UK SDR and Investment Label Rules

As discussed in our Q4 2023 - European Regulatory Update for Funds, the FCA published a policy statement (the "Policy Statement") on 28 November 2023 which contained final rules and guidance in respect of its new Sustainability Disclosure Requirements ("SDR") and investment labels (the "Final SDR Package").

The FCA's introduction of the Final SDR Package represents the UK's attempt to establish its own flagship sustainable disclosure regime, similar to what the EU has achieved in the form of SFDR. However, given that SFDR has been in effect since 2021, the FCA (unlike the EU) has had the benefit of seeing how the implementation of a parallel regime has played out, and what successes and challenges have emerged. As such, many in the UK market have been holding out hope that the details of these final rules will reflect a sustainable disclosure regime which proactively addresses some of the frictions that EU firms faced when implementing SFDR. One example of this is the FCA's creation of a specific "labelling" regime alongside its disclosure rules. In our view, this is very likely to be a reaction to the market practice, which has emerged in the European funds industry, of using the Article 8 and Article 9 SFDR categories as pseudo-labels to signal how 'green' a fund is to investors.

In terms of the rules themselves, the Final SDR Package includes:

• an anti-greenwashing rule;
• four investment labels for use by UK managers of UK funds, as well as qualifying criteria that must be met in order for products to use an investment label;
• naming and marketing rules for investment products to ensure that the use of sustainability-related terms is accurate;
• consumer (i.e. retail investor)-facing disclosure requirements;
• detailed product-level disclosures; and
• detailed entity-level disclosures.

As currently drafted, most of these rules only apply if you are a UK manager of a UK fund (a "UK Asset Manager") (though note that the anti-greenwashing rule will apply to all FCA authorised firms making sustainability-related claims about products or services).

Some other general points to note about the scope of the regime are that:

• the rules do not currently apply in respect of overseas (i.e. non-UK) funds (though see section 7 'Next steps' below); and
• some of the rules apply slightly differently in respect of feeder funds, and so must be considered carefully in that context.

We have produced below a high-level summary of these requirements, as well as the key next steps the FCA will be taking which are relevant to private fund managers.

1. Anti-greenwashing rule

Application: Applies to all FCA authorised firms making sustainability-related claims about products or services to clients/persons in the UK.

Summary: Firms are required to ensure that any reference to "sustainability characteristics" (i.e. environmental or social characteristics) of a product or service is: (a) consistent with the actual environmental/social characteristics of the product or service; and (b) is fair, clear and not misleading, when:

• communicating with clients in the UK about a product or service; or
• communicating a financial promotion^[1] to a person in the UK.

The rule is simply stated to apply to references to "sustainability characteristics" of financial products or services. The FCA has elected not to provide a specific list of terms that would trigger the rule.

The FCA has specified that sustainability-related references can be present in (but are not limited to) statements, assertions, strategies, targets, policies, information and images.

The FCA has published a consultation on anti-greenwashing guidance, which closed on the 26 January 2024.

Timing: Comes into force on 31 May 2024.

2. Investment labels

Application: Use of the labels is voluntary; however, they are only available to UK Asset Managers in respect of the UK AIFs and UK UCITS they are managing.

Summary: The FCA will be introducing four mutually exclusive investment labels with sustainability objectives with the aim of giving consumers (i.e. retail investors) more confidence when navigating the investment product landscape.

The four labels that the FCA will be introducing, and which UK Asset Managers can use if their funds meet the qualifying criteria, are: Sustainability Focus; Sustainability Improvers; Sustainability Impact; and Sustainability Mixed Goals (the "Labels").

The Labels are designed to reflect different sustainability objectives and investment approaches as between products. For example, whilst two funds may invest in similar assets, they may have different Labels depending on their objectives. The sustainability objectives relevant to each Label are:

• Sustainability Focus: this is for products with a sustainability objective consistent with an aim to invest at least 70% in assets that are environmentally and/or socially sustainable;
• Sustainability Improvers: this is for products with a sustainability objective consistent with an aim to invest at least 70% in assets that have the potential to improve environmental and/or social sustainability over time;
• Sustainability Impact: this is for products with a sustainability objective consistent with an aim to achieve a pre-defined positive, measurable impact in relation to an environmental and/or social outcome (and invest at least 70% of their assets in accordance with that aim); and
• Sustainability Mixed Goals: this is for products with a sustainability objective to invest at least 70% in accordance with a combination of the sustainability objectives for the other Labels.

