Disclosure requirements and product labels among FCA ‘greenwashing’ proposals

The paper (179 pages / 1.97MB), which sets out the FCA’s proposals for classification and labelling – as well as disclosures – is primarily aimed at UK-based fund managers, portfolio managers and distributors of UK UCITS funds, Alternative Investment Funds and segregated mandates. It is, however, also relevant to all FCA-regulated firms as, in addition to the general anti-greenwashing rule, it marks a clear direction of travel which is likely to be rolled out to non-UK funds and other types of products and firms.

In view of this, the FCA recognises that its proposals do not fully align with Department for Work and Pensions (DWP) requirements for pensions and asks for views on the challenges and practicalities of how its proposals will interact with the DWP’s requirements.

Labelling

While the UK asset management community has become used to referring to Article 6, 8 and 9 funds under the EU’s Sustainable Finance Disclosures Regulation (SFDR), the FCA plans to take a slightly different approach, noting that “SFDR was intended to be a disclosure regime only, while our [FCA’s] regime introduces a labelling regime to help protect consumers.” Under its proposals, the UK will have three types of sustainable investment product labels that will first apply to environmental, social, and governance (ESG) funds. The labels reflect different sustainability objectives – rather than being a hierarchy with one label regarded as better than another. With the labels the FCA’s aim is to help investors assess the sustainability criteria of investment products, so for investment funds the labels will indicate the ESG emphasis followed by a fund’s strategy.

The three labels the FCA proposes and outlined in the consultation paper are: ‘Sustainable focus’, ‘Sustainable improvers’ and ‘Sustainable impact’.

Sustainable focus

Products using this label must have an objective to maintain a high standard of sustainability with at least 70% of the product’s assets either meeting a credible standard of environmental and/or social sustainability or aligning with a specified environmental and/or social sustainability theme. A consumer-facing description would be that the fund invests mainly in assets that are sustainable for people and/or the planet.

In pursuing a sustainable focus, the FCA has indicated that the primary channel for assessing sustainability outcomes for products with this label would be influencing asset prices and the secondary channel would be through improvement via stewardship of the sustainability performance of assets. A sustainable focus fund would likely fall under Article 8 of the EU SFDR although each fund should be assessed to confirm.

Sustainable Improvers

Products under this label will have an objective to deliver measurable improvements in the sustainability profile of assets over time. These products are invested in assets that, while not currently environmentally or socially sustainable, are selected for their potential to become more environmentally and/or socially sustainable over time – including in response to the stewardship influence of the firm. A consumer-facing description would be that the product invests in assets that may not be sustainable now, with an aim to improve their sustainability for people and/or the planet over time.

For sustainable improvers, the FCA has indicated the primary channel to assess improvement outcomes would be via asset stewardship by improving their environmental or social sustainability profile, and the secondary channel would be by identifying assets to improve their sustainability profile over time. Such funds would likely fall under Article 8 of the EU SFDR. Again, each fund would need to be assessed.

Sustainable Impact

Products under this label will have an explicit objective to achieve a positive, measurable contribution to sustainable outcomes. These are invested in assets that provide solutions to environmental or social problems, often in underserved markets or to address observed market failures. Products would be expected to have a selection strategy aligned to a stated theory of change. A consumer-facing description is that the product invests in solutions to problems affecting people or the planet to achieve real-world impact.

For sustainable impact the FCA has indicated the primary channel for impact outcomes would be by directing typically new capital to projects and activities offering solutions to environmental or social problems. Such products would be expected to have what the FCA refers to as “a stated theory of change” with rigorous asset selection aligned with that change theory. A secondary channel would be stewardship, seeking to drive continuous improvements in assets’ sustainability performance. Subject to individual confirmation a sustainable impact fund would likely fall under Article 9 of EU SFDR.

Using a label would be voluntary, but a firm that wishes to use a label for a fund product or portfolio strategy would then be required to comply with that label’s requirements. The consultation paper makes clear that the FCA will not regard funds that simply apply negative screening as eligible for a sustainable investment label. Portfolio management services will only be able to use a particular label if 90% or more by value of the products in which the portfolio manager invests qualify for the that label. The FCA explains the three labels are intended to be mutually exclusive. So products with a blended strategy cannot qualify for more than one label, and it is not possible to blend different product labels and adopt a label of the lowest sustainable level.   

