On the road(map) to sustainable investing: The FCA’s final rules on sustainability disclosures and labelling

The Financial Conduct Authority (FCA) published its long-awaited Policy Statement on Sustainability Disclosure Requirements (SDR) and investment labels (PS23/16) on 28 November. Delayed from an initial expected publication date of 30 June 2023 to allow the regulator to take account of the significant level of responses received to its 2022 Consultation Paper (CP22/20), it sets out the FCA’s ‘final rules and guidance to improve trust and transparency to the market for sustainable investment products’, aimed at reducing greenwashing and other associated harms in this space.

In this blog post, we summarise the key areas covered by the new rules and consider the broader international context and next steps.

The Policy Statement introduces important changes to the previous proposals, which are of interest to firms within scope of the rules as well as to consumers and other stakeholders. In particular: 

• The FCA has introduced an additional investment label in recognition of the fact that funds may have a blend of sustainability strategies within the regime;
• Portfolio managers, which were previously proposed to be within scope, are excluded from the application of the rules and will be addressed in a second stage; and
• Previous proposals to prohibit the use of sustainability-related terms in product names and marketing for in-scope retail investor products without a sustainability label have not been adopted, and the use of such terms will be permitted if certain conditions are met.

The final rules cover the following areas:

• Sustainability product labels
• Naming and marketing rules
• Disclosure requirements
• Anti-greenwashing rule
• Distributor requirements

The regime will come into effect in several stages over the next few years. Given its complexities, impacted firms will be well advised to carefully consider the impact of the final rules and likely implementation challenges in preparation for its introduction.

The broader context: international developments and increased regulatory scrutiny

As discussed in our previous blog post on the 2022 Consultation Paper (see here), the SDR seeks to ensure the UK’s place at the forefront of sustainable investment. The regime is being introduced in the context of a broader international and UK focus on green finance, including the UK Government’s plans as set out in its 2021 Roadmap to Sustainable Investing and 2023 Green Finance Strategy.

The FCA notes that the UK regime is among the first to consider the introduction of investment labels, but there are parallel initiatives on sustainable investment in various other jurisdictions. Of particular interest is the interaction of the UK regime with the EU’s Sustainable Finance Disclosure Requirements (SFDR), noting in particular the targeted consultation on the implementation of the SFDR published by the European Commission in September which includes the consideration of an EU labelling regime for financial products. While the FCA notes that the UK regime is compatible with the SFDR to the extent possible and that firms should be able to leverage existing SFDR compliance processes, the regimes nevertheless have different starting points and provisions, and the UK in some cases imposes additional requirements on firms. Proposals on labelling and/or greenwashing are also underway in other jurisdictions, such as the US, Australia and Switzerland. While the FCA highlights its willingness to work with EU authorities, as well as its continued engagement with developments in other jurisdictions, there will inevitably be a number of important differences between the regimes that will involve some complexity for firms and groups subject to several regimes. 

The Policy Statement should be seen in the light of an increased regulatory focus on greenwashing as well as consumer protection. Much of the SDR and labelling regime is aimed at retail investors, and the Policy Statement cross-refers to the FCA’s new Consumer Duty. The FCA has confirmed that it will apply its usual supervisory and enforcement approaches to the regime, which will include responding to any compliance issues and acting on intelligence indicating non-compliance. In cases of serious misconduct, the FCA has indicated that it may take enforcement action. Firms may also face scrutiny from other stakeholders, such as customers, NGOs and other bodies. 

Firms and products within scope

The application of the Policy Statement is generally limited to the UK – the anti-greenwashing rule will apply to all FCA authorised firms who make sustainability-related claims about their products and services. Other rules, including on labelling, disclosures, and naming and marketing, will apply to UK asset management firms and UK funds. In addition, there are targeted requirements for distributors of investment products to UK retail investors. 

However, the Policy Statement is only a starting point, with the regime expected to expand and evolve over time. In particular, as a next step the FCA expects to extend the regime to portfolio management and overseas funds marketed into the UK and, in the medium term, pension and other investment products. Portfolio managers were initially intended to be covered by the Policy Statement but have been excluded from scope following concerns that they would not be suitable for inclusion, in particular as most portfolios are diversified and unlikely to invest only in labelled UK funds. A further consultation on portfolio management, with a focus on UK retail clients and including wealth management, is expected early next year. The FCA also intends to establish an independent working group for the financial advice industry to consider how the SDR and labelling regime can support their role.

Sustainable investment labels

The FCA’s introduction of a labelling regime to help consumers navigate the complex sustainable investment market is perhaps the headline point of the new regime. Under the rules set out in the Policy Statement, there will be four labels available to firms, applying to products with different profiles of assets and investment aims but with no hierarchy between the labels: 

• ‘Sustainability Focus’ will be available for products with an objective consistent with an aim to invest at least 70% in environmentally and/or socially sustainable assets;
• ‘Sustainability Improvers’ is intended for products the objective of which is consistent with an aim to invest at least 70% in assets with the potential to improve environmental and/or social sustainability over time (even if they are not sustainable now);  
• ‘Sustainability Impact’ covers products with an objective consistent with an aim to achieve a pre-defined positive measurable impact for an environmental and/or social outcome and invest at least 70% of their assets in accordance with that aim; and
• NEW: ‘Sustainability Mixed Goals’ is intended for products that have an objective to invest at least 70% in accordance with a combination of the sustainability objectives for the other labels, with the requirements for each relevant label being met. 

