The FCA has published Discussion Paper 21/04 with proposals on the UK's Sustainability Disclosure Requirements regime (“SDR”). 

The discussion paper proposes a product classification, labelling and disclosure regime, which has similar aims to the SFDR but differs substantially from the EU rules as it looks to build on the FCA’s TCFD regime, Dear Chair letter from earlier this year for UK authorised fund managers and international standards (e.g. IFRS and IOSCO standards). 

In terms of timing, the consultation paper is open for comment until 7 January 2022, and the FCA plans to publish a consultation paper in Q2 2022 with detailed rules for further consultations. 

Alongside the discussion paper, the FCA has published “A Strategy for positive change: our ESG priorities” and a summary paper highlighting key FCA ESG milestones: Our ESG Strategy: Upcoming milestones 2022

Please see below our summary of the key points from each publication.


1. Key points to note from the SDR Discussion Paper

  • Scope - the paper suggests that the starting point for entity / product scoping should be the same as for the FCA’s TCFD proposals -which would effectively capture the majority of UK asset managers and asset owners and their products (regardless of whether they have ESG aims or not). However the FCA has asked whether certain types of products should be excluded from the labelling regime – e.g. separate accounts or more broadly, products that are not targeted at retail investors.


  • Application to overseas funds - the FCA has noted that it is considering how overseas funds marketing into the UK should be treated under the SDR, including funds that access the UK under the upcoming Overseas Funds Regime.


  • Application to financial advisers – the FCA are exploring what rules should be introduced for UK financial advisers. Similar to the EU rules, they consider it would be appropriate for advisers to consider sustainability matters in their investment advice and to ensure their advice is suitable and reflects consumer sustainability-related needs and preferences, but have asked for industry feedback on this point.


  • Three tiered product labelling and disclosure regime - the proposals can be summarised as having 3 main tiers:
    • Product labels – 5 products labels are proposed with different eligibility criteria, as summarised in the table below.
    • Consumer-facing disclosures (product level) – i.e. a brief ESG key facts document similar to the website summary that firms need to prepare for SFDR website product disclosures. This should cover items such as the product’s FCA label, ESG objectives, investment strategy pursued, asset allocation to ESG vs. non-ESG investments; approach to stewardship and wider ESG performance metrics. Note: the FCA is also considering whether to set a baselines set of ESG metrics for all products to enable consumers to understand the ESG performance of their investments over time – it seems like the E metrics in the TCFD reforms would be used as the base, supplemented by additional baseline S and G metrics.
    • Detailed disclosures aimed at institutional investors (product and entity level): although expressed as being aimed at institutional investors, we assume the idea is that they will be made available to all investors:  
      • product level: these will be an extension of the brief consumer facing product disclosures noted above, and will require detailed disclosure on data sources, data limitations, methodologies used to measure impact, supporting contextual and historical information, further information about UK Taxonomy alignment and information about benchmarking and performance. Without giving much detail on how, the FCA has stated that the SFDR principal adverse impact indicators could be used as a starting point.
      • entity level: the FCA intends for the entity level disclosures to be an expansion of the entity level TCFD reports – i.e. to cover ESG metrics beyond climate (i.e. what is the firm’s ESG strategy, governance etc. more broadly).


  • Verification and supervision: the FCA has queried whether independent verifiers could play a role in the process (e.g. to verify labels or disclosures) to underpin trust in the system. They have also noted that they will supervise and challenge firm’s labels and disclosures, as appropriate, including in the new fund authorisation process or as part of supervisory dialogue.


  • Product design and governance: the proposed regime will require firms to take account of the design and governance principles set out in the FCA’s Dear Chair letter to UK authorised fund managers (including regarding delivery, strategy, reporting and stewardship approach) for their products. The design and governance processes would also need to ensure that the product continues to meet the eligibility criteria for its selected label.


  • Templates: the FCA would like to ensure a baseline level of prescription for the consumer facing disclosures at least to ensure consistency and comparability, and have asked whether they should prescribe templates.


  • Derivatives, short sales and securities lending transactions – the FCA has specifically requested feedback on whether such products have a role to play in sustainable investing and how they should impact on eligibility for product labels.