New ESG principles

The consultation paper also introduces five overarching principles or ‘general criteria’:

1. Sustainability Objective: A sustainable investment product must have an explicit environmental and/or social sustainability objective.
2. Investment Policy and Strategy: A firm’s investment policy and strategy for a sustainable product must align with its sustainable objective.
3. Key Performance Indicators (KPIs): A firm must specify credible, rigorous and evidence-based KPIs that measure a sustainable investment product’s ongoing performance towards achieving its sustainability objective.
4. Resources and Governance: A firm must apply and maintain appropriate resources, governance and organisational arrangements required to deliver the sustainable investment product’s sustainability objective.
5. Stewardship: A firm must maintain its active investor stewardship strategy and resources at firm or product level in a manner consistent with the sustainable product’s sustainability objective.

Firms would need to ensure the requirements for a particular sustainable investment label and the overarching principles are met on an ongoing basis. For each of the five principles the FCA proposes key ‘cross-cutting’ considerations. These considerations can be used to help make an assessment as to whether the principle is met, and include considerations relating to the firm’s governance, processes, resources, investment policy, investible universe and asset selection. Firms would also need to fulfil the applicable disclosure and product reporting requirements the FCA is proposing in respect of each principle.

Disclosures

Disclosures address both the product and the entity, and helpfully build on the current disclosures under the FCA’s rules in the ESG Sourcebook to adopt disclosure criteria set out by the Task Force on Climate-related Financial Disclosures (TCFD). Disclosures will be designed for consumers and separately for institutional investors or those who want deeper and more detailed information.

Consumer-facing disclosures will include a new, standalone summary of the information in the detailed product-level disclosures in a document not exceeding 2 pages of A4 when printed, in addition to other consumer disclosures, such as the packaged retail investment and insurance-based products (PRIIPs) Key Information Document (KID). All in-scope firms (fund managers and asset managers) will need to produce the new annual ESG disclosure document for all in-scope products - even those not using a sustainable label. The consultation proposes the categories of disclosure the standalone consumer document is to contain, which include the product label – or a statement that there is ‘no sustainable label’ – as well as the sustainability goal and the approach. Notably, it should also include a statement regarding any unexpected investments, what they are and proposals regarding them. This statement must be clearly signposted as ‘unexpected investments’. 

At product-level there will be pre-contractual disclosure, for example in the prospectus for a fund, that will address Principles 1, 2 and 5. A detailed annual sustainability report for the product will need to be produced. In addition to including material covered in pre-contractual disclosure documentation – known as ‘Part A’ – the annual product report will also cover ESG Principles 2, 3 and 5 in what is known as ‘Part B’ of the report. Part A disclosures are to be available the same time as labels become required, which is expected to be 30 June 2024. Meanwhile, the provisional publication date for Part B of the sustainability product report is proposed to be no later than 30 June 2025. The FCA is proposing disclosures are updated anually.In contrast to the EU position there will not be a requirement regarding disclosures on “Do No Significant Harm”.

Disclosures will need to be prepared not only on a product basis, but also on an entity basis, and the proposal builds on the current position in the FCA’s ESG Sourcebook. All in-scope managers will have to prepare a sustainability entity report on how the firm manages sustainability-related risks and opportunities at entity-level. This will be a phased implementation, with asset managers having over £50 billion of assets under management being required to make their first disclosures from 30 June 2025 and smaller firms with over £5 billion of assets under management doing so a year later.

The consultation paper builds on the TCFD’s four recommendations for the proposed entity level sustainability report disclosures:

• governance around sustainability-related risks and opportunities
• actual and potential impacts of sustainability-related risks and opportunities on the business, strategy, financial planning, where such information is material
• how the firm identifies, assesses, and manages sustainability-related risks
• metrics and targets used to assess and manage relevant sustainability-related risks where material.

The consultation paper proposes that the policy statement will be published for 30 June 2023. Fund managers will need to review the investment objectives and policies of their funds to assess where those funds sit within the three labels and to assess whether any changes need to be made. A change to investment objectives will require shareholders’ approval for authorised funds, and almost certainly for unauthorised ones. Similarly, if the investment policy is to be changed significantly this will likely also require shareholder approval.

Although implementation is not expected until June 2024, fund managers should start assessing now how the new regime will impact on their businesses and any changes that need to be implemented to ensure a smooth transition. The FCA’s consultation period ends on 25 January 2023.