'SDR is first and foremost about anti-greenwashing'

In its policy paper released on Tuesday (November 28), the Financial Conduct Authority outlined it had created four investment labels that asset managers need to start using with accompanying disclosures from July 31 2024:

• Sustainability focus: at least 70 per cent of a product's assets must invest in assets that are environmentally or socially sustainable. 
• Sustainability improvers: this is for products investing in assets that may not be sustainable now but have an aim to improve their sustainability over time.
• Sustainability impact: this is a label for products investing in solutions to problems affecting people or the planet, to “achieve pre-defined, positive, measurable impact”. 
• Sustainability mixed goals: this applies to a mix of sustainability of objectives and approaches present. 

The rules recognise the existence of transitional investments, the ability to have some non-sustainable investments (subject to disclosure), and a clear and workable concept of 'impact'.

In its paper the FCA states: "Our aim with SDR and investment labels regime is simple: financial products that are marketed as sustainable should do as they claim and have the evidence to back it up."

Hilkka Komulainen, head of responsible investing at Aegon, says: “The paper outlines a significant step towards addressing greenwashing and enhancing transparency for sustainable funds. 

“The enhanced disclosure requirements, traffic light system for fund categorisation, and anti-greenwashing rule hold the potential to curb misleading claims and empower investors in their selection and monitoring of funds.”

What SDR changes is the clarity around product offerings and therefore adviser confidence.Julia Dreblow, SRI Services

The fourth label (sustainability mixed goals), a later addition not in the original consultation, has been widely welcomed.

Paul Hamalainen, director of sustainable finance consulting at Mazars and a former manager in risk and compliance oversight at the FCA, says: “[The fourth] label is going to be very useful because that was something firms were concerned about, that they would have to slot into one of the three other labels, whereas they can now have funds that actually naturally would have been across more than one of those labels.

Frank Potaczek, associate director at Mazars, adds: “Introducing the sustainable mixed goals is really, really good because it allows most of the funds that are currently around to be able to be labelled by the system.

“It allows managers to innovate with new funds, and actually offer something a little bit different for those people that want to innovate in asset management.”

Additionally, the FCA introduced an anti-greenwashing rule for all FCA-authorised firms to reinforce that sustainability-related claims must be fair, clear and not misleading. It is also consulting on supporting guidance.

The rules and guidance come into force on the following dates:

When it comes to defining what is meant by environmentally or socially sustainable, for example, this will be left largely in the hands of the asset managers.

But the fund characterisation must be backed up by strong evidence.

The FCA says: “Firms will need to determine a standard that aligns with their product’s sustainability objectives, and select assets that meet the standard, based on a methodology or approach that is determined by industry practice, an authoritative body or proprietary standards. 

“The standard may be based on general environmental and/or social criteria such as the percentage of revenue associated with sustainability matters; reference an authoritative taxonomy such as the EU taxonomy or forthcoming UK green taxonomy; or set a minimum threshold of greenhouse gas emissions for assets.

“It must, however, be robust (ie stand up to scrutiny), and evidence-based (ie derived from or informed by an objective and relevant body of data or other evidence).” 

Potazcek says: “We live under a principle-based regulatory sort of system. So the FCA has never told people what to do. Within SDR, it basically gives guidance of what those definitions are. 

“When you look at the anti-greenwashing rule, that sort of sits with the SDR, it basically means that when you as an asset manager have to define those sorts of words, then you have to be sure that it's credible and authentic.”

So in the new world, it is likely to be a combination of the industry coalescing around accepted definitions and individual companies coming up with their own definitions.

Role of distributors

The FCA has also introduced targeted rules for the distributors of investment products to retail investors in the UK.

It is also working on providing further guidance for advisers around suitability and how to build on existing capabilities in sustainable finance, including how the SDR and labels support advisers in their role. 

When it comes to IFAs and platforms, which are classed as distributors, the FCA says they play a key role in communicating sustainability information to retail investors. 

Julia Dreblow, founder of SRI Services, says: “Under Prod, consumer duty and a range of other long-standing requirements, advisers should already be discussing sustainability with their clients because it is so important to so many people.  

"The only way to identify appropriate funds is for funds to identify clients' interests and opinions and match them to fund options. What SDR changes is the clarity around product offerings and therefore adviser confidence."  

