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The Financial Conduct Authority (FCA) has bared its teeth on sustainability reporting and, late last year, published its Sustainability Disclosure Requirements (SDR) and investment labels policy statement.
The policy was created to improve trust in the market for sustainable investment products, and it is hoped that the regulations will ensure that customers are more informed and protected, whilst enhancing competition.
In a nutshell, the SDRs are designed to be the flagship of the sustainability-focused, post-Brexit financial services industry in the UK, and should offer investors clarity thanks to the initiative’s focus on labelling and greenwashing mitigation. According to the government, SDR is a core element of its ‘Greening Finance’ strategy, which was published in 2021.
The new regulations are summarised by the UK’s watchdog, the Financial Conduct Authority (FCA) as the following:
· An anti-greenwashing rule for all FCA-authorised companies to reinforce that sustainability-related claims must be fair, clear, and not misleading. The regulator is also consulting on supporting guidance.
· Four labels to help consumers navigate the investment product landscape and enhance consumer trust.
· Naming and marketing rules for investment products, to ensure the use of sustainability-related terms is accurate.
· Consumer-facing information to provide consumers with better, more accessible information to help them understand the key sustainability features of a product.
· Detailed information in pre-contractual, ongoing product-level, and entity-level disclosures, targeted at institutional investors and consumers seeking more information.
· Requirements for distributors to ensure that product-level information (including the labels) is made available to consumers.
The FCA initially consulted on the plan in 2022, and the original intention was to publish the policy in Q3 2024. The investment industry expressed disappointment when it was revealed that the document would not be unveiled until Q4 2023. It was duly published that November. The rules on greenwashing come into effect on 31 May this year, which has meant that timelines for investment firms to ensure they meet anti-greenwashing principles have been tight.
Experts suggest that the main focus should be on the anti-greenwashing component and ensuring that documentation and marketing is fair and not misleading. For insurers dependent on asset management partners, transparent information is essential to support governance and, crucially, the Prudent Person Principle (PPP) obligations.
“The introduction of SDR, seen through a PPP lens, will require greater confidence in what is received from asset managers, and a greater ability to fully interpret and challenge what’s being received,” said Dan Grandage, Head of Sustainable Investment at abrdn.
“We are supportive of SDR, we continue to work through the
labelling requirements for our products."
For the most part, experts have broadly welcomed SDR, in particular because its requirements are less onerous than its EU equivalent, the Sustainable Finance Disclosure Regulation (SFDR). SDR very specifically focuses on labelling and greenwashing across key products, whereas SDFR is a wider framework with more far-reaching expectations.
“We are supportive of SDR, we continue to work through the labelling requirements for our products,” said Grandage. “At present, our view [and] experience of the market is that this is not driving the same level of investor demand and queries as we saw with SFDR."
He added that: “This is to be expected as the SFDR is broad disclosure requirement that applies to all participants rather than the SDR which has very specific optional requirements that only applies to a small subset of products”.
The regulator is now consulting on the extension of SDR to portfolio management services as, in the initial proposals, very few were able to qualify for the ‘sustainable investment’ labels.
There remains some questions as to how the labelling may work. Grandage explained that, “there are a number of areas where further clarity from the FCA would be helpful. Abrdn is continuing to engage with the Investment Association (IA) to ensure that these are being addressed. One challenge in particular, is the lack of clarity on how the labels will practically work for passive strategies.”
Experts have already flagged some challenges relating to the sequencing of the new SDR rule. For asset managers, the rules came into force last year, but for corporate reporting the rules will likely not be brought into play until June this year, due to the government assessing the ISSB standards. It is still unclear how the recently-announced General Election might affect these timings.
Some experts have suggested that this gap could lead to data availability issues for financial services companies. Essentially, a potential information vacuum could mean that these organisations are unable to fall back on corporate reporting to support their disclosures and drive sustainability efforts.
“Currently, asset managers are the ones feeling the main effects of
the FCA’s Sustainability Disclosure Requirements."
Oscar Warwick Thompson, Head of Policy and Regulatory Affairs at UKSIF, warned that corporates, such as insurers, are yet to feel the heat from the new rule, with asset managers previously taking the brunt of the changes. The FCA is also likely to apply SDR rules to a wider range of products, including pensions, going forward.
