Portfolio managers look ahead to the extension of the UK’s Sustainability Disclosure Requirements

As part of its wider focus on sustainability and greenwashing, on 23 April 2024, the Financial Conduct Authority (FCA) published a Consultation Paper (CP 24/8) on extending the Sustainability Disclosure Requirements (SDR) and investment labelling regime to portfolio management (the Consultation Paper). Together with the final anti-greenwashing guidance published the same day (which we consider here), these proposals constitute important milestones in maintaining the UK’s place at the forefront of sustainable investment. Portfolio managers, including certain private equity advisers, will need to review the proposals carefully and consider the impact they may have on their activities. 

Whilst consideration has been given to the different nature of portfolio management services, with a portfolio manager typically managing a diverse portfolio of investments which may include a variety of investment types, the current proposals follow a very similar approach to the final rules for fund managers (such as UK UCITS management companies, full-scope UK AIFMs and small authorised UK AIFMs), which were published last year. 

The FCA’s new proposals include four voluntary investment labels, rules for naming and marketing of portfolio management offerings based on their sustainability characteristics, and related disclosure requirements. Requirements applicable to distributors of products are also extended to portfolio management offerings.

The consultation is open for responses until 14 June 2024. The FCA plans to publish its final rules in the second half of 2024.

Background to proposals

The extension of the regime reflects the broader international and UK focus on green finance, including the UK Government’s plans set out in the 2021 Roadmap to Sustainable Investing and the 2023 Green Finance Strategy. The measures are intended to ensure portfolio management offerings that claim to be sustainable meet high standards. The FCA is also seeking to enhance trust in the market and strengthen the UK’s position as a competitive location for sustainable investments. Ultimately, it is envisaged that this will contribute to increased availability of sustainable investment products and greater capital flows into sustainable activities in the UK.

This is not the first time we have seen proposals relating to the application of this regime to portfolio managers. The FCA’s original 2022 Consultation Paper (CP 22/20) included portfolio managers within scope. However, the Policy Statement on the SDR for fund managers published in November 2023 (the Policy Statement, see our previous post here) excluded portfolio management from scope, indicating that a further consultation would take place in 2024. This was largely due to feedback received by the FCA suggesting that the measures were not suitable for portfolio managers based on the nature of the proposals at that time. 

In light of previous responses and more recent stakeholder engagement, the FCA’s current consultation features revised proposals for the application of the SDR regime to portfolio management.  In particular, the FCA notes that many stakeholders asked them to take a similar approach to funds whereby the portfolio manager would assess all assets in the portfolio against labelling criteria. As a result, the revised proposals depart from earlier proposals in several ways and follow a very similar approach to the final rules for fund managers, as explained below.

Scope and international compatibility

The Consultation Paper uses the same definition of ‘portfolio management’ as that introduced for the FCA’s disclosure rules aligned with the Taskforce on Climate-related Financial Disclosures (TCFD). This is a broad definition, which includes managing investments on a discretionary basis and also captures services related to ‘private equity or other private market activities consisting of either advising on investment or managing investments on a recurring or ongoing basis in connection with an arrangement the predominant purpose of which is investment in unlisted securities’. The FCA welcomes any particular views on this approach.

Given the focus of the SDR on protecting retail investors, the Consultation Paper is primarily aimed at wealth management services for individuals and model portfolios for retail investors. Firms that offer portfolio management services to professional investors can opt into the labelling regime, but the FCA does not intend that the naming and marketing requirements and associated disclosures would apply to them.

The proposals apply to portfolio management carried out from an establishment maintained by a firm in the UK. Where clients are based overseas, services provided to them are excluded from scope, i.e. this will apply where clients normally reside outside the UK or have their registered office (or head office) outside the UK. Portfolio management services provided to a client that is a fund, an AIFM or management company for or on behalf of a fund, are also excluded.

The FCA acknowledges stakeholder feedback on the significance of ensuring compatibility with other regimes, including the EU Sustainable Finance Disclosure Regulation (SFDR), which also applies to portfolio managers, and the ongoing SFDR review (including a labelling regime). However, there are a number of differences between these regimes, as highlighted by the FCA in the previous Policy Statement. The FCA intends to continue to engage with developments in other jurisdictions and to encourage interoperability and compatibility between regimes as those jurisdictions continue to develop their own path. In the meantime, it is likely that firms or groups operating across multiple jurisdictions will face some complexity due to the application of differing regimes.

Overseas funds remain out of scope of the SDR and labelling regime, although HMT (the UK Government’s Treasury) have announced their intention to consult on extending the regime to overseas recognised funds. 

An investment labelling regime for portfolio management

The proposed regime regarding investment labels applies to services targeted at retail investors, as well as professional investors where the portfolio manager opts into the regime.

