In its recently published consultation paper “Sustainability Disclosure Requirements (SDR) and investment labels”, the Financial Conduct Authority (FCA) is proposing a set of new measures designed to reduce greenwashing and improve consumer and investor confidence in products that make sustainability claims.
The proposed rules include the introduction of three sustainable investment ‘labels’ to apply to products, disclosure requirements regarding products’ sustainability features, risks and opportunities, and rules limiting how sustainability-related terms can be used in product names and marketing.
Scope of greenwashing proposals
The FCA’s proposals will initially target UK-based investment fund managers, portfolio managers and distributors of in-scope products (such as investment platforms) to retail investors. They are, however, meant to be a starting point for a regime that will expand and evolve over time.
The FCA recognises that firms will need time to apply the new measures. Therefore, the rules in respect of labelling, disclosures, distribution, and naming and marketing will only come into effect from 30 June 2024 onwards, and have varying degrees of effect depending on the target market for the product in question (i.e. retail, institutional, or professional investors).
However, the proposed general ‘anti-greenwashing’ rule will enter into force immediately after the final rules are published, on or before 30 June 2023. This rule clarifies that sustainability-related claims in all communications regarding financial products and services must be clear, fair and not misleading, and proportionate to the sustainability profile of the product or services in question. Significantly, this rule will apply to all firms regulated by the FCA.
The proposals are to take effect by way of amendment to the Environmental, Social and Governance Sourcebook, a relatively new addition to the FCA Handbook, which came into force in January 2022.
Sustainable investment labels
In addition to establishing the general ‘anti-greenwashing’ rule, the FCA proposes to institute a taxonomic regime relating to how sustainability is described, consisting of three distinct labels. There is no hierarchy between the labels and they are meant to distinguish between different types of sustainable product. Each label is designed to encompass different asset profiles and consumer preferences.
Firms can choose whether to label their products. If firms use the labels, they must meet the FCA’s proposed qualifying criteria. For portfolio managers who wish to apply a label to a portfolio of assets, 90% of the total value of the products in the portfolio must meet the qualifying criteria for the label that is applied.
The three labels available are:
- ‘Sustainable focus’: products with this label must meet a credible standard of environmental and/or social sustainability or align with a specified environmental and/or social sustainability theme.
- ‘Sustainable improvers’: these products aim to invest in assets that are not currently environmentally or socially sustainable, but which have been selected for their potential to become more environmentally and/or socially sustainable over time.
- ‘Sustainable impact’: these products must invest in assets that look to provide solutions to environmental or social problems, with the explicit objective of making a positive and measurable contribution to sustainability outcomes.
This labelling regime could be compared to the traffic light system on food packaging. It will provide a relatively straightforward way for consumers of financial products to know immediately whether a product is geared towards sustainability and, if so, in which way.
Naming and marketing rules
Where firms choose not to use these labels or their products do not meet the criteria set by the FCA, the FCA proposes restrictions on the use of sustainability-related terms for those firms’ product names and marketing. Under these restrictions, firms will be prohibited from using relevant terms including (but not limited to) ‘Paris-aligned’, ‘net zero’, sustainable’, ‘sustainability’, ‘ESG’ (or ‘environmental’, ‘social’ or ‘governance’), ‘SDG’ (referring to Sustainable Development Goals), or even ‘climate’, ‘green’, ‘impact’ or ‘responsible’, in the names and marketing of in-scope products offered to retail investors in the UK. The regulator’s stated intention is to ensure that consumers are protected from greenwashing.
For proportionality reasons, the FCA states that these rules will not apply “at this stage” to products offered to institutional investors.
The FCA also introduces new sustainability disclosure requirements that must be reviewed and updated at least annually.
The rules state that consumer-facing disclosures should provide a summary of the products’ key sustainability-related features, helping consumers to better understand those sustainability features, compare similar products or the same product over time, and hold the provider to account for its sustainability claims. Consumer-facing disclosures will be required for in-scope products offered to retail investors, regardless of whether a label is applied to the products (although disclosure requirements will be lower for those products without a label).
The FCA has sought to ensure that disclosures are clear and concise for consumers. They must be accessible in a digital format, must be provided to consumers on request, and must not exceed two A4 pages when printed. Any ‘unexpected investments’, described as ones “a consumer may not typically associate with the sustainability objective”, must be identified.
Detailed product-level disclosures will provide more granular information, which would be aimed at sophisticated investors (such as institutional investors and a broader range of stakeholders). These will involve pre-contractual disclosures detailing the sustainability-related features of an investment product, e.g. detail in a UK-based fund’s prospectus about its sustainability objective and investment policy and strategy. Pre-contractual disclosures will be required for both labelled products and non-labelled products for which sustainability is a core element of the investment strategy. Additionally, from (provisionally) 30 June 2025, labelled products must on an ongoing basis provide information regarding sustainability performance in a ‘sustainability product report’.
Detailed disclosures will also be required at entity-level (i.e. at investment firm-level) for asset managers with at least £5 billion in assets under management (“AUM”). These disclosures will be obligatory whether or not an in-scope firm uses one of the sustainable investment labels, and they must cover asset managers’ governance, identification, assessment and management of sustainability-related risks and opportunities, as well as their material actual and potential impacts on businesses. The disclosures will be included in a ‘sustainability entity report’, which will likewise be due (provisionally) from 30 June 2025 for firms with £50 bn or more in AUM. Both the product and entity reports will build on existing disclosure requirements that are aligned with recommendations from the Task Force on Climate-Related Financial Disclosures.
The FCA had already previously made clear its intention to expand the new sustainability regime to include other UK investment products like pensions, overseas products, financial advisers and other FCA-regulated asset owners, with separate consultation papers expected to be published in due course.
These detailed proposals nevertheless represent a clear signal from the FCA that regulated firms’ sustainability-related statements will be subjected to ever-increasing scrutiny in future and that products’ incorrect or misleading ‘green’ claims will no longer wash.
There remain some concerns about the extent to which the proposals preserve a degree of uncertainty where, for example, the FCA does not propose to commit to an objective standard of sustainability upon the application of the “sustainable focus” label. It is also unclear how effective the regulatory enforcement of the new regime will be: the proposed changes will bring a significant volume of additional products into the scope of FCA regulation, and the market for sustainable investments continues to grow exponentially, but there are no proposals to correspondingly increase the resource available to the FCA as the primary enforcement agency.
However, steps towards strengthening the regime are welcome, and the proposed new rules increase the potential for greenwashing-related private enforcement, with claims under section 138D (for private persons) and section 90 (in relation to prospectuses) of the Financial Services and Markets Act 2000 gaining a more solid footing as a result of the changes.