Only the first three labels were included in the FCA’s Consultation Paper; the fourth has been introduced in response to concerns that funds which are invested with a combination of the attributes of these labels would not qualify for any label, even though they have sustainability characteristics. We have discussed this and other potential difficulties with the FCA’s previous proposals further in this article. All label names have also been amended from ‘sustainable’ impact, improvers and focus to ‘sustainability’, as the FCA’s research found that the previous term was confusing to consumers (as it suggested, for example, that a product could be both ‘improving’ and already ‘sustainable’).

Firms will determine which label they can apply to particular products and will be responsible for ensuring that the relevant criteria are met on an ongoing basis. The main general criteria for the use of any of the labels relate to:

• Sustainability objective – the product must have an explicit sustainability objective; 
• Investment policy and strategy – with limited exceptions, at least 70% of the product’s assets must be invested in accordance with the sustainability objective (a criterion previously proposed to apply only to the ‘Sustainability Focus’ label); 
• KPIs – the product must have key performance indicators that demonstrate progress towards the sustainability objective;
• Resources and governance – firms will need appropriate resources, governance, and organisational arrangements to enable delivery of the sustainability objective; and
• Stewardship – firms must identify the investor stewardship strategy required to deliver the sustainability objective.

The FCA has also clarified the need for an independent assessment, providing that firms must obtain or undertake an independent assessment of the standard for sustainability to confirm that it is appropriate for selecting assets. This can be undertaken in-house or by a third party, provided that the function is independent from the investment process and the relevant individuals are skilled to carry out the assessment.

Naming and marketing rules and anti-greenwashing

Where in-scope products do not have a label, naming and marketing rules will apply when the products are marketed to retail investors to ensure that the use of sustainability-related language in relation to them is appropriate. 

Under the FCA’s 2022 Consultation Paper, the regulator proposed prohibiting the use of a large number of sustainability-related terms in product names or marketing where products are provided to retail investors, including ‘ESG’, ‘climate’, ‘impact’, ‘sustainability’, ‘responsible’ or ‘green’. 

This requirement has been relaxed in the final rules, following feedback that it would be too constraining and could make it harder for consumers to differentiate between sustainability credentials of products without a label. Firms will be allowed to use sustainability-related terminology for non-labelled products if certain criteria are met; for example, the product’s name accurately reflects the product’s sustainability characteristics, the same disclosures are made as for labelled products, product names avoid terminology which could cause confusion with the labels and a prominent statement explains why the product does not have a label. The term ‘impact’, due to its associations with the ‘Sustainability Impact’ label, will be subject to restrictions on its use in product names also for other products with labels, as under the previous proposals.

In addition, a general ‘anti‑greenwashing’ rule will apply to all FCA authorised firms, with firms having to ensure that any reference to the sustainability characteristics of a product or service is consistent with the sustainability characteristics of that product or service and fair, clear and not misleading. This requires that sustainability claims made by firms are (i) correct and capable of being substantiated; (ii) clear and presented in a way that can be understood; (iii) complete; and (iv) fair and meaningful in relation to any comparisons to other products or services. The FCA is separately consulting (until 26 January 2024) on further guidance in relation to this rule (GC23/3).

Product and entity disclosures

The new regime will introduce disclosure requirements designed to ensure that accessible information is provided to retail investors (i) on products with a label or products without a label which use sustainability-related terms and (ii) by in-scope asset managers. Following respondents’ feedback, the FCA has made a number of changes to the scope and rules in relation to these disclosures. 

• Consumer-facing product-level disclosures will summarise a product’s key sustainability-related features to support consumer understanding and comparisons between products. Products not using sustainability-related terms are excluded from this requirement on proportionality grounds (having been within scope under the previous proposals).  
• Separate detailed disclosures at product and entity level will be aimed at a wider audience, including institutional investors, and provide more granular information. These disclosure rules are largely as consulted on in 2022 and will involve:
  • pre‑contractual disclosures focusing on the product’s sustainability-related features;
  • a sustainability product report detailing ongoing sustainability‑related performance information annually, including performance indicators and metrics; and
  • a sustainability entity report setting out how the firm is managing sustainability-related risks and opportunities at an entity level. These annual disclosures are mandatory for all asset managers with assets under management of over £5bn.

Requirements for distributors

To ensure that consumers receive sustainability-related information, distributors of relevant products (such as financial advisers and platforms) will be subject to a number of requirements to communicate labels to retail investors and provide access to consumer-facing disclosures. They must also notify retail investors that overseas products are not subject to the UK labelling and disclosure requirements. Rules applicable to distributors will be introduced largely in the form set out in the 2022 Consultation Paper.

The FCA will continue to explore how to clarify its expectations for advisers around taking sustainability matters into account in investment advice and suitability.

Implementation and next steps

The FCA previously proposed that the anti-greenwashing rule would come into effect immediately upon publication of the Policy Statement, as it aims to clarify existing requirements. However, the regulator has taken into account respondents’ feedback that firms may encounter operational issues in implementation and has given firms time until 31 May 2024 before the rule comes into effect, which will allow time to consider the guidance that the FCA is consulting on separately.

Given the delay in publication of the Policy Statement, the implementation dates for other rules have also been pushed back. They will come into force in several stages:

• Firms will be able to begin using labels from 31 July 2024;
• The rules on naming and marketing will come into force on 2 December 2024;
• Rules on ongoing product-level disclosures and entity-level disclosures for larger firms (with AUM of over £50bn) will become effective on 2 December 2025; and
• Entity-level disclosures rules will be extended to smaller firms (with AUM of more than £5bn) on 2 December 2026.

The FCA has noted that it remains committed to supporting firms and consumers in the move towards a more sustainable future. Given the complexities of the new regime, further consideration of key implementation challenges and engagement with impacted firms and other stakeholders may well be of value in preparation for its introduction.