The sustainability disclosure requirements introduce investment labels to improve consistency across the market, reduce greenwashing, and improve comparability for investors. The new regime also includes a general anti-greenwashing rule, to prevent unsubstantiated claims around sustainability, and restrict misleading terminology for naming and marketing purposes. Building on considerable market feedback, which has largely been addressed, the FCA has published its final rules (PS23/16), which include a range of changes (most notably to the labelling regime) and published comprehensive guidance on the anti-greenwashing rule.
Broad changes to the labelling regime
The FCA has proposed a number of changes to the labelling regime compared to the initial consultation. The first is predominantly a cosmetic change that applies to all categories, replacing the label ‘sustainable’ with ‘sustainability’. This reflects that not all assets are fully sustainable at this point in time, but highlights that they have the potential to be sustainable in the future.
The second key change is again one of terminology. The initial sustainability disclosure requirements proposals included distinct primary and secondary channels for investor contribution. Stakeholders felt that these channels appeared to be prescriptive, and limited the range of other options available. The FCA has moved away from this language, to clarify that they aren't prescriptive and to remove any confusion during implementation.
The third key change is the new 70% threshold, which now extends to all categories (previously only applying to the sustainability focus category). Under the updated sustainability disclosure requirements, at least 70% of assets within a product with a sustainability label must align to the given sustainability objective. The remaining 30% cannot conflict with the stated sustainability objective. However, it's important to note that there are some exceptions to the threshold, namely:
- products that build a portfolio over time and haven't fully invested in all assets, such as LTAFs
- firms that haven't effectively demonstrated their sustainability credentials or KPIs and are on an escalation plan with the FCA to remedy it.
A new label for ‘sustainability mixed goals’
The updated sustainability disclosure requirements include a new label for 'sustainability mixed goals', covering portfolios that span sustainability objectives and strategies across a range of categories. Where firms are using this label, they must be able to demonstrate how each asset within the fund aligns to one of the other labels. This is to prevent any potential loss in transparency.
Changes to the ‘sustainability improvers’ label
The sustainability improvers label gives firms the option to include assets that aren’t socially or environmentally sustainable as yet, but that are working towards that goal. Stakeholders had concerns that this could become a catch all category, with challenges around identifying potential improvers, difficulties in quantifying improvements, and what to do with assets as they reach their sustainable potential.
As such, the FCA has made three key clarifications in this area:
- Assets marked as ‘sustainable improvers’ must have the potential to meet “a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability over time”. Firms need to support these goals with short and medium-term targets for improvement. Once they’ve become sustainable, it’s up to individual firms to decide how to treat those assets, ie, whether to divest them or move them to another portfolio
- Firms must set KPIs for improvement, which can either focus on the wider product or individual assets within it
- There are no longer any explicit stewardship requirements associated with the sustainability improvers label, but it remains a key element of the general criteria applying to all label categories
Firms need to demonstrate how these assets will become sustainable over time, with relevant KPIs and clear timelines. Effective stewardship is integral to these products and helping them reach their desired environmental or social sustainability goals.
Updates to the ‘sustainability focus’ label
Under the sustainability disclosure requirements, products that have a ‘sustainable focus’ must meet a credible standard of environmental and/or social sustainability, or align with specific environmental or social themes. The key challenge here is working out what constitutes a 'credible standard'. The FCA has confirmed that firms can use their own internal frameworks to define that, and they can use internal processes or third-parties to provide independent assessment over it as long as this is backed up by 'robust evidence'.
Updates to the ‘sustainability impact’ label
The sustainability impact label covers products that aim for a "positive, measurable contribution to real world sustainability outcomes". Assets will mostly achieve this by directing capital to activities targeting key social and environmental issues. In response to stakeholder feedback, the FCA’s confirmed that investments in public markets can qualify for the sustainability impact label, provided all other criteria are met, and that firms can align with wider industry frameworks as relevant.