Whilst use of a Label by a UK Asset Manager is optional, in order to use the relevant Label, the fund product in question must meet certain qualifying general criteria (the "General Criteria"), as well as qualifying criteria which are specific to that Label ("Specific Criteria"). Additionally, UK Asset Managers will need to make the necessary disclosures associated with that Label (see section 5 below to see a general description of product-level disclosures).

General Criteria

The first General Criteria that a fund product must meet in order use a Label is that it must have an explicit sustainability objective as part of its investment objectives that aligns with one of the Labels, and which is clear, specific and measurable.

As indicated above, another General Criteria that a fund product must meet is to have 70% of its assets invested in accordance with the sustainability objective relevant to the applicable Label.^[2] This requirement comes with the added proviso that the relevant assets are selected with reference to "a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability" (the "robust, evidence-based standard"). Further, the other assets of the fund product must not conflict with the relevant sustainability objective.

In terms of the robust, evidence-based standard, this may be based on/determined by an authoritative body (e.g., a government or regulator), an industry practice (e.g., a third-party data or analytics service provider) or a proprietary methodology (developed by the firm). However, in order for this to meet the required standard, it must be capable of standing up to scrutiny and be derived from or informed by an objective and relevant body of data or other evidence. The FCA has suggested (on a non-exhaustive basis) some examples of different standards that may be used in this regard:

• general environmental and/or social criteria: e.g. the standard may set a minimum threshold for the percentage of revenue, or the percentage of expenditure on operations, capital or research and development associated with environmental or social matters relevant to the product's sustainability objective;
• taxonomy-based: e.g. the standard may directly reference an authoritative taxonomy relevant to the sustainability objective of the product, such as the EU taxonomy for sustainable activities, or the forthcoming UK Green Taxonomy;
• emissions profiles: e.g. the standard may set a minimum absolute threshold of GHG emissions or carbon emissions intensity for assets.

A key point for UK Asset Managers to be aware of is that the role of the robust, evidence-based standard-and the way it is applied in selecting the fund product's assets-will differ according to the Label relevant to that product.

In order to meet the General Criteria, the product must also have KPIs (either at a fund level or asset level) that demonstrate progress toward achieving the sustainability objective. The FCA has not prescribed any KPIs for UK Asset Managers to use in this regard. This is because the most relevant KPIs are likely to depend on the specific sustainability objectives for each fund product. However, the FCA has made clear that UK Asset Managers:

• must take reasonable steps to ensure that any data used to meet the labelling requirements is accurate and complete; and
• deliver a fair representation of the product's progress towards the objective and enable retail investors to understand that progress.

The UK Asset Manager must also, as part of meeting the General Criteria, comply with certain manager requirements in relation to the use of the Label, including (inter alia):

• determining whether any material negative environmental and/or social outcomes may arise in pursuing the sustainability objective
• having an escalation plan setting out the actions that the UK Asset Manager will take if any of the fund product's assets do not demonstrate sufficient performance against either the relevant sustainability objective or the relevant KPIs;
• having in place appropriate resources, governance and organisational arrangements, commensurate with the delivery of the sustainability objective;
• identifying the investor stewardship strategy needed to deliver the relevant sustainability objective, including the expected activities and outcomes, and ensuring the strategy and appropriate resources are applied.

Specific Criteria

In addition to the General Criteria, a UK Asset Manager must only use a Label if the fund product in question meets the Specific Criteria applicable to that Label. In terms of the Specific Criteria that apply in respect of each Label:

• Sustainability Focus: the fund product's sustainability objective must be consistent with the aim of investing at least 70% in assets that are environmentally and/or socially sustainable (as determined by the robust, evidence-based standard);
• Sustainability Improvers: the fund product's sustainability objective must be consistent with the aim of investing at least 70% in assets that have the potential to improve environmental and/or social sustainability over time (as determined by the robust, evidence-based standard).
  In addition, UK Asset Managers must obtain robust evidence for selecting those assets and identify a period of time in which the fund product and/or its assets are expected to meet the standard (including short and medium-term targets for improvements);
• Sustainability Impact: the fund product's sustainability objective must be consistent with the aim of achieving a pre-defined, positive, measurable impact in relation to an environmental and/or social outcome (and invest at least 70% of assets in accordance with that aim).
  In addition, the UK Asset Manager must: (i) specify a theory of change (setting out how they expect their investment activities and the product's assets to contribute to the positive impact); and (ii) specify a robust method for measuring and demonstrating the positive impact of both their investment activities and the fund product's assets;
• Sustainability Mixed Goals: the fund product's sustainability objective must be to invest at least 70% in accordance with two or more of the sustainability objectives for the other Labels.
  The UK Asset Manager must also: (i) identify (and disclose) the proportion of assets invested in accordance with any combination of the other Labels; and (ii) meet the requirements of the other relevant Labels.

