CP22/20: Further leaves unfurl on the tree of the UK ESG regime
November 18, 2022
Introduction
After some delay, the United Kingdom’s financial services regulator, the Financial Conduct Authority (the “FCA”) has published Consultation Paper CP 22/20 (Sustainability Disclosure Requirements (“SDR”) and investment labels) (the “Consultation Paper”)1 setting out its proposed sustainability-related disclosure rules for UK funds, portfolio management mandates and the UK firms managing such products.
The proposed regime set out in the Consultation Paper is retail focused but also applies to firms with an institutional client base, and has limited overlap with the EU regime in force under the Sustainable Finance Disclosure Regulation (“SFDR”).2
The proposed regime does not apply to investment managers that are not FCA regulated, nor does it apply to non-UK funds, although the FCA intends to follow with a separate consultation on how the proposals in the Consultation Paper may be applied in respect of non-UK funds.
The proposals cover the following areas:
1. Sustainable investment labels. The aim of these is to help consumers navigate the investment product landscape and enhance consumer trust. There will be three categories, each underpinned by objective criteria, that distinguish between the different types of sustainable product according to the primary channel by which each can contribute to positive sustainability outcomes.
The labelling regime distinguishes between products according to whether they aim to invest:
- in assets that are environmentally and/or socially sustainable ("sustainable focus");
- to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm ("sustainable improvers"); or
- in solutions to environmental or social problems, to achieve positive, real-world impact ("sustainable impact").
2. Consumer facing disclosures. These are to help consumers understand the key sustainability-related features of an investment product, and must be set out in a standalone document. This includes its sustainability objective, investment approach and (over time) performance against the objective. It also includes disclosing investments that a consumer may not expect to be held in the product given its sustainability objectives. These disclosures must be produced for products with or without a sustainable investment label, although disclosures will inherently be more limited for products that do not have a label.
3. Detailed disclosures. These are more granular than the consumer-facing disclosures and are targeted at a wider audience (institutional investors and consumers seeking more information) and concern:
- pre contractual disclosures (for example, in the fund prospectus), covering the sustainability-related features of investment products;
- ongoing sustainability related performance information including key sustainability-related performance indicators and metrics, in a sustainability product report; and
- a sustainability entity report covering how firms are managing sustainability-related risks and opportunities.
4. Naming and marketing rules. These will restrict the use of certain sustainability-related terms in product names and marketing materials provided to retail investors unless the product uses a sustainable investment label. For example, terms such as ’ESG‘, ’green‘ or ’sustainable’.
5. Requirements for distributors (such as investment platforms). These are to ensure that product-level information (including labels) is made available and is clear to consumers.
6. A general anti-greenwashing rule. A general rule will apply to all FCA regulated firms that reiterates existing rules that sustainability-related claims must be clear, fair and not misleading and are consistent with the sustainability profile of the product or service (i.e. proportionate and not exaggerated).
Timing
The deadline for response to the Consultation Paper is 25 January 2023.
Subject to feedback on the Consultation Paper, its proposed rules will be final and in force provisionally by 30 June 2023. The rules will then come into effect in tiers, with provisional timings below:
- The general anti-greenwashing rule will come in effect on 30 June 2023.
- The sustainable investment label regime, the consumer-facing disclosures, naming and marketing rules and requirements for distributors will come into effect on 30 June 2024.
- Rules relating to the ongoing sustainability related performance information report will come into effect on 30 June 2025.
- Rules relating to the sustainability entity report will come into effect on 30 June 2025 for firms with assets under management (“AUM”) of £50 billion or more and 30 June 2026 for firms with AUM of greater than £5 billon but less than £50 billion.
The labelling regime
Scope: The labelling regime applies to the following FCA regulated firms:
- Firms carrying out portfolio management;
- UK Undertakings for Collective Investment in Transferable Securities (“UCITS”) management companies;
- Investment companies with variable capital (“ICVC”) that is a UCITS scheme without a separate management company;
- Full-scope UK Alternative Investment Fund Manager (“AIFMs”); and
- Small authorised UK AIFMs.
These are collectively referred to in the Consultation Paper as "in-scope firms”.
The labelling regime applies to the following investment products:
- UK authorised funds (excluding feeder funds and funds in the process of winding up or termination);
- UK unauthorised Alternative Investment Funds (“AIFs”), including investment trusts; and
- Portfolio management services if 90% or more of the value of all constituent products in which they invest qualify for the same label.
These are collectively referred to in the Consultation Paper “in-scope products”.
The “sustainable focus” label
The features of this category of product are:
- Sustainability objective. Alongside its financial risk/return objective, a ‘sustainable focus’ product will have an objective of investing in assets that meet a credible standard of environmental and/or social sustainability, or that align with a specified environmental and/or social sustainability theme.