The FCA is proposing to apply a similar approach to labelling for portfolio managers as for fund managers to ensure consistency and a level playing field. This means firms can choose to use one of four labels for portfolio management offerings, where the objective is to achieve positive sustainability outcomes:

• Sustainability Impact. The sustainability objective must be consistent with an aim to achieve a pre-defined, positive, measurable impact in relation to an environmental and/or social outcome.
• Sustainability Focus. The sustainability objective must be consistent with an aim to invest in assets that are environmentally and/or socially sustainable.
• Sustainability Improvers. The sustainability objective must be consistent with an aim to invest in assets that have the potential to improve environmental and/or social sustainability over time.
• Sustainability Mixed Goals. This is for products with a sustainability objective to invest in line with a combination of the sustainability objectives for the other labels.

Portfolio management offerings must meet general and specific criteria related to that label on an ongoing basis.  In addition to the need for an explicit sustainability objective, the main criteria for use of any of the labels relate to:

• Investment policy and strategy. With limited exceptions, at least 70% of the gross value of the portfolio must be invested in accordance with the sustainability objective. This is a reduction from the initial proposal where a 90% threshold for investment in labelled products was suggested. Respondents to the consultation indicated this was too high. It was unlikely that 90% of the value of a portfolio would be invested in labelled funds, as they may also include direct investments in securities and investments in overseas funds. 
• KPIs. The portfolio must have KPIs 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.
• Stewardship. Firms must identify the investor stewardship strategy required to deliver the sustainability objective.

If a label is used for a portfolio, the portfolio manager will be responsible for ensuring the qualifying criteria are met, both with respect to a model portfolio and bespoke portfolio management services. The portfolio may include labelled as well as non-labelled funds, including UK and overseas funds, or other securities that are held directly. 

However, the FCA has indicated that the fact that a label is attached to a fund that the portfolio invests in would not constitute an absolute measure of sustainability. The portfolio manager would need make its selections with reference to a ‘robust, evidence-based standard that is an absolute measure of sustainability’. That standard (and how assets are chosen based on it) should be determined by the portfolio manager – for example the FCA notes that the standard may be ‘general sustainability criteria, taxonomy-based, emissions profiles etc’. 

Naming and marketing rules

Similar naming and marketing rules to those applicable to fund managers are proposed to apply to portfolio management services marketed to retail investors. A portfolio management offering can use sustainability-related terms in its name and marketing:

• The portfolio uses a sustainability label – provided that the word ‘impact’ cannot be used in the name unless the label used is the ‘Sustainability Impact’ label.
• The offering does not use a sustainability label – provided that it complies with the naming and marketing rules. These include requirements that the offering has sustainability characteristics that are accurately reflected in the name; restrictions on use of the terms ‘sustainable, ‘sustainability’ and ‘impact’; application of disclosure requirements; and the need for a statement that the offering does not have a label and an explanation why.

With respect to marketing, portfolio managers must ensure that financial promotions relating to the offering are consistent with its label and associated disclosures. Firms that are not using a label, but are using sustainability-related terms in financial promotions, must produce the same disclosures and statements as required under the naming rules.

These requirements are in addition to the general “anti-greenwashing” rules that apply to all FCA-authorised firms from 31 May 2024 (for further details, please see our separate post here).

Disclosure requirements

Consistent with the regime for fund managers, the FCA’s new proposals include a three-tiered disclosure structure for portfolio managers, encompassing consumer-facing disclosures, detailed product-level disclosures and entity-level disclosures. 

This is another departure from the previous proposals which, in respect of consumer-facing and product-level disclosures, required portfolio managers to provide access or links to disclosures for underlying products or to provide certain information pursuant to an ‘on-demand’ regime. 

Distributor requirements

Financial advisers, platforms and other distributors of products will be required to communicate to retail clients the labels used for portfolio management offerings and provide retail investors with access to consumer-facing disclosures. If the portfolio manager makes any changes to these label or disclosures, the distributor would need to update the information it provides to its clients.

Implementation and next steps

The FCA has proposed that the new rules will come into force in several stages, with the labelling and naming and marketing requirements, and associated consumer-facing and pre-contractual disclosures, coming into force on 2 December 2024. Ongoing product-level disclosure requirements would apply one year later. Firms with AUM above £50 billion would be required to produce entity-level disclosures by 2 December 2025, whilst the requirement would apply one year later to firms with AUM above £5 billion. 

Apart from the start date for labelling and the associated disclosures, these dates are consistent with the measures applicable to fund managers. As final rules are expected to be published in the second half of 2024, portfolio managers will need to carefully consider the impact of these proposals and plan for a relatively swift implementation of the final requirements once published.