“Currently, asset managers are the ones feeling the main effects of the FCA’s Sustainability Disclosure Requirements,” said Warwick Thompson. “However, with time, we expect asset owners (including some insurers) will increasingly begin to feel the impacts of the new rules. The Financial Conduct Authority has been clear that they intend to extend SDR to pension products and insurance-based investment products.”
The FCA is currently working with the Department for Work and Pensions and The Pensions Regulator (TPR) to develop proposals in these areas, but for now it is a case of ‘wait and see’ for the eagle-eyed insurers honing in on what the developments will mean for them.
Warwick Thompson urged insurers to look further ahead, and called for more clarity on the FCA’s approach. “While these rules might not affect them directly right now, we know some of our insurer members will be watching the developments closely. Our sense is that some institutional investors will want to use the sustainability labels as a way to demonstrate their own sustainability credentials and commitments," he said.
The FCA is not the only watchdog insurers will need to consider as they seek to abide by SDR. They must also reflect on frameworks from other bodies, such as the Competition and Markets Authority (CMA) and the Advertising Standards Authority. All three are highly focused on ESG and invested in the prevention of greenwashing.
“The FCA has pointed out that they have worked with the CMA, the Competition and Markets Authority and the Advertising Standards Authority (ASA) to ensure consistency within the UK,” said Rebecca Macdonald, Head of Products at Hymans Robertson.
Hearteningly, most experts do not believe that SDR will create ‘no go’ sectors for insurers to invest in. This is due to the fact that SDR does not prescribe specific approaches or criteria, and so that outcome is considered unlikely.
Many organisations welcome the ethos of the rules and support their role in the UK’s green strategy; however, there remains confusion around the practicalities. Despite this, insurers must familiarise themselves with the regulations, working toward full implementation sooner rather than later, otherwise there is a strong chance they could fall foul of the FCA.
The FCA is still undertaking work to better determine how SDR fits into international and EU regimes. In the policy statement, it noted that: “We continue to engage with counterparts in the EU and other jurisdictions to encourage interoperability and compatibility as they consider their sustainability regimes.”
“The European Insurance and Occupational Pensions Authority (EIOPA) has also opened a consultation on greenwashing, with the view to create a more effective and harmonised supervision of sustainability claims across European firms,” said MacDonald. “This focus will no doubt be maintained, and insurers should look to take every possible step now to be ready.”
“There is a real danger that the competing and conflicting requirements
actually stifle innovation."
The impact of SDR on overseas funds is also a major question. A consultation will take place later this year to address the extension of SDR to overseas funds, but experts are concerned that there is already confusion around the implications of SDR for funds domiciled overseas, particularly those with sustainability and climate terms in their names or marketing.
Grandage said he was mindful of the increasing number of comparable but fundamentally different sustainable disclosure regulations globally being implemented. “Our strong preference would be for greater comparability and interoperability across the different regimes, to allow us to more easily navigate this landscape,” he said.
“There is a real danger that the competing and conflicting requirements actually stifle innovation and prevent sustainable outcomes. It is our view that this would be a missed opportunity,” he added.
UKSIF’s Warwick Thompson pointed out that ensuring interoperability between geographies was a core priority. “We expect there will be anticipation around how this consultation may align with international developments,” he said. “This includes the fund naming guidance from the European Securities and Markets Authority (ESMA). It is also of central importance to ensure a level playing field as far as possible when regulating how UK and EU sustainable labelled funds are marketed to UK clients and customers."
He continued that: “Clarity will be needed on exactly what disclosures will be necessary for overseas funds; for example, whether an overseas fund may need to come with any disclaimer notes when being sold into the UK.”
There are several steps for insurers to follow to ensure that they do not come into conflict with SDR rules going forward. Essential actions ahead of FCA’s anti-greenwashing rule coming into effect, according to Hyman Robertson, are:
· Conduct a thorough review of customer facing materials to identify any sustainability claims
· Check that all claims are substantiated, and all evidence is available
· Check that sustainability benefits are objectively measurable
· For thorough compliance consider obtaining an external review of customer materials
· Incorporate greenwashing risk into your existing risk management framework.