- Primary channel for sustainability outcomes. This category of product pursues its sustainability goals primarily via the market-led channel of influencing asset prices, and thereby reducing the relative cost of capital of sustainable economic activities/projects.
- Secondary channel for sustainability outcomes. In addition to the primary channel criteria, products in this category will also typically pursue continuous improvements in the sustainability performance of assets through investor stewardship activities.
Further, at least 70% of a ‘sustainable focus’ product’s assets must meet a credible standard of environmental and/or social sustainability, or align with a specified environmental and/or social sustainability theme.
The “sustainable improvers” label
The features of this category of product are:
- Sustainability objective. Alongside its financial risk/return objective, a ‘sustainable improvers’ product will have an objective of delivering measurable improvements in the sustainability profile of its assets over time, including through investor stewardship.
- Primary channel for sustainability outcomes. This category of product pursues its sustainability goals primarily via the channel of investor stewardship. The product’s stewardship approach is directed towards encouraging and accelerating improvements in the environmental or social sustainability profile of its assets, including through participation in system-wide initiatives, with flow-on positive implications for environmental and/or social sustainability.
- Secondary channel for sustainability outcomes. Portfolio construction and asset selection in ‘sustainable improvers’ products is geared towards identifying those assets that are best-placed to improve their sustainability profile over time. So, a secondary channel would be the market-led channel of influencing asset prices and the relative cost of capital of more sustainable economic activities/ projects.
The “sustainable impact” label
The features of this category of product are:
- Sustainability objective. Alongside its financial risk/return objective, a ‘sustainable impact’ product will have an objective of achieving a pre-defined, positive and measurable environmental and/or social impact.
- Primary channel for sustainability outcomes. This category of product pursues its sustainability goals by directing typically new capital to projects and activities that offer solutions to environmental or social problems, often in underserved markets, or to address observed market failures. Products would be expected to have a stated theory of change, and to pursue a highly selective asset selection strategy aligned with that theory of change.
- Secondary channel for sustainability outcomes. Driving continuous improvements in the sustainability performance of assets through investor stewardship activities would be a secondary channel
Further, to qualify for any sustainable investment label, the product must meet:
- five overarching principles covering (1) sustainability objective; (2) investment policy and strategy; (3) Key Performance Indicators (“KPIs”); (4) resources and governance; and (5) investor stewardship (the “Principles”);
- a number of key considerations associated with the Principles, described in the Consultation Paper as “cross-cutting” considerations; and
- certain category-specific key considerations relevant to their particular label.
The FCA is clear that the three categories of labels are intended to be mutually exclusive. Products with a blended strategy could not qualify for more than one label according to the FCA’s criteria, as the firm would be expected to set a clear objective that, together with the other criteria, determines which label is appropriate for the product. The FCA expressly states that there is no hierarchy between the proposed labels: each is designed to deliver a different profile of assets and consumer preferences.
The FCA has created tables setting out the detail of these qualification criteria, as set out in the Annex. Products without a sustainability objective, but which may use strategies such as ‘ESG integration’, would not qualify for a sustainable investment label.
Similarly, products employing strategies such as ‘exclusion/negative screening’ or basic ‘ESG tilts’ are not viewed by the FCA as contributing to positive sustainability outcomes, so would not qualify for a sustainable investment label.
The FCA’s initial view of how these three labels map across to SFDR categorisation is set out in the table below. As can be seen, in some cases funds falling within the Article 8 or Article 9 SFDR categories still cannot meet any sustainable labels.
The disclosure regime
Consumer-facing disclosures
Scope: The consumer facing disclosure regime applies to all in-scope firms marketing in-scope products to retail investors, regardless of whether they qualify for and choose to use a label, but excludes firms providing portfolio management services.
Location: These disclosures should be made available in a prominent place in a digital medium, for instance, the firm's main product webpage, and will need to be in a standalone document, alongside other documents that present other key investor information such as the Packaged Retail Investment and Insurance-Based Products (“PRIIPs”) Key Information Document (“KID”).
Format: Whilst there is some prescription governing the format and content of the disclosures, the FCA is not introducing a template but encourages firms to develop a market-led one.
Content: The following must be disclosed:
- Basic information. Include the firm’s name, product name, International Securities Identification Number (ISIN), or any other unique identifier, and date.
- Product label. This must be displayed towards the beginning of the disclosure and include a brief description of what the label means.
- Sustainability goal. The product’s sustainability objective, signposted as ‘sustainability goal’, highlighting if there is an impact or expected impact on the financial return (e.g. expected implications for the financial risk profile).
- Sustainability approach. A summary of key elements of the product’s investment strategy to pursue the objective (e.g. investible universe, screening, themes).
- Unexpected investments. 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.
- Sustainability metrics. Relevant metrics/KPIs linked to achieving the sustainability objective and, where relevant, any other metrics that would help consumers to further understand the approach that the firm has taken, including an explanation of how the metrics should be interpreted.
