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Our Guide to the UK Sustainability Disclosure Requirements (UK SDR)
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The UK SDR is currently in the final stages of development by the FCA and the finalized 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?
What are the UK Sustainability Disclosure Requirements (SDR)?
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 FCA
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.
The FCA’s SDR Consultation
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.”
“ The decision to develop sustainable disclosure regulations was in response to a concern that “firms are making exaggerated or misleading sustainability-related claims about their investment products and claims that don’t stand up to scrutiny (ie. greenwashing).” ”
💡 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:
- Sustainable investment labels - these labels are aimed at helping customers to better understand the sustainability levels of different investment products;
- Consumer-facing disclosures - these disclosures would help consumers better understand the main sustainability related features of a financial product;
- Detailed disclosures - such detailed disclosures would include pre-contractual disclosures (ie. contained within the fund prospectus), ongoing sustainability related performance information, and a sustainability report that details how firms are managing sustainability related risks and opportunities;
- Naming and marketing restrictions - these rules would govern the use of sustainability related terms in product names and marketing materials and help to ensure that sustainability related terms are proportionate to the sustainability profile of the product;
- Distributor requirements - these requirements would ensure that distributors of financial products share product level information with consumers;
- Anti greenwashing rule - this rule clarifies that all sustainability related claims must be clear, fair and must not mislead the customer.
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.
Next steps for the UK SDR
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 finalizing 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.
UK SDR - the details
Who will the UK SDR apply to?
The UK SDR will apply to:
- Firms managing investment products for retail investors - both the firms and their products will be subject to the new UK SDR rules. This will include wealth, fund, and asset managers.
- Distributors of investment products that fall within the scope of the UK SDR - this will include financial advisors and platforms. Requirements include displaying labels clearly alongside consumer facing disclosures.
- FCA regulated firms - firms will be subject to the new anti-greenwashing rule which requires that information provided to customers is clear and not misleading in nature. Customers must also be linked directly to any sustainability claims.
👉 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.
What are the details of the UK SDR requirements?
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.
UK SDR labels
The main change introduced by the UK SDR is the label based system of rating. Under the UK SDR financial products will be labeled 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:
- Sustainable focus - Assets with this label are those that ‘mainly have an environmentally or socially sustainable focus’. Funds must maintain a high level of sustainability, investing a minimum of 70% in sustainable assets.
- Sustainable improvers - Assets with this label class are those that aim to have a positive environmental or sustainable impact in the future. Asset managers will be expected to show a measurable improvement on the funds ESG performance.
- Sustainable impact - Assets with this label are those that focus on investments that address real-world problems with measurable contributions to environmental or socially sustainable results. The label classification doesn’t have a minimum sustainable investment amount, however, financial products must have a specific sustainable outcome as their objective.
UK SDR Disclosures
The UK SDR will introduce new disclosure requirements at both the product level and the firm level:
Product level consumer-facing disclosures
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 for a broader audience
Product level disclosures provide more detailed information for a broader audience and fall under two categories:
- Pre-contractual disclosures - such disclosures must be included in the fund prospectus and published in a prominent place where financial products use one of the SDR labels, or for funds that don’t use a label but have adopted sustainability objectives. Information that is required to be disclosed include sustainability objectives, investment policy and management approach, and details on whether any investments that are not typically associated with the sustainability objective have been made.
- Ongoing sustainability product reports disclosures - these disclosures follow on from any pre-contractual disclosures and are intended to keep stakeholders informed of the ongoing performance of the financial product. These types of disclosures are only required where products use a SDR label. Under this disclosure requirement progress towards the funds sustainability objective should be disclosed, including details on performance against KPIs.
Entity level disclosures
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:
- Information on governance arrangements;
- Actual and potential impacts of sustainability related risks and opportunities;
- Risk management processes;
- Metrics and targets used to manage sustainability risks.
Naming and marketing restrictions
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.
When will the UK SDR come into effect?
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.
How does the SDR compare with the SFDR?
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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:
- Article 6 funds - these are funds that do not integrate sustainability into their investment processes;
- Article 8 funds - these are funds that promote sustainable investment, however it is not their primary objective;
- Article 9 funds - these are funds that have sustainable investment as their main objective.v
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.
Advice for firms in the UK
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.
What about Greenly?
At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required.
If reading this article has inspired you to consider your company’s own carbon footprint, Greenly can help. Learn more about Greenly’s carbon management platform here.
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