Disclosures
The sustainability disclosure requirements include consumer facing product disclosures, and three different types of disclosures at product and entity level (pre-contractual disclosures, product reports and sustainability entity reports). Stakeholders highlighted that this was potentially burdensome and could be covered by existing product disclosures, with consumer-facing disclosures being unnecessary for all products. The FCA has retained the requirement for consumer-facing disclosures, but it has tweaked the rules to only require disclosures for products using labels or sustainability-related terms.
Overseas funds
There remain some concerns around the potential for greenwashing through overseas products. As such, the FCA will continue to work with HM Treasury on overseas funds, and will consult separately on applying the regime to all types of portfolio managers.
Stewardship
Effective stewardship is integral to maintaining all sustainability label categories. In response to the previous sustainability disclosure requirements proposal, stakeholders raised questions about the role of stewardship, the ability to demonstrate its impact, and the fact that these activities generally apply at a firm-wide, rather than product specific level.
The FCA has clarified that firms must identify and apply an appropriate investor stewardship strategy to be able to qualify for any sustainability label. This includes the necessary resources and activities to achieve the intended goals. It’s important to note that the FCA doesn’t expect firms to demonstrate a link between stewardship activities and sustainability investment outcomes.
Anti-greenwashing rule
The anti-greenwashing rule requires all sustainability-related claims to be "clear, fair and not misleading". Stakeholders asked for more information on how to apply this, so the FCA has published additional guidance to accompany PS23/16. The guidance will be open for feedback until 26 January 2024.
The rule proposes that sustainability references should be (as stated in the new guidance):
- Correct and capable of being substantiated
- Clear and presented in a way that can be understood
- Complete – they shouldn't omit or hide important information and should consider the full life cycle of the product or service
- Fair and meaningful in relation to any comparisons to other products or services
The rule is an integral element of the sustainability disclosure requirements, and applies to all FCA-authorised firms from 31 May 2024.
Naming and marketing rules
The proposed naming and marketing rules prevented firms from using sustainability-related terms for products that don't have a sustainability label. The final policy statement relaxes this somewhat, to allow for accurate descriptions of products that don’t qualify for a label, but that do have some sustainability characteristics.
However, firms using sustainability-related terms in the name or marketing of a product that doesn’t qualify for a label, must disclose this and make a statement to clearly state that the product doesn’t qualify for a label and why.
The naming and marketing rules only apply when using sustainability-related terms for products targeting retail investors. They don't apply to "short, factual or non-promotional statements about a product".
Interaction with Consumer Duty
It’s important to consider how the sustainability disclosure requirements relate to the new Consumer Duty. Firms must act in good faith, actively prevent foreseeable harm to consumers, and help them meet their financial objectives. In addition to these cross-cutting rules, firms need think about how they're specifically embedding the consumer understanding outcome throughout their sustainability disclosure requirements implementation.
Who’s in scope and what are the timelines?
The range of in-scope firms hasn’t changed since the previous consultation paper. As such, UK asset managers are subject to the investment labels, disclosures, and naming and marketing rules. The anti-greenwashing rule applies to all FCA-regulated firms.
The updated sustainability disclosure requirements implementation timeline is as follows:
- 31 May 2024 Anti-greenwashing rules apply
- 31 July 2024 Firms can start using the appropriate labels, with accompanying disclosures
- 2 Dec 2024 Naming and marketing rules apply
- 2 Dec 2025 Rules on product-level and entity level disclosures apply to firms with AUM > £50 billion
- 2 Dec 2026 Rules on product-level and entity level disclosures apply to firms with AUM > £5 billion
Next steps
The sustainability disclosures requirements create a complex framework that is inherently broad in-scope, affecting firms’ treatment of a wide range of products, portfolios, and assets. It will take considerable time to identify the sustainability credentials of all in-scope products, and monitor them in the long-term. Firms need to think about what data is available, what metrics they will collect, and what reporting processes need to be in place. Getting an early start on implementation will help firms meet regulatory expectation, and establish a leading edge for sustainable investment.
For more insight and guidance, contact Irina Velkova.