Whilst the regime was designed with retail investors in mind, it is available for use in respect of professional-only fund products too.

Timing: Available from 31 July 2024 (though must be accompanied by required disclosures)

3. Naming and marketing rules

Application: Applies to UK Asset Managers in respect of products available to retail investors, and financial promotions made to retail investors.

Summary:

Product naming rules

Sustainability-related terms can only be used in a fund product's name if:

• the fund product in question uses a Label (though where the relevant Label used is "Sustainability Focus," "Sustainability Improvers" or "Sustainability Mixed Goals," the fund product must not have the word "impact" in its name); or
• the fund product does not use a Label, specific naming rules are followed. These include that:
  • the fund product in question must have sustainability characteristics and a name which accurately reflects the fund product's sustainability characteristics;
  • the fund product does not, in its name, use the term 'sustainable,' 'sustainability,' or 'impact' or any other variation of those terms to refer to its sustainability characteristics;
  • the UK Asset Manager produces the same types of disclosures as required for products using a Label;
  • the UK Asset Manager prominently publishes a statement (on the relevant digital medium for the fund product and in the product-level disclosures) to clarify that the product does not have a Label and specify the reasons why.

Feeder funds are subject to separate rules.

Product marketing rules

For fund products which use a Label, UK Asset Managers must ensure that financial promotions made to retail investors are consistent with the relevant Label, the product's consumer-facing disclosure, the product's pre-contractual disclosure and certain parts of the product's public sustainability report.

In respect of fund products which do not use a Label, but whose financial promotions made to retail investors contain sustainability-related terms, UK Asset Managers must:

• produce the same types of disclosures as required for products using a Label; and
• produce and prominently publish a statement to clarify that the product does not have a Label and specify the reasons why (as described above in relation to product naming rules that apply to non-Label fund products).

Timing: In force from 2 December 2024 (though UK Asset Managers that are ready to use Labels earlier than this point must comply with any relevant naming and marketing rules from when the Label is first used).

4. Consumer-facing disclosures

Application: Applies to UK Asset Managers in respect of products available to retail investors where the product uses a Label or sustainability-related terms.

Summary:

UK Asset Managers are required to produce consumer-facing disclosures for:

• fund products with a Label; and
• fund products without a Label using sustainability-related terms.

The disclosure must be a standalone document located in a prominent place on the relevant digital medium (e.g. website) through which the product is offered, and hard copies must be made available on request.

The disclosure must not exceed two pages, and must include^[3]:

• either the product's sustainability objective and Label, or a statement to clarify that the product does not have a Label;
• the investment policy and strategy (including what the product will and will not invest in);
• relevant metrics;
• details of where a consumer can access other relevant sustainability and non-sustainability information; and
• for products with the 'Sustainability Mixed Goals' Label only, the proportion of assets invested in accordance with each of the other relevant Labels.

Timing: 2 December 2024 for UK Asset Managers using sustainability-related terms without Labels. For UK Asset Managers using Labels from 31 July 2024, consumer-facing disclosures must be published at the same time the Label is first used.

5. Product-level disclosures

Application:

Pre-contractual disclosures

Applies to UK Asset Managers in respect of products available to retail and/or professional investors where the product uses a Label or sustainability-related terms.

Ongoing product-level disclosures

The application of the ongoing product disclosures differs depending on the regulatory profile of the UK Asset Manager and the fund product in question.

In particular, UK managed authorised or listed funds, which use a Label or sustainability-related terms, are in-scope for the requirements relating to producing public product-level sustainability reports (though they are not subject to the rules relating to providing on-demand product-level sustainability information). On the contrary, full-scope UK AIFMs and small authorised UK AIFMs managing unauthorised and unlisted AIFs are not subject to the public product-level sustainability reporting obligations (but will be in-scope of the requirements relating to providing on-demand product-level information^[4]).

Summary:

Pre-contractual disclosures

The pre-contractual disclosure obligations under SDR require that certain information related to the sustainability features of in-scope fund products is provided in the prospectus or disclosure document (produced per FUND 3.2 of the FCA Handbook) of the relevant fund.^[5]

For products using a Label, the information that must be disclosed is broadly associated with the qualifying criteria for the Labels.

