SDR will impact every Financial Services firms


INSIGHT
Published
Nov 29th '23
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Every financial services firm will be impacted by the Sustainability Disclosure Requirements (SDR).

 

The Financial Conduct Authority (FCA) has released the eagerly awaited SDR and Labelling Regime. Though it’s a heavy read at 212 pages, the UK regulator has fulfilled its promise not to spoil our Christmas with a delayed release. But fear not—we’ve got you prepared. Below is a high-level rundown of the salient features of the new regime:

 

Anti-greenwashing rule

Although there is consumer demand for green financial goods, the market is still unclear at best (what exactly qualifies as “green”), and the FCA is concerned that certain companies may be inflating their qualifications. For this reason, a new anti-greenwashing regulation has been created, which will be operative for all FCA-authorized companies on May 31, 2024. Concerning the Consumer Duty, companies have to make sure that any communications they make regarding financial products or services that mention sustainability features are truthful, transparent, and not deceptive. This includes naming products and using images, among other forms of communication. If you have immediate concerns, we can let you know the regulator’s areas of focus. We will publish a detailed analysis of the Guidance on greenwashing rules in the coming weeks.

 

This includes a wide range of messages, such as visuals and product names. We will delve into the Guidance on greenwashing standards in the coming weeks, but in the meanwhile, if you have urgent issues, don’t hesitate to get in touch with us. We are aware of the regulator’s priorities and what is expected of green products.

 

Labelling regime

Because of the sharp increase in customer demand for greener investment products, the remaining SDR requirements are mostly directed at fund managers.   According to the FCA’s most recent Financial Lives Survey, more than 80% of participating people want both financial gains and positive social impact from their investments. But because of ambiguous product titles (like ESG) or opaque investment methodologies, these same retail investors have trouble locating goods that suit their investing preferences. The FCA has created both broad and particular rules for firms to be allowed to apply a label to their funds in order to address this lack of transparency and the growing worries about greenwashing.

 

 

General criteria

Fund managers must be aware of the following general requirements if they wish to use these labels:

 

  1. Every fund that bears a label is required to have a well defined, quantifiable, and explicit sustainability aim that corresponds with one of the four labels.
  2. The fund’s assets must be allocated to achieving the sustainability goal to the tune of at least 70%.
  3. To achieve the sustainable investment goal, a strong criterion based on evidence must be applied methodically. To guarantee that the assets chosen for every fund with a label are acceptable, the FCA requires an independent assessment of this requirement.
  4. To make sure the fund’s sustainability goal is being met, KPIs must be chosen and reported on.
  5. In order to support the sustainability goal, managers must create escalation plans and stewardship methods.

 

The labels 

Four new sustainability marks are being introduced by the FCA, and they are meant to apply to products that invest in a variety of assets that are either presently sustainable or heading toward sustainability. These labels are what they are:

 

  • Impact on Sustainability: An asset in this category must directly help achieve a predetermined favorable social or environmental outcome. This can be done through investment activities (e.g., capital allocation to companies that solve environmental crises) or through the companies themselves (e.g., clean energy firms).
  • The assets in this category are already characterized by or have qualifications related to environmental or social sustainability.
  • Sustainability Enhancer: resources falling under this category might not be regarded as sustainable right now, but they have a set course for improving their social or environmental credentials.
  • Sustainability Mixed Goals refers to funds that combine assets from the preceding three groups. For the features of funds of funds or multi-asset funds, it might be more suitable.

 

A fund may only have one of these names because they are mutually exclusive and not hierarchical.

 

Name and marketing rules

Whether or not to wear a label is a personal decision. You will not, however, be permitted to use the terms “sustainable,” “sustainability,” or “impact” on any of your goods if your company chooses to disregard the labeling rules for its ESG or sustainable funds. Furthermore, you will need to provide further product-level disclosures and explain why you have not applied a label even if you use other sustainability-related terms (like “green,” “ESG,” or “responsible”) in the names of your funds or financial campaigns. Starting on December 2, 2024, firms must assess all marketing materials related to their funds to make sure they comply with the new regulation.

 

Product level disclosures 

Managers of funds that either use the labels or use sustainability-related language in their fund names or marketing materials will need to provide three different kinds of disclosures:

 

  1. A maximum of two A4 pages of a consumer-facing disclosure that is easily readable and highlights the fund’s primary sustainability features will be posted on the company website.
  2. Pre-contractual disclosures, which go into further depth about the fund’s sustainability characteristics than the consumer-facing disclosure, will be added to the prospectus for the fund.
  3. Ongoing product-level disclosures in the form of yearly reports against predetermined KPIs, engagement initiatives, escalations, or any other pertinent data that demonstrates a contribution to the fund’s sustainability goal.

 

As soon as a fund begins to use a label, disclosures aimed at consumers and those that come before contracts must be released (at any time after 31 July 2024).  Annual disclosures after that will be necessary.

 

 Entity-level disclosures 

Every year, managers will have to create a “sustainability entity report.”  Although it focuses on more than simply climate, this report follows the format of current TCFD reporting, which covers governance, strategy, risk management, metrics, and targets. For bigger asset managers (>£50 billion AUM), this reporting requirement begins on December 2, 2025; for smaller asset managers (>£5 billion AUM), it begins on December 2, 2026.

 

There is a lot to do in the upcoming months that will affect EVERY regulated firm, from the initial mapping of items to the examination of all marketing materials to the independent assessment of your “evidence-based” standard. As you work through the most recent events, we would be happy to assist in easing the burden of SDR.

 

If you have any queries about Compliance impacts on the ESG space,

please contact us.

 

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