The whole point of SDR, first and foremost is to reduce greenwashing. It's that simple. And we do that by adding labels, adding disclosures etc.Frank Potaczek, Mazars

Dreblow adds: “Although advisers should go beyond simply using labels, in order to meet interested clients' specific needs, the labels will help get them started. 

"They will importantly help advisers to differentiate between funds that focus on real-world sustainability issues and outcomes, and for example funds focused on basic ESG risk mitigation, which until recently has not been well understood."

As part of the FCA rules, distributors are required to communicate the label and consumer-facing disclosures (both for labelled and unlabelled funds) to retail investors. 

This may be by displaying the label prominently on the relevant digital medium (eg product webpage), and by providing access to the consumer-facing disclosures, or otherwise communicating them to consumers via the distributors’ usual channels of communication. 

The FCA says: “Distributors must also ensure the labels and disclosures are kept up to date in accordance with any changes the firm makes to their products. Distributors and advisers are also subject to the anti-greenwashing rule and must therefore ensure all sustainability-related references comply with that rule. 

“We expect distributors to make the labels and consumer-facing disclosures available to retail investors as soon as reasonably practicable after the firm produces them, however we have not prescribed timelines within our rules. This approach recognises that firms are likely to apply labels to their products at different times after July 31 2024. 

“We also remind distributors that the purpose of the rules is to meet the needs of retail investors. We expect distributors to take this into consideration when determining where and how to provide retail clients with access to the labels and consumer-facing disclosures.” 

Seeking clarity

In its original consultation paper, when the FCA proposed that distributors, such as financial advisers and platforms, must ensure the labels and consumer-facing disclosures are made available to retail investors, respondents asked the FCA to introduce or clarify suitability rules as soon as possible. 

It also received several suggestions for matters to take into account or clarify. This included whether advisers are expected to understand the labelling regime, qualification requirements, interaction between existing rules and expectations such as Mifid II suitability and governance rules, or 'know your customer' expectations.

The FCA said: “We continue to explore how to clarify our expectations for advisers around taking sustainability matters into account in investment advice and suitability. We are conscious of the need to be proportionate given the different sizes of advisers. 

“We plan to establish an independent working group for the advice industry to help build on existing capabilities in sustainable finance, including how the SDR and labels support their role. 

“While the consumer-facing disclosures have been designed for consumers, they should also help advisers to better understand the sustainability characteristics of investment products.”

All about greenwashing

Potazcek adds: “When you talk to advisers about SDR, many may think that we just take the labels and see whether it's appropriate to us or not. A lot of people have not cottoned on to the anti-greenwashing rule at the moment. 

“The whole point of SDR, first and foremost is to reduce greenwashing. It's that simple. And we do that by adding labels, adding disclosures etc.

"So if the regulator, follows on its stated aim of reducing greenwashing, in asset management and in financial services generally, then the anti-greenwashing is something that advisers have to be mindful of when they make any responsible investing or sustainable or ESG claims, be it on a website or financial promotion.

“I would say to our clients: SDR is great. But also look at the anti-greenwashing rule to see where that comes into the way that you do business today.”

Claude Brown, a partner at Reed Smith, says the FCA’s measures should go some way to alleviate greenwashing in investments and are an encouraging sign for the development of the sustainable investment market in the UK. 

But they are only a start, and they raise many questions, which will only be answered when more detail is released.

However, he says, a challenge remains in cases where there are inadvertent misrepresentations. For example, where there has been accidental double counting, differing reporting standards or baselines.

Additionally, there remains ambiguity in these instances, which may mean that some milder forms of greenwashing persist.

Brown adds: “The introduction of the requirement that sustainability characteristics be 'fair, clear and not misleading' is not dissimilar from the requirements set by the Advertising Standards Authority for all adverts.

"This requirement should empower the FCA to take action against cases where it can show wilful greenwashing, that is, deliberate or reckless misrepresentations made by a sustainable fund. This will be helpful in deterring and tackling any funds making outright false or wild claims.

“The implications for advisers and how they should respond will be clearer when we have the details. However, these standards are a promising start and a sound chassis on which a sustainable investments market can be built.”

Ima Jackson-Obot is deputy features editor of FT Adviser