The regulator published a discussion paper on SDR and investment labels on 3 November. The document lays out the proposals around sustainability-linked disclosures and a new system to categorise and label products. The consultation runs until 7 January 2022 and will inform policy proposals to be issued for consultation in Q2 2022.
It's important to note that the European Commission has postponed the implementation of its Sustainable Finance Disclosure Regulation (SFDR). The SFDR has parallels with SDR, but the latter has a broader remit.
SDR aims to provide consistent and reliable sustainability information to consumers and investors. These disclosures will give a holistic view on a firm’s ESG profile as well as the sustainability characteristics of investment products.
The regulator is seeking responses to its discussion paper to guide development in several areas with regards to SDR, including:
The FCA noted that sustainability-related information, when standardised, could be useful to institutional investors as well as retail consumers. This has prompted the regulator to consider a three-tiered approach to incorporating labels and disclosures.
The FCA defined three tiers.
Product labels are a standardised product classification and labelling system that would help consumers understand the sustainability characteristics of different products.
Consumer-facing disclosures provide standardised information on the product’s key sustainability attributes. This would allow consumers to better understand the sustainability characteristics of the product, compare similar products or the same product over time, and hold the provider to account for sustainability claims made.
Detailed disclosures could be made at entity and product level. These could provide more granular information than the consumer-facing disclosures, as well as additional information. The disclosures could be useful to institutional investors, as well as a broader range of stakeholders. Entity-level information will likely leverage the implementation of the UK’s TCFD, which makes it mandatory for some firms to provide climate disclosures from 2022. However, SDR has a wider scope and looks beyond climate change.
The regulator said:
"In setting the potential scope of firms and products, we could as a starting point consider basing this on the proposed scope of our TCFD regime. Working with the Treasury, we are also considering how overseas funds marketing into the UK would be treated.”
The FCA noted that it is also exploring the best approach for introducing requirements for financial advisers.
The FCA wants to develop a regime that encourages better disclosure and gives consumers a better idea of the ESG profile of products and companies. It's also hoping to improve clarity for institutional investors through the labelling system. Using objective criteria and common terminology, the FCA says it could help combat potential greenwashing and enhance trust.
Interestingly, the regulator said that the classification and labelling system would cover the “full range of investment products available to retail consumers”. This is likely to include open and closed-ended funds open to retail investors, as well as packaged pension and insurance products.
Products that fall within the scope will have to show their sustainability profile through labels on a classification scale. This is intended to complement the entity and product level disclosures within SDR.
Taking into consideration that many firms have already invested in systems and processes to classify products according to SFDR provisions, the FCA put forward a potential approach for its labelling system, which maps categories set out against SFDR.
This draws up five categories that runs in order of sustainability and corresponds to SFDR articles:
However, this mapping only works when using products from the UK regime to the SFDR, not vice versa.
While the FCA’s plans on SDR and investment labels for sustainability are in early stages, the impact of these proposals should not be ignored. Firms looking to stay ahead of the curve will be considering how to embed sustainability into their overall strategies.
Adapting to new disclosure regimes and classification systems for labelling will require extensive resources from firms to understand how commercial activities correspond with these new frameworks. They must be prepared to carry out internal reviews and amend compliance practices.
Financial services companies must quantify the impact of these regulatory changes, and be proactive in their approach with the FCA.
If you need support understanding and preparing for these proposals, get in touch with Rashim Arora.