FCA Product Label 

Overview of Category 

Proposed Eligibility Criteria* 

Potential SFDR mapping (FCA view)

Sustainable – Impact

Products that have an objective to deliver a net positive E or S impact alongside a financial return.

  • Intentionality to deliver a net positive E or S impact
  • Theoretical ability to deliver and measure “additionality” through investment decision-making and investor stewardship
  • Impact measurement and verification

Article 9

Sustainable - Aligned

Products with sustainable characteristics, themes or objectives, with high minimum % of UK Taxonomy aligned investments (or which could otherwise be verifiably presented as “sustainable”, if UK Taxonomy not available).


Minimum thresholds for asset allocation including high minimum % of UK Taxonomy aligned investments. There must be evidence of sustainability characteristics, themes or objectives that are reflected fairly and consistently in the investment policy or strategy. These may include a combination of:

  • restrictions to the investible universe, including investment limits and thresholds;
  • screening criteria (positive or negative);
  • the application of benchmarks or indices and expected or typical tracking error relative to the benchmark; and
  • the entity’s stewardship approach as applied to the product

Article 9

Sustainable – Transitioning

Products with sustainable characteristics, themes or objectives and low % allocation of Taxonomy aligned investments. These products must pursue strategies that aim to influence underlying assets towards meeting sustainability criteria over time, for instance through active and targeted investor stewardship. The expectation, is for the % of sustainable / Taxonomy aligned investments to increase over time.


As above, but with no minimum thresholds for asset allocation.

Article 8

Responsible

Products that consider the impact of material sustainability factors on financial risk / return with a view to deliver long-term, sustainable returns. No specific sustainability goals.

ESG integration, evidence of ESG analytical organisational capabilities and resources, demonstrable stewardship – all at product level.

Article 8

[Note: although the FCA has suggested this classification, we don't think such products would ordinarily be considered as Article 8 products under SFDR as ESG integration / stewardship are not generally regarded as binding E/S characteristics that Article 8 SFDR products must have. See also cell below.]

Not promoted as sustainable

Sustainability risks have not been integrated into investment decisions (even as form of risk management). No specific sustainability goals.

N/A

Article 6

[Note: this category seems too narrow, as the guidance suggests that products that consider ESG risks will not fall within this category and so presumably with fall within the “Responsible” bucket instead – which would potentially result in greenwashing / misleading outcomes unless strict expectations for ESG risk integration are imposed for “Responsible” products.]


*Note: the FCA has suggested imposing baseline entity-level criteria as well i.e. a product manufacturer cannot badge its products as falling within the Sustainable or Responsible buckets unless it complies with certain baseline ESG criteria at the entity level. The would involve ensuring that systems and controls, governance, ESG integration and stewardship at the entity level meet certain minimum ESG standards (which have not yet been defined by the FCA – but could include ESG/responsible investment credentials of the firm, e.g. whether it’s a signatory to te UK FRC Stewardship Code or the UNPRI). It looks like potentially higher entity level criteria may be applied for manufacturers and managers of Sustainable vs. Responsible products.


2. FCA refreshed ESG strategy and priorities

With the focus on how the FCA plans to change and adapt itself in order to deliver on its ESG objectives, it also provides a reminder of the future supervisory and enforcement priorities of the FCA in this space – disclosures and greenwashing, appropriate culture and governance, and the role of ESG rating and data providers are highlighted, with a warning that those firms who have the greatest impact should expect the greatest scrutiny. Of particular note:

  • FCA links ESG with its three operational objectives (consumer protection, integrity of the financial system and promoting competition in the interests of consumers) noting that ESG considerations have the potential to influence the integrity of the financial markets. This connection embeds ESG as a priority area for FCA supervision, and makes the link with the role FCA places on firm governance and culture in driving positive change in environmental and climate matters.
  • Making the link between ESG considerations and market integrity, FCA describes areas of enforcement risk (“potential harms”) for firms. Starting with disclosures, FCA identifies miss-selling and misrepresentation of ESG data as key areas of concern. Appropriate governance is also highlighted, as is the need for active investor stewardship and the role of data and ratings services (where there is work underway to consider the need for further regulation in this space).