note that terms such as “ESG” and “sustainability” are often used as product names for funds that primarily target ESG integration from a financial risk and return perspective and would otherwise not meet labelling requirements (particularly with respect to the need to demonstrate a “plausible link, targeted and credible with an environmental and/or social outcome”). Therefore, companies that manage such products with a focus on the consumer may need to re-evaluate their marketing strategy and/or increase the “intentionality” of their sustainability strategies. In October 2021, the government charted its course in the strategy paper “Greening Finance: A Roadmap to Sustainable Investing,” which listed SDRs as a key element.
The paper aimed to show how the UK would proceed with sustainable investing and outlined how actionable sustainability information requirements would boost businesses and financial systems and shift financial flows “towards a net-zero economy that is positive for nature”. Companies should consider disclosing the sustainability issues they have prioritized in their governance, strategy and risk management, and the reasons for doing so, and the CFA has provided guidance to this effect. These labels largely reflect the categories proposed in DP21/4 for sustainable investment. The FCA has removed the terms “responsible” and “not sustainably promoted” from its proposals. Therefore, a fund without sustainability objectives that uses strategies such as ESG integration would not fall under any of the proposed investment labels. Negative or exclusion screening strategies would also not be eligible. As expected, the FCA also notes that Article 6 SFDR funds and US “integration funds” are not eligible for sustainability labels, so products without a sustainability objective, but which can use strategies such as “ESG integration” (i.e. ESG risks), would not be eligible for a sustainable investment label. All products using the sustainable investment label must provide pre-contractual information. “SDRs will explicitly bring dual materiality,” said Matt Feehily, senior managing partner of the Sidley Austin law firm. “At the same time, the FCA is trying to extend the scope beyond climate-related disclosures,” he says, adding that the UK`s current TCFD-based system can be characterised as narrower but deeper compared to the EU pathway.
Benjamin Maconick, an ESG partner at law firm Linklaters, says SDRs will provide a more formal framework for sustainable investing. “The FCA deliberately designed the SDR as a marking system. They started from the premise that there should be concrete labels and layers of regulatory disclosures. They realized that if you want to make this useful, you need to make disclosures easy to digest and have a clear labeling system. While the consultation paper notes that “the fight against greenwashing is a key regulatory priority for the FCA”, it proposes a number of new rules to combat greenwashing, including sustainability labels for investment products and restrictions on the use of terms such as “ESG”, “green” and “sustainable”. Each of these requirements will be discussed in more detail below and commented on what this means in practice. It is important to note that these proposals do not currently apply to foreign funds marketed in the UK, but the FCA is making great efforts to stress that it will soon be discussing extending the scheme to this product population. Fund managers outside the UK should expect the UK to take the same approach to the extraterritoriality of these requirements as is currently the case under the EU RDFD.
The FCA is also proposing to introduce a general anti-greenwashing rule that will apply to all regulated entities from June 2023, repeating existing rules to clarify that sustainability-related claims must be fair, clear and not misleading. The rule will provide the FCA with an explicit basis on which to challenge companies and take enforcement action where appropriate. Businesses need to be aware of the new consumer tax rules, which will come into effect in July 2023, and consider how they will test, monitor and adapt their communications and disclosures to improve consumer understanding. The FCA has signalled that it expects companies to conduct consumer testing as part of disclosures and has conducted its own research (PDF 1.6MB) that could serve as a minimum benchmark for companies to conduct mandatory consumer testing. The content of the consumer-oriented disclosure must include the following: All other products do not have a sustainability label. If a product does not have any of the three sustainability labels, but has environmental, social or governance characteristics that are integral to its strategy, the product name and its marketing and related communications must comply with the naming rules, and companies must prepare an abbreviated pre-contractual disclosure as well as the required information for all other products to consumers. The FCA`s proposals build on the first views set out in its discussion paper on sustainability requirements and investment labels (DP21/4) published last November, which focuses on the following key areas: sustainable investment labels, the qualification criteria that companies must meet in order to use a label, information at product and company level, and naming and marketing rules. The FCA notes that the proposals contained in this consultation paper are the starting point for a system that will grow and evolve over time. As mentioned above, the SFDR does not currently impose minimum standards on the sustainability of “Article 8 funds” for the EU (with the exception of the requirement that all companies in which to invest must have good corporate governance), although this is currently assessed by the European Commission and the European Supervisory Authorities. The FCA should publish follow-up consultations on extending the scope of SDRs to foreign products, certain insurance products and financial advisers, for example.
It is also expected that there will be more guidance on the parameters to support the use of the label, as well as the location, content and form of disclosures. SDRs are likely to change the nature of reporting requirements if, as expected, they herald the introduction of dual materiality. From 1 January 2022, for example, investors regulated by the Financial Conduct Authority (FCA) will be subject to new rules on climate disclosure obligations based on TCFD recommendations. Since October, large occupational pension schemes have been required to report in accordance with TCFD-based rules. This proposed disclosure requirement is expected to enter into force from June 2024 and the information must be updated at least once a year. The FCA proposes to restrict the use of certain sustainability-related terms in product names and consumer-oriented marketing materials, unless the consumer product uses a sustainable investment label. However, this restriction does not apply to institutional products. Companies that meet the criteria applicable to their investment products and wish to use the label must publish on their website detailed information on the sustainability labels applied to the products concerned and information on where consumer information on those products is easily accessible. The product`s sustainability label must be included in consumer disclosures, pre-contractual information and the product sustainability report. Companies must inform the FCA within one month that they are using a sustainable investment label.
The new rule will allow the FCA to challenge companies that it believes are potentially greenwashing their products or services and, if necessary, take enforcement action against them (such powers may have already existed under the fair, clear and not misleading rule, which it explicitly emphasises in relation to sustainability claims).