What's the UK SDR all about?

What’s the background?

Over the past few years, there has been an increase in greenwashing allegations across all industries and countries across the globe. With consumers now demanding more transparency on sustainability and ethical matters and investors also steering more capital into sustainable and impact investments, it was only a matter of time before regulators began to get involved.

We have since seen the development of sustainability disclosure regulations being adopted, the most common being those in the EU for both financial institutions (via the Sustainable Finance Disclosure Regulation - SFDR), and companies (via the Corporate Sustainability Reporting Directive - CSRD). 

Following the UK’s exit from the EU in 2020, the decision from the UK Government and British policymakers was not to adopt the EU’s SFDR, despite many stakeholders voicing that rolling out the EU’s SFDR would help to uncomplicate the ESG landscape and support standardization. Instead the UK has opted to develop its own version of the SFDR with the Financial Conduct Authority (FCA) publishing draft rules for consultation in October 2022 and the final guidance being released today.

In short, the FCA will impose sustainable investment product labels to provide more confidence to consumers, restrictions on how certain sustainability-related terms are used in product names and marketing (e.g. ESG, green, sustainable) to reduce misleading marketing of products and impose more detailed disclosure requirements.

What’s happened today?

Today the FCA (finally) published the final rules on Sustainability Disclosure Requirements (SDR) and investment labels.

The highly anticipated Anti-Greenwashing Rule which was due to be finalized (and implemented immediately!) by the end of this year has now been pushed back to the end of May 2024 with a consultation open until 26th January 2024. This pushback is the result of industry feedback requesting further guidance on the rule before it comes into force, but in short, the rule will require firms to make fair, clear and non-misleading claims on the sustainability profile of their products and services.

There have also been changes from what was initially proposed including, most of which seem to be a step in the right direction and taking advantage of some of the EU’s Sustainable Finance Disclosure Regulation (SFDR)’s failures.

What’s new?

I will note here that there a lot of things to wrap our heads around and I’ve only pulled out some of the most obvious changes. The full Policy Statement can be found here – let me know if I’ve missed anything!

A summary of the key changes from the UK SDR’s initial proposal include:

• Scrapped rule: The initial proposal included the requirement for consumer-directed disclosures to apply to all funds, including non-sustainable ones, however this has since been scrapped meaning that only sustainability-related products should be disclosing... I’m not sure how I feel about this one – on one side, it feels like a missed opportunity to encourage transparency, on the other, it feels like it may help to avoid products being forced  to fit a square peg in a round hole.
• One Up: The introduction of four labels (instead of three) to provide a label which supports multi-asset and blended strategies which was previously not accounted for... This ultimately helps to account for funds which have the potential to improve their sustainability over time
• Naming update: An update in the naming of the labels to now include: Sustainability Focus, Sustainability Improvers, Sustainability Impact, and Sustainability Mixed Goals... Again here, the word ‘Sustainable’ has been changed to ‘Sustainability’ to reflect that some products may be transitioning to becoming more sustainable rather than be sustainable from the outset. I expect this has been added based on the feedback from those impacted by the EU SFDR and also helps to encourage the correct labelling of brown-green investments.
• Thresholds will be introduced across all labels. All funds under the four labels will be subject to a 70% minimum threshold rule – the FCA has clarified that  funds may invest in other assets for liquidity and risk management purposes, "so long as 70% of the gross value of the product's assets are invested in line with the sustainability objective" ...There are some exceptions to the 70% rule which should be reviewed in the regulation, however overall I see this as another lesson learnt from the SFDR
• In-house assessments of credible standards are acceptable – The FCA has confirmed that the assessment of whether an investment strategy is “credible” can be done in-house or by a third party, provided that it is independent to the manager’s investment process... Initially it was understood that this assessment could only be undertaken by a third-party.

What are the labels and how are they to be used?

The SDR aims to reduce greenwashing and instil a sense of trust in the sustainable investment market. The labelling rules are expected to come into force on 31st July 2024 and will only apply to UK asset managers. I’ve pulled the descriptions out and provided them below for ease:

• Sustainability Focus: applicable to products investing mainly in assets that are sustainable for people and/or the planet. Firms will be tasked to set their own "robust, evidence-based" standards to ensure they align with the product's sustainability objectives.
• Sustainability Improvers: applicable to funds investing in assets that may not be sustainable now, but aim to improve their sustainability for people and/or the planet over time, including in response to the firm's stewardship influence. This category focuses on the assets' potential to meet the standards over time, placing an even higher emphasis on firms' asset selection processes.
• Sustainability Impact: applicable to funds investing in solutions to problems impacting people or the planet to achieve "real-world impact". These products will need to have an explicit objective to achieve a positive and measurable contribution to sustainability outcomes.
• Sustainability Mixed Goals: applicable to funds investing across different sustainability objectives and strategies aligned with the other three categories. This means firms will also need to disclose details of the proportion of assets invested "in accordance with each relevant label".

Please remember that the labels are not designed to be in a hierarchy and the objective of these labels is to help consumers to differentiate between different sustainability objectives and different investment approaches to achieve those objectives.

What does the timeline look like?

It is expected to take around three years to complete the SDR implementation process. From what is proposed, the timeline looks sensible and allows room for firms to adapt, adopt, and feedback – something the SFDR failed to really account for. It’s also worth noting that a review will take place after three years to assess whether the intended outcomes have been met, to identify any implementation issues and any potential unintended consequences, alongside an assessment of rule compliance.

A summary of the key dates is below:

• 31 May 2024 - Anti-greenwashing rules will come into place. It’s important to remember that these will be applicable all FCA regulated firms, not just asset managers.
• 31 July 2024 - The labelling regime will come into effect and firms will be expected to start using the relevant labels alongside disclosures.
• 2 December 2024 - The naming and marketing rules will be implemented alongside accompanying disclosures.
• 2 December 2025 - The ongoing product-level and entity-level disclosures will come into force for firms with more than £50bn in assets under management.
• 2 December 2026 - Entity-level disclosure rules for firms with more than £5bn AUM will be introduced.

 I'll end this article here with a lovely diagram provided by the FCA: