By Louisa Guy, UK Policy Analyst, PRI
The UK’s Financial Conduct Authority (FCA) has released its highly anticipated Sustainability Disclosure Requirements (SDR) Consultation Paper – a development expected to bring clarity on how the regulator will approach greenwashing, while also increasing transparency and trust in sustainable investing.
Why is the FCA holding a consultation?
The FCA has developed a package of measures aimed at reducing greenwashing. It is taking a holistic approach and addressing several areas: introducing sustainable investment labels, disclosure requirements, an anti-greenwashing rule, and restrictions on using sustainability-related terms in product naming and marketing.
The FCA’s approach is a core tenet in implementing the UK Government’s Greening Finance Roadmap. The SDR support the first phase of this strategy; informing investors and consumers. They play a crucial role in enabling the flow of comparable and decision-useful information on the extent to which economic activities are sustainable.
The proposals set a strong precedent; they send a clear signal that the FCA recognises greenwashing as a barrier to sustainable investment and that sustainability issues can be material to investors’ allocation of capital.
The SDR are intended to be the main regulatory tool to substantiate sustainability claims and disclosures against minimum safeguards, an important first step to enact the UK’s Greening Finance Roadmap. The FCA aims to improve how markets function by increasing the sustainability profiles of products and firms, while also reducing risks of harm from greenwashing.
The proposals are framed through the lens of consumer protection, and in many ways, they respond to consumers’ desire to understand their products’ positive environmental impact, by offering clear and consistent investment product labels.
As the market for sustainable investing has grown rapidly, we believe an integrated framework for decision-useful disclosures across the economy is a natural next step to embedding sustainability within the mainstream financial system.
A deeper dive into sustainable investment labels
There will be three sustainable investment labels: sustainable focus, sustainable improvers, and sustainable impact. These are simplified from original proposals for five categories.
To apply the sustainable focus label, investment managers must evaluate assets to determine their sustainable credentials. For the sustainable improvers label, firms must state, in a measurable way, how the sustainability potential of the asset will be achieved. Lastly, the sustainable impact label covers assets that address environmental or social problems in underserved markets, or those that address observed market failures. More detail for each category is available below in Table 1.
Table 1: Proposed sustainable investment labels’ definitions and channels for achieving positive sustainability outcomes
| Sustainable focus | Sustainable improvers | Sustainable impact |
|---|---|---|
| Definition: products with an objective to maintain a high standard of sustainability; invested in assets regarded as environmentally and/or socially sustainable. | Definition: products with an objective to deliver measurable improvements in the sustainability profile of assets over time. | Definition: products with an explicit objective to contribute to positive sustainability outcomes in a measurable way. |
| Primary channel: influencing asset prices. | Primary channel: stewardship aimed at improving the environmental or social sustainability profile of assets. | Primary channel: directing new capital to projects and activities that offer solutions to environmental or social problems. |
| Secondary channel: continuous stewardship activities. | Secondary channel: identifying funds that are best placed to improve their sustainability profile over time. | Secondary channel: continuous stewardship activities. |
Importantly, the FCA envisages no hierarchy between the label categories. Instead, each product type is designed to deliver a different asset profile and risk appetite to meet consumer preferences. Restrictions will apply to all products and only labelled funds will be allowed to use designated words and phrases, including sustainable, environmental, social, and governance (ESG), impact, responsible, green, Sustainable Development Goals (SDG), Paris-aligned.
Each sustainable investment label will be underpinned by a set of criteria covering investment policy and strategy, key performance indicators, firm-level attributes, and investor stewardship. They will also be voluntary and should only be used by firms for products that meet the prerequisite criteria.
However, firms choosing not to use them will still have to produce detailed sustainability disclosures at product and entity level, in accordance with the FCA’s proposal for a general anti-greenwashing rule, which aims to ensure that the naming and marketing of financial products in the UK is clear, fair, and not misleading.
The label framework broadly covers ESG investment approaches that exist in the market. To give a few examples, the sustainable improvers label recognises investments that are improving their sustainability credentials and therefore aligns well with transition plans. Similarly, the sustainable focus label could use a taxonomy – such as the UK Green Taxonomy, once developed – to demonstrate how assets meet a credible standard of sustainability. However, the sustainable impact label goes further than current approaches in its requirement to demonstrate and measure additionality in contributions to real-world outcomes.
In its initial proposals for this consultation, the FCA did not detail any plans for external label verification; instead it pointed to the value that verification could play. However, the regulator has since announced the future development of an internationally consistent code of conduct, which introduces regulatory oversight of certain ESG data and ratings providers.
Interoperability
While there will be some divergences, the FCA has sought to achieve international coherence with other regimes as much as possible, namely the European Commission’s Sustainable Finance Disclosure Regulation (SFDR) and the approach taken by the US Securities and Exchange Commission (SEC).
The FCA conducted high-level mapping on how its approach compares to SFDR requirements and SEC proposals in Annex 1 of the Consultation Paper. However, the starting point for the FCA’s proposals is different, which makes precise mapping difficult.
The regimes also differ in their intent. Although the SFDR was not intended to label or classify funds, it is (mis)used by the market as a de facto product labelling system. Similarly, the SEC’s approach is based on disclosures; it is not a labelling regime.
Therefore, although the FCA has sought to incorporate elements and language from other approaches in its proposal, the three inherently differ in some key areas.
We recognise that the number of ESG investment-related reporting requirements to tackle greenwashing is rising, which creates a complex and fragmented environment for global investors to navigate.
We support the FCA’s commitment to global regulatory alignment and encourage it to work closely with other regulators to align approaches, aim for interoperability, and avoid market fragmentation.
Call to action
The FCA has proposed a strong package of measures, with a largely clear direction of travel and investor choice at the core. The proposals have certainly improved since it set out its initial Discussion Paper DP21/4 and have taken on board a number of PRI recommendations, which will support the transition towards a sustainable financial system and minimise climate change impacts.
To further contribute to these proposals, we are developing key recommendations for the FCA in our consultation response, which will be open for signatory input until 23 January 2023, and we will also be holding a signatory drop-in session on 18 January 2023 at 12:30 – 15:00 GMT.
If you would like to provide input, engage on the FCA’s proposals, or require any additional information, please get in touch. We welcome your views.
Please register your interest if you wish to attend the signatory drop-in session.
The PRI blog aims to contribute to the debate around topical responsible investment issues. It is written by PRI staff members and occasionally guest contributors. Blog authors write in their individual capacity – posts do not necessarily represent a PRI view.
