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The UK SDR is currently in the final stages of development by the FCA and the finalised rules are expected to be published later this year. In this article we’ll explore what the SDR means for investment firms operating in the UK, what changes they will face, and how it differs from requirements under the EU SFDR.
👉 What is the UK SDR? What requirements will it introduce? And how does it align with the EU SFDR?
The UK Sustainability Disclosure Requirements (UK SDR) are a proposed set of rules that will govern sustainability disclosure requirements for financial market participants in the United Kingdom.
The FCA is tasked with developing the UK SDR, and so, before delving into the details on the new requirements, let’s first start with a quick overview of what the FCA is and what role it plays.
The Financial Conduct Authority (FCA) is the UK’s financial regulatory body. It operates independently of the UK Government and is charged with regulating the financial services industry in the UK as per the Financial Services and Markets Act 2000 (FSMA). Its role includes protecting the consumers, promoting competition between financial service providers, and maintaining stability within the industry.
👉 The FCA regulates the conduct of over 58,000 financial service firms and financial markets in the UK.
In efforts to clamp down on ‘greenwashing’, the FCA announced in 2022 that it would begin developing a ‘package of measures to tackle the issues, including “investment labels, disclosure requirements, and restrictions on the use of sustainability-related terms in product naming and marketing.”
💡 To find out more about greenwashing, why not check out our article on the topic.
The FCA published a proposal (Consultation Paper 22/20) containing proposed measures that aim to increase transparency within the UK’s financial financial market when it comes to the sustainability profile of financial products and reduce the risk of greenwashing. The proposed measures include:
The FCA’s SDR proposal was opened up to consultation at the end of 2022, meaning that the FCA invited stakeholders to provide feedback and thoughts on the proposed measures and regulations.
The consultation closed on January 25th 2023, and in March the FCA announced updates, including feedback on the proposed measures and timings for the eventual release of the regulations.
The FCA initially intended to release a policy statement finalising the details of the UK SDR before the end of the first half of 2023, however, owing to the ‘significant response’ to the consultation paper, it has indicated that it has delayed the policy statement until Q3 of 2023.
👉 A policy statement follows on from a period of consultation. It allows the FCA to publish its response to feedback and also sets out the final legal rules (known as FCA handbook rules).
The FCA has indicated that it will use this extra time to consider its approach to market restrictions, refine criteria for the sustainability labels, and to clarify how different products can quality.
The UK SDR will apply to:
👉 For the time being the UK SDR will only apply to financial products and firms within the UK, though the FCA has stated that it may seek to extend the scope of the rules at a later date.
We’ve already touched on the measures proposed by the FCA’s consultation paper in the previous section. In this section we'll go into a bit more detail as to what these measures will actually entail.
The main change introduced by the UK SDR is the label based system of rating. Under the UK SDR financial products will be labelled based on the level of sustainability that can be attributed to the product. This is designed to help investors distinguish between financial products based on their sustainability credentials.
Three different labels have been proposed, each one with a different objective and intention:
The UK SDR will introduce new disclosure requirements at both the product level and the firm level:
Product level consumer-facing disclosures are required in addition to any existing disclosure requirements. These disclosures will be required even where the financial product does not have any label.
The consumer facing disclosure requirement is intended to help investors understand a financial product’s sustainability features. The information includes details on a product’s sustainability objectives and how much progress has been made towards this. The disclosure information will detail the investment products policy and approach to management, and the KPIs used to measure progress.
Product level disclosures provide more detailed information for a broader audience and fall under two categories:
Entity level disclosures must be prominently displayed on the financial firm’s website. These disclosures build on the FCA’s TCFD aligned reporting requirements.
There are 4 disclosure requirements that are based on the TCFD’s recommendations, namely:
The UK SDR will also introduce new restrictions around the naming and marketing of investment products in an effort to tackle greenwashing. The rules will apply to all financial products that don’t have a label.
For products without a label, the marketing and communications will be restricted. For example, it will not be possible to use language such as ‘ESG’, ‘green’, ‘sustainable’ in any customer facing materials.
Pending the publication of the policy statement, the UK SDR is expected to come into effect 12 months later, although it should be noted that the updated definition of ‘greenwashing’ will be immediately applicable.
The SFDR (Sustainable Finance Disclosure Regulation) is an EU regulation that imposes mandatory ESG disclosure requirements for EU financial market participants. The regulations came into effect in 2021 and aim to provide investors with transparency when it comes to the environmental or social aspects of financial products.
👉 To find out more about the details of the SFDR why not read our article on the regulations, which details everything you need to know.
So how does the UK SDR compare to the SFDR and is there much overlap?
Unlike the UK SDR the EU SFDR does not consist of labels that apply to products, instead the SFDR introduced different levels of disclosure. Depending on a fund’s level of sustainability, they will fall under one of 3 different categories:
What’s clear is that only funds falling under article 8 and 9 of the EU’s SFDR will (potentially) meet the requirements of the new UK SDR labels. However, since the two regulations are not aligned, article 8 and 9 funds will not automatically meet the requirements of the SDR labels - something that may cause confusion as a product may be considered to be sustainable in the EU, but fail to meet the sustainability requirements in the UK.
Other notable differences between the two regulations are that the UK SDR does not include a ‘do no significant harm’ test as per the EU SFDR. Under the EU SFDR the ‘do no significant harm’ principle applies to all sustainable investments and requires that in addition to contributing to an environmental or social objective, the investment fund must also be able to prove that it does not cause any environmental or social harm. The UK’s FCA decided not to include this test as it felt it was overly restrictive.
Similarly, the UK SDR doesn’t require financial firms to disclose Principal Adverse Impact Indicators. The EU SFDR on the other hand does require this. PAI indicators are metrics that require firms to disclose information on the investee company’s principal adverse impacts (ie. prescribed factors relating to environmental, social, employee rights, human rights, anti corruption and anti-bribery matters).
In terms of similarities between the two regulations, both the SFDR and the UK SDR require pre-contractual, ongoing, and entity-level disclosures. However, where they differ is that the EU SFDR provides mandatory reporting templates, whereas in the case of the UK SDR, firms will be left with the discretion to determine the content of disclosures.
According to the FCA, over 450 investment funds and 1,500 asset managers, managing 10.6 trillion GBP worth of assets may fall under the scope of the UK SDR. And although some requirements will be phased in gradually others can be expected to come into effect much more quickly. This is why firms in the UK should work to understand how their investment products will be impacted by the UK’s Sustainability Disclosure Regulations.
In order to better prepare for the requirements, firms will be in a better position where they ensure that existing products with a sustainability element are specific, measurable, and that the funds environmental or social objectives are clearly defined.
Equally, where a fund is not considered to be sustainable, firms should look to ensure that no risk arises from the inclusion of sustainability related claims in any marketing or product communication.
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