- Signposting to other disclosures. A cross reference/hyperlink to further information in the detailed product-level disclosures (pre-contractual and ongoing performance disclosures), entity-level disclosures, and relevant documents that set out non-sustainability-related information for the product (e.g. costs and charges).
Frequency: The disclosures must be made and reviewed annually.
Pre-contractual disclosures
Scope: The pre-contractual disclosures apply to all in-scope firms using a sustainable investment label, excluding firms providing portfolio management services, and to firms not using a label but where sustainability-related features are integral to the investment policy and strategy (excluding firms providing portfolio management services).
The pre-contractual disclosures apply to all in-scope products, excluding portfolio management services. Firms providing portfolio management services will not be required to produce pre-contractual disclosures, but must instead provide access to the pre-contractual disclosures for the underlying in-scope product.
Location: These disclosures must be made in the relevant fund prospectus, investor information document as required under FUND 3.2 of the FCA Handbook or sustainability product report.
Format: There is no prescribed format.
Content: The disclosures must cover the product’s compliance with the following Principles under the labelling regime:
- Principle 1 – sustainability objective.
- Principle 2 – investment policy and strategy.
- Principle 5 – stewardship.
Frequency: The first pre-contractual disclosures must be made available at the same time as the label and consumer-facing disclosures (i.e. provisionally from 30 June 2024).
Ongoing sustainability related performance information
Firms must produce disclosures on the sustainability-related performance of their products on an ongoing basis, in a dedicated sustainability product report which builds from the Task Force for Climate-related Financial Disclosures (“TCFD”) product report.3
Scope: Where the product does not have a fund prospectus or other pre-contractual disclosure requirements, firms will be required to publish "Part A" of their sustainability product report in a prominent place on a relevant digital medium where the product is offered, such as on the product webpage. Firms will also be required to ensure investors are made aware of the contents of the report before they invest in the product.
"Part B" of the sustainability product report will only be required in relation to products using a sustainable investment label (except for firms providing portfolio management services and UK AIFMs managing unauthorised AIFs not listed on a recognised exchange).
Location: The sustainability product report must be published in a prominent place on the firm's website though, as with the existing disclosure obligation under the FCA’s ESG Sourcebook4, the FCA recognises that public disclosures are not appropriate in some situations, specifically (i) UK AIFMs managing unauthorised (and unlisted) AIFs and (ii) firms that provide discretionary portfolio management services to individuals or institutional investors. In these scenarios, the firm will be required to disclose this information on request on an annual basis.
Format: Provided the report contains the prescribed content, the Consultation Paper is not prescriptive as to the format used.
Content: Part A of the report must display the sustainable investment label (where applicable) and state the product’s sustainability objective as well as progress towards meeting that objective, and the link between the products sustainability objective and environmental or social outcome.
Part B of the report must display the sustainable investment label, and state the product’s sustainability objective as well as progress towards meeting that objective. In addition, the firm must make the following disclosures associated with the criteria under the labelling regime:
- Principle 2 – investment policy and strategy.
- Principle 3 – KPIs
- Principle 5 – stewardship
Frequency: The report must be made and reviewed annually.
Sustainability entity report
Scope: All in-scope firms with AUM of £5 billion or more will be required to produce a sustainability entity report in relation to their in-scope business.
Firms with assets under administration or management amounting to less than £5 billion calculated as a 3-year rolling average on an annual assessment will be exempt from the new entity-level disclosures.
Asset managers with above £50 billion in AUM will be required to make their first disclosures by 30 June 2025, with smaller firms, excluding those with under £5 billion in AUM, required to make their first disclosures by 30 June 2026.
Location: The report must be published in a prominent place on the main website for the business of the firm (e.g. with a link from the homepage).
Format: Provided the report contains the prescribed content, the Consultation Paper is not prescriptive as to the format used.
Content: The report must contain:
- The firm’s governance in relation to sustainability-related risks and opportunities.
- The actual and potential impacts of sustainability-related risks and opportunities on its businesses, strategy and financial planning, where such information is material
- How the firm identifies, assesses and manages sustainability-related risks.
- The metrics and targets the firm uses to assess and manage relevant sustainability-related risks, where such information is material.
Where a firm uses a sustainable investment label, it must also make disclosures associated with the criteria under Principle 4 – Resources and Governance.
Frequency: The report must be made and updated annually.
Naming and marketing rules
The FCA is proposing to prohibit firms providing in-scope products to retail investors that do not qualify for and use one of the sustainable labels from using certain sustainability-related terms including (but not limited to) ‘ESG’ (or ‘environmental’, ‘social’ or ‘governance’), ‘climate’, ‘impact’, ‘sustainable’ or ‘sustainability’, ‘responsible’, ‘green’, ‘SDG’ (sustainable development goals), ‘Paris-aligned’ or ‘net zero’ in their product names and marketing.