For products not using a Label, the pre-contractual information must, at a minimum, include information relating to the investment policy and strategy and any relevant metrics.

Ongoing product-level disclosures

The sustainability product-level reporting requirements are designed to ensure that UK Asset Managers produce disclosures on the sustainability-related performance of their in-scope products on an ongoing basis.

As above (in respect of the pre-contractual disclosure requirements):

• for products using a Label, the information that must be disclosed is broadly associated with the qualifying criteria for the Labels; and
• for products not using a Label, the ongoing product-level disclosures must, at a minimum, include information relating to the investment policy and strategy and any relevant metrics.

Timing:

Pre-contractual disclosures

2 December 2024 for UK Asset Managers using sustainability-related terms without Labels. For UK Asset Managers using Labels from 31 July 2024, pre-contractual disclosures must be published at the same time the Label is first used.

Ongoing product-level disclosures

Annually (after 12 months from either the date the Label or terms are used).

6. Entity-level disclosures

Application:

Applies to UK Asset Managers with UK funds under management of £5 billion or more (calculated annually on a three-year rolling average).

Summary:

The entity-level disclosure obligations require all UK Asset Managers with UK funds under management above £5 billion (regardless of whether they use a Label or sustainability terms) to produce disclosures on how they are managing sustainability risks and opportunities in a 'sustainability entity report.'

As part of the required disclosures, in-scope UK Asset Managers:

• are required to disclose their governance, strategy, risk management, and metrics and targets in relation to managing sustainability-related risks and opportunities; and
• where they use Labels or sustainability-related terms in their product names and marketing, must include details on their resources, governance and organisational arrangements in relation to those products.

The report must be published annually, covering a reporting period of 12 months. The report must be made available in a prominent place on the main website for the business of the UK Asset Manager (e.g. with a link from the homepage).

Timing:

Where the in-scope UK Asset Manager has AUM of £50 bn or more in relation to managing UK UCITS and UK AIFs, the first report must be published by 2 December 2025.

Where the UK Asset Manager does not meet the criteria described above, but has AUM of £5 billion or more in relation to managing UK UCITS and UK AIFs, the first report must be published by 2 December 2026.

7. Next steps

The FCA has stated that these rules, as contained in the Policy Statement, are a starting point, and has made it clear that it intends to expand the regime in the future. In that vein, we note the following areas that the FCA has identified in terms of "next steps."

• Portfolio management: while portfolio management is currently out of scope, the FCA plans to consult on its approach in regards to portfolio management in early 2024, particularly where it is undertaken for UK retail clients.
• Overseas funds: as stated above, overseas funds are not currently in-scope of the Final SDR Package. The FCA, however, has stated that it wants all firms marketing their products in the UK to be subject to the same broad requirements. The FCA is therefore working with His Majesty's Treasury to understand the options for extending the regime to overseas recognised funds, including those marketing under the Overseas Funds Regime. It remains to be seen whether plans to extend the requirements to overseas funds would include those non-UK funds which are not "recognised" for UK regulatory purposes (i.e. non-UK AIFs marketed in the UK under Regulation 59 of the UK's Alternative Investment Fund Managers Regulations 2013). To the extent they are, this expansion of scope would have a significant impact on private fund managers which market in the UK, and so developments should be followed closely.
• Disclosures: the FCA has made clear that it intends to build on the disclosure requirements set out above over time in line with UK and international developments. The FCA has stated that it may, in particular, consider updating product-level disclosure requirements once the UK Green Taxonomy is in use, and product and entity-level disclosure requirements in line with future ISSB standards.

8. Conclusions

At present, given the limited application to UK Asset Managers (i.e. UK managers of UK funds) and the restrictions in most of the rules to products available to or promotions targeted at retail investors, the expectation is that Final SDR Package will have a relatively minor impact on our clients since, in the main, UK private fund managers have used non-UK fund vehicles in order to access the AIFMD passport, typically act as portfolio manager to a European AIFM for the same reason, and in general limit offerings to professional investors.

However, there will certainly be work to do for those UK managers that do manage UK funds and admit retail investors, and it will be important more generally for managers to monitor how the regime develops-both as to the possible extension to include portfolio management and overseas funds and also as to the industry response-although Labels are optional under the regime, it is possible that they will become commonplace due to investor demand in much the same way as SFDR categorisation has in part been driven by investor demand, so this will be an area to keep a close eye on.

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