His Majesty's Treasury (HMT) and the Financial Conduct Authority (FCA) have issued publications that seek to expand the application of the United Kingdom (UK) sustainability disclosure requirements (the SDR) and labelling regime.
HMT has set out next steps, including introduction of sustainability reporting standards aligned with the IFRS Foundation's International Sustainability Standards Board (ISSB) standards, applicable to UK-listed companies and a consultation on the extension of the SDR and labelling regime to overseas funds.
The FCA is consulting on extending the SDR and labelling regime to FCA-authorised firms offering portfolio management services.
Below is an overview of the key aspects of the publications.
HMT's Sustainability Disclosure Requirements Implementation Update
On 16 May 2024, HMT published Sustainability Disclosure Requirements (SDR): Implementation Update 2024,1 setting out the next steps with respect to the UK's sustainability disclosure framework.
The UK is expected to endorse the ISSB sustainability standards published in June 2023. HMT plans to introduce ISSB-aligned sustainability standards, termed UK Sustainability Reporting Standards, in Q1 2025. The UK Sustainability Reporting Standards will be applied to UK-listed companies once endorsed by the UK government and following consultation by the FCA. The UK Sustainability Reporting Standards may also be applied to UK companies that do not fall within the FCA's regulatory perimeter, depending on the outcome of a cost-benefit assessment.
HMT also notes that there will be a consultation—planned for Q3 2024—to extend the scope of SDR and labelling regime to include funds under the Overseas Funds Regime.
FCA Consults on Extending SDR to Portfolio Management Services
The FCA published its consultation2 (the Consultation), on extending the current SDR and investment labels regime—currently applicable to FCA-authorised investment managers and their UK-based fund products—to firms offering portfolio management services other than as a manager of a UK fund.
The consultation period is due to close on 14 June 2024.
The FCA plans to publish its final rules in h3 of 2024.
Scope of the FCA Consultation
The term “portfolio management services” will have an extended definition, in line with the existing scoping provisions in the FCA's ESG sourcebook for firms required to make TCFD-aligned disclosures.
Accordingly, this will cover discretionary management services provided by FCA-authorised firms to UK clients comprising:
- Managing investments.
- Private equity or other private market activities consisting of advising on investments or managing investments on a recurring or ongoing basis in connection with an arrangement, the predominant purpose of which is investment in unlisted securities.
Under the Consultation, FCA-authorised firms providing portfolio management services will not be in scope in respect of such services provided to:
- Clients based overseas, i.e. individuals normally resident outside the UK or entities that have their registered or head office outside the UK.
- Clients that are funds or their alternative investment fund managers (AIFMs) or management companies (wherever located), where the firm acts as a delegate discretionary manager.
As noted above, HMT intends to consult on extending the SDR regime to overseas recognised funds. The FCA notes it will engage with HMT to assess options to expand the SDR to overseas funds more broadly. It is unclear, however, if this may also expand to include portfolios of overseas clients in the context of portfolio management services.
Proposed Timeline
- The use of labels, accompanying disclosures and naming and marketing rules will come into force on 2 December 2024.
- Firms required to produce ongoing product-level disclosures, and firms with assets under management (AUM) over £50 billion to produce entity-level disclosures, by 2 December 2025.
- Firms with AUM over £5 billion will need to produce entity-level disclosures by 2 December 2026.
Current Regime
The SDR and labelling regime was implemented by the FCA through extending the ESG sourcebook to include several components of the regime, including the FCA's anti-greenwashing rule; retail investor-specific requirements on naming and marketing; the voluntary labelling regime for products with a sustainability objective as part of their investment objective; product disclosure requirements; and sustainability entity-level reporting.
How the SDR and Labelling Regime is Proposed to Apply to Portfolio Management Services
The Consultation proposes to apply the SDR and labelling regime on a consistent basis with the rules that currently apply to firms subject to the regime.
As the SDR and labelling regime has been developed primarily for retail investors, the proposals to extend the regime are primarily aimed at wealth management services for individuals and model portfolios for retail investors.
The labelling regime will apply on an opt-in basis to firms offering portfolio management services to professional clients. Such firms will not be subject to the naming and marketing requirements and associated disclosures.
Below is an overview of the key aspects of the SDR and labelling regime as it may apply to portfolio managers.
General Requirements
The general anti-greenwashing rule and guidance will require all FCA-authorised firms, including portfolio managers to ensure sustainability-related claims align with the actual sustainability characteristics of a product or service. Claims must be clear, fair, and not misleading.
The anti-greenwashing rule and guidance will come into force on 31 May 2024.
Naming and Marketing Rules
Portfolio managers must comply with retail-specific rules – and ensure that sustainability terms in portfolio names and marketing documents are evidenced and substantiated. The specific naming and marketing rules will not apply to portfolio management services provided to professional clients though note the application of the general anti-greenwashing rule.
Voluntary Product Sustainable Investment Labels
Portfolio managers must comply with granular and specific rules to use four voluntary sustainable-investment-branded labels: Sustainability Focus, Sustainability Improvers, Sustainability Impact and Sustainability Mixed Goals.
Each label requires that the portfolio must have a sustainability objective, and at least 70% of the gross value of the portfolio's assets, barring some exceptions, must be invested according to the sustainability objective and refer to a robust, evidence-based standard of sustainability. The portfolio manager must ensure that the portfolio's assets meet these criteria, including those managed by third parties, including where the portfolio manager may have delegated management of part or all the portfolio to a sub-investment manager.
Product Disclosure Requirements
Portfolio managers must expand the scope of disclosures in their TCFD product-level reports (which only concern climate-related financial risks) to disclose information on the sustainability characteristics of portfolios that use investment labels or portfolios which are unlabelled but use ESG terms in their names or marketing documents.
Unlike the existing provisions for UK AIFMs of unauthorised unlisted alternative investment funds, who are only required to provide product level disclosures upon request from investors, portfolio managers will be required to either publish the information or provide it to clients directly without a preceding request from clients.
Sustainability Entity Reporting
Portfolio managers with over £5 billion AUM in in-scope business must produce a sustainability entity report. This report builds on the TCFD entity-level report.
Footnotes
1 Sustainability Disclosure Requirements: Implementation Update 2024: https://assets.publishing.service.gov.uk/media/66505ba9adfc6a4843fe04e5/Sustainability_Disclosure_Requirements__SDR__Implementation_Update_2024.pdf.
2 Consultation Paper 24/8: Extending the SDR regime to Portfolio Management: https://www.fca.org.uk/publications/consultation-papers/cp24-8-extending-sdr-regime-portfolio-management.
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