The FCA also propose that ‘sustainable focus’ or ‘sustainable improvers’ products be prohibited from using the term ‘impact’ in the naming and marketing of these products.
The rules will apply to in-scope products that are made available to retail investors in the UK. Products offered to institutional investors are not in scope of these requirements.
Specific rules will apply in relation to the use of sustainability-related terms in the naming and marketing of portfolio management agreements or arrangements to retail investors. In particular, firms will be able to use such terms, provided that 90% or more of the total value of the products in which the relevant portfolio invests qualify for a sustainability label and that the terms are not used in a misleading way.
Requirements for distributors
Firms that are distributors of in-scope products to retail investors (including platforms and advisers) must display the product’s label prominently on a relevant digital medium and provide access to the relevant customer-facing disclosures. Distributors must keep the relevant digital medium and marketing communications updated with any changes a firm makes to the label and disclosures. Where the product does not use a label, the distributor must still provide retail investors with access to the consumer-facing disclosure.
Where prohibited sustainability-related terms are used in relation to the naming and marketing of overseas products that are recognised schemes, including exchange-traded funds, distributors of those products to retail investors must place a notice on that product, alerting retail investors that: “This product is based overseas and is not subject to FCA sustainable investment labelling and disclosure requirements”. The notice must be placed in a prominent place on the relevant digital medium (e.g. product webpage or page on a mobile application), and be accompanied by a hyperlink to the FCA webpage which will set out what the labelling and disclosure requirements are for retail investors that wish to know more.
Anti-greenwashing rules
These proposed rules would require all FCA regulated firms to ensure that the naming and marketing of financial products and services in the UK is clear, fair and not misleading, and consistent with the sustainability profile of the product or service.
Annex: Sustainable investment label principles
Principle 1, Sustainability Objective. A sustainable investment product must have an explicit environmental and/or social sustainability objective. Key considerations (cross-cutting)
Category-specific criteria | ||
Sustainable Focus | Sustainable Improvers | Sustainable Impact |
The sustainability objective must align with requirements in the ‘investment policy and strategy’ section below i.e. to invest predominantly (at least 70%) in assets that meet a credible standard* for environmental and/ or social sustainability; or that align with a specified environmental and/or social sustainability theme. *A credible standard is one that is robust, independently assessed, evidence-based and transparent. | The sustainability objective must align with requirements in the ‘investment policy and strategy’ section below i.e. to invest in assets that have the potential to become more environmentally and/or socially sustainable over time, including in response to active investor stewardship. | The sustainability objective must be to achieve a pre-defined, positive, measurable real-world environmental and/or social outcome. |
Principle 2, Investment Policy and Strategy. A firm’s investment policy and strategy for the sustainable investment product must be aligned with its sustainability objective. Key considerations (cross-cutting)
Category-specific criteria | ||
Sustainable Focus | Sustainable Improvers | Sustainable Impact |
The firm must ensure that 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. If reasons for beyond the firms’ control, the assets cease to meet the requirements above, the firm must take action to restore compliance as soon as reasonably practicable, having regard to the interests of the firm’s investors (i.e. clients and consumers). | The firm must ensure that the product is invested in assets that have the potential to become more environmentally and/or socially sustainable over time, including in response to active investor stewardship. | The firm must specify:
|
Principle 3, Key Performance Indicators. A firm must specify sustainability objective.credible, rigorous and evidence-based KPIs that measure a sustainable investment product’s ongoing performance towards achieving its Key considerations (cross-cutting)
Category-specific criteria | ||
Sustainable Focus | Sustainable Improvers | Sustainable Impact |
| In specifying KPIs to assess performance of the product, a firm must ensure that those KPIs include metrics that demonstrate the ongoing alignment of the product’s assets with a target environmental and/ or social sustainability profile, and the product’s ongoing adherence to asset-level sustainability features in accordance with its investment policy and strategy. | In specifying KPIs to assess performance of the product, a firm must ensure that those KPIs include metrics that demonstrate:
| In specifying KPIs to assess performance of the product, a firm must apply enhanced impact measurement and reporting based on industry best practices. |
Principle 4, Resources and Governance. A firm must apply and maintain appropriate resources, governance and organisational arrangements commensurate with the delivery of the sustainable investment product's sustainability objective. Key considerations (cross-cutting)
|
Principle 5, Stewardship. A firm must maintain its active investor stewardship strategy and resources (at firm-level or product-level) in Key considerations (cross-cutting)
|
Footnotes
1. The Consultation Paper is available here.
2. Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector, as amended by Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation).
3. For more information on the TCFD product report, please see our OnPoint “FCA Policy Statement on Enhancing Climate-Related Disclosures by UK Asset Managers” available here.
4. See ESG 2.3.5R of the FCA Handbook.
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