The FCA hopes the proposals will protect consumer trust in ESG-related financial products and help consumers navigate the increasingly complex ESG-related financial market.
On 25 October 2022, the UK’s Financial Conduct Authority (FCA) issued a consultation paper (the Consultation Paper) on Sustainability Disclosure Requirements (SDR) and investment labels. According to the FCA, investment firms in the UK may intentionally or unintentionally be making exaggerated, misleading, or unsubstantiated sustainability-related claims about their products — also known as greenwashing — which has impacted consumer confidence in ESG-related or sustainable investment products in the UK. The proposals in the Consultation Paper seek to address this risk and restore consumer faith.
The Consultation Paper builds on the UK government’s October 2021 Roadmap to Sustainable Investing (which introduced plans to implement the SDR and an investment labelling regime across the UK market) and on the FCA’s November 2021 discussion paper (DP21/4) (which set out early stage views on these initiatives).
The FCA notes that it expects the proposals in the Consultation Paper to reflect a “starting point” for a regime that will expand and evolve over time, including working with other government departments and building on the global baseline ESG reporting standards being developed by the International Sustainability Standard Board (ISSB).
The Consultation Paper acknowledges that many firms that will be within the scope of the FCA’s proposed rules operate internationally and, therefore, consistency and coherence across jurisdictions will be important to many firms. In this regard, the FCA notes that it has “as far as possible” sought to achieve coherence with initiatives such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) and the proposals by the Securities and Exchange Commission (SEC) in the US. However, the FCA acknowledges that the starting point for its regime is different and that, as a result, there are differences in approach. The FCA’s policy rationale for categorising products is to help consumers identify sustainable investment products and navigate the market. Therefore the criteria are designed to set a high bar for products that make sustainability claims, which is important to help clamp down on greenwashing against a backdrop of trust concerns. To date, the starting point in the EU and US regimes, by contrast, has been to categorise products principally to determine disclosure requirements.
The FCA also provides information in relation to the considerations when mapping a product categorised under SFDR to its proposed regime, and highlights in particular that Article 8 and 9 products under SFDR would need to meet both the cross cutting criteria and the category specific criteria before a Sustainable Investment Label could be applied under the proposed UK SDR regime. Undertaking such a mapping exercise will therefore be a key risk management point for firms in scope of both regimes.
Sustainable Investment Labels
The Consultation Paper proposes to introduce sustainable investment product labels, divided into three categories:
- Investments in assets that are environmentally and/or socially sustainable (referred to as “sustainable focus”). To qualify for this label, at least 70% of the product’s assets either meet a credible standard of environmental and/ or social sustainability; or align with a specified environmental and/or social sustainability theme
- Investments to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm (“sustainable improvers”)
- Investments in solutions to environmental or social problems, to achieve positive, real-world impact (“sustainable impact”)
The FCA stresses that there is no hierarchy between each category, and the differentiation between labels is not in “rank” or level of sustainability but rather in the objective criteria that will be used to identify the different purposes of the sustainable investment products. Firms offering products will have to determine whether they wish to apply one of the labels to their products (and therefore meet the associated criteria) and, to the extent that they do not, must abide by the proposed naming and marketing rules (see below).
Firms that do meet the criteria for their investment products and seek to use the label must notify the FCA that they are using the label within a month of doing so.
Consumer Facing and Detailed Disclosures
The Consultation Paper also proposes the introduction of mandatory disclosure requirements, both in relation to (i) consumer-facing product level disclosures, and (ii) more detailed product and entity-level disclosures for institutional investors and consumers. These disclosures will form part of the underlying basis of the UK’s proposed SDR regime.
The consumer-facing disclosures would be intended to help consumers understand the key sustainability-related features of an investment product. These disclosures would include the product’s sustainability objective, investment approach, and the product’s performance against such objective. In addition, firms would be required to provide a summary of the types of holdings that the firm would reasonably expect consumers of the product to find ‘surprising’ (i.e., inconsistent with the sustainability objective), considering factors such as the sector in which the product invests or trade-offs within the sustainability profile of a company. This must be clearly signposted as “unexpected investments” and include the type of investment e.g., its sector and an explanation as to why it is held in the product. Such disclosures would be required both for products with a sustainability investment label and those without.
The more detailed and granular disclosures that would be required would include the following:
- Pre-contractual disclosures setting out the sustainability-related features of a product. These disclosures would be required both for products with a sustainable investment label and those products that are not labelled, but “which have sustainability-related features that are integral to their investment strategy”. This latter category of products would include those where products with sustainability-related feature or objectives do not meet the criteria set out by the FCA in order to gain a sustainable investment label, possibly due to issues such as the sustainability objective being too vague, or a lack of KPIs being monitored.
- Annual sustainability-product level reports in relation to the sustainability-related performance of the product. This disclosure would be required for products with a sustainable investment label only.
- Entity-level disclosures, contained in a “sustainability entity report” which would discuss how firms are managing sustainability-related risks and opportunities. This requirement would apply to all firms that manage investment funds in the UK with AUM of £5 billion or more on a three year rolling average, and apply regardless of whether any product of the firm has a sustainable investment label.
The product and entity-level reports would build on the pre-existing TCFD product and entity reports required under the UK TCFD rules for asset managers.
Naming and Marketing Rules
The Consultation Paper proposes prohibiting the use of “sustainability-related terms” in the naming and marketing of products offered to retail investors that do not use a sustainable investment label. Such terms would include “ESG”, “green”, or “sustainable”. In particular, this may be relevant for those entities that choose to market products with “sustainability-related features that are integral to an investment policy”, but that do not use a sustainable investment label. The Consultation Paper states that, in these instances, firms would not be permitted to use such terms in the name of the fund, but would be permitted to use them when disclosing factual information in pre-contractual disclosures.
Requirements for Distributors
The Consultation Paper also proposes introducing rules on distributors of certain investment products to retail investors in the UK. These rules would require such distributors to make the sustainable investment label and consumer-facing disclosures that would be required under the SDR available to those investors.
Finally, the Consultation Paper proposes including a “clarification” that sustainability-related claims must be “clear, fair and not misleading” in relation to all financial products. This restatement of the FCA’s position is intended to combat greenwashing among advertisements for financial products, and would therefore enter into effect prior to the new requirements that the Consultation Paper proposes.
The Consultation Paper welcomes views from stakeholders as part of a formal public consultation which is open until 25 January 2023, with the aim of making final rules during Q2 2023. The FCA acknowledges that many of the proposed rules will require time to enable market participants to adjust, and therefore proposes that the labelling, naming, and marketing and initial disclosure requirements would not come into effect until 30 June 2024 at the earliest. However, as noted above, the FCA proposes that the “anti-greenwashing rule” will enter into effect as soon the FCA publishes the relevant policy statement, as this rule is said to clarify existing obligations rather than introducing anything new.
The FCA has also indicated that it will seek to consult on how the proposals in the Consultation Paper may be applied with respect to overseas funds and work with government departments to see how the regime can be expanded to include other investment products marketed to consumers (e.g., pension products), and updates will be announced with respect to these initiatives in due course.
Finally, the FCA has indicated that it is also stepping up its supervisory engagement on “sustainable finance” and enhancing its enforcement strategy, including with respect to greenwashing allegations.
How the proposals will impact the UK’s desire to be at the “forefront of the sustainable investment internationally” remains to be seen, but the FCA is continuing to take an active role in the sustainable/ESG-related finance market.
Latham & Watkins will continue to monitor these and related developments in the UK and other jurisdictions.
 In particular, the SEC proposed requirements for sustainable investment funds, categorising products to determine disclosures and proposing changes to product naming rules. See https://www.sec.gov/rules/proposed/2022/ia-6034.pdf and https://www.sec.gov/rules/proposed/2022/33-11067.pdf.