UK SDR Impact on Fund Names and EEA UCITS
- The UK opted not to onshore the oncoming EU SFDR just before withdrawing from the European Union. The UK sustainability disclosure regime will kick in the UK progressively during 2024. We start with rules and guidance on anti-greenwashing in May up to naming and marketing rules by the end of the year. The rules are tailored first and foremost on the needs of the UK market.
- The UK SDR is consumer and market centric. The creation of sustainability labels for investment products is a testament to that and so are the rules on fund naming and marketing. This is to the contrary of the European sustainable finance disclosure regime, which is more product centric and where the rules on fund naming seems to be divorced from the entire regulatory infrastructure.
- It has not been ascertained yet whether the UK SDR rules will be applicable to EEA UCITS marketed under the Overseas Fund Regime in the UK. Under the UK SDR, distributors will be required to communicate to consumers that EEA UCITS are not eligible for labels under the new rules. European retail funds will also have to disclaim that they are not eligible for the ombudsman and the compensation scheme.
The UK officially rolls out its Sustainability Disclosure Requirements (SDR) and investment labels rules. This will happen progressively during 2024.
First the rules and guidance on anti-greenwashing will come into force by the end of May 2024. By the end of July 2024 firms will be able to start using labels and accompanying disclosures. Naming and marketing rules will be imposed at the beginning of December 2024. Ongoing product and entity level disclosures will be rolled out in 2025 and 2026 respectively, with a view to capture the widest variety of firms possible.
At the time when European authorities started their world first initiative on sustainable finance disclosures, the UK was preparing for the withdrawal from the EU. As part of that process, the UK exercised the option not to onshore the EU SFDR related regulation. Since then, data showed how the approach the UK adopted on its financial services regulatory framework has been far from being one of deregulation. Consumer protection remains of paramount importance, both in the existing and newly introduced regulatory architecture on financial services.
This approach allowed for continued alignment with Europe, which bodes well for future equivalence purposes. Nevertheless, regained sovereignty means that any new rules must be tailored first and foremost to business practices and needs of the UK internal market.
An Issue of International Coherence
UK SDR allows for the development of the UK own regime on sustainability disclosures in a full sovereignty mode. That means that the UK regime on sustainable disclosures will be fully aligned with the FCA operational objectives of consumer protection, market integrity enhancement and promotion of effective market competition. The UK regime on sustainability disclosures comes in approximately at the same time when the US is proposing its own rules on the same topic. Many more countries where UK firms have business exposure already will also have their own rules soon. This exercise of sovereignty is characterised by a fine balancing act between the need to cater for the needs of its own internal market and the acknowledgment of both the position of the UK as a global market itself and the global remit of most UK investment firms. The majority of these are already subject to compliance with EU SFDR and will be subject going forward at least to the sustainability disclosures rules imposed by the SEC in the USA. The UK SDR rules are presented by the FCA already in their comparison with the existing EU SFDR regime. That is to facilitate the task of firms with global remit and exposure both to the UK and Europe. Even though it has not been ascertained yet whether EEA UCITS under the Overseas Fund Regime will be subject to these rules when marketed in the UK, the official gap analysis prepared by the FCA is additional comfort of the fact that international coherence is taken into account in the development of these rules.
At the same time, whilst the UK rules on sustainability disclosures are indeed compatible with EU SFDR and the proposed SEC rules, the starting point and the approach is completely different. Both the EU and the US rules aim at categorising products for the purpose of determining related disclosure requirements. UK rules instead have a more consumer and market centric approach. The main goal is to empower consumers to discern amongst different products with a sustainability profile and help them navigate the market accordingly. Investment labels and fund names rules are integral part of this approach to the contrary of the EU SFDR at least, more product centric in nature, where fund names rules seem to be divorced from the main regulatory infrastructure.
Classification and Labelling
For the UK SDR having a consumer centric approach, both product classification and labelling are considered fundamental pillars of its architecture. In concert with fund naming and marketing rules, product classification and labelling support the two main pillars of the UK sustainability disclosures rules, being combatting greenwashing and assisting consumers in navigating the market independently. More namely, on the consumer protection aspect, product classification and labelling play a twofold role. Help consumers in identifying sustainable products from the non-sustainable ones, based on their sustainability characteristics, themes and outcomes, as well as distinguishing between different types of sustainable investment products.
A sustainable investment product that can be considered as such under the UK sustainability disclosure rules is one that explicitly pursues an environmental or social objective as part of its broader objectives, which also include the ones that are financial in nature. One of the distinguishing aspects of sustainable investment products is that the sustainable objective is expressed in a way that is specific and measurable. More namely, for a fund to claim legitimately under UK SDR to have a sustainability object, it is necessary either that the underlying assets have a credible link to positive outcomes for either the environment or the society or that the investment objective itself directly aims at attaining positive outcomes for the environment or the society.
An additional layer of complexity is introduced with the distinction between enterprise and investor contribution under UK SDR. The enterprise contribution of the underlying assets refers to the contribution made by the issuer of the asset itself to the sustainable outcomes, irrespective and independently of the actions of the investor. Investor contribution instead refers to the additional outcomes that can be attributed directly to the actions that investors take in respect of their assets. This distinction is introduced in a current scenario where the norm seems to emphasise the enterprise contribution and too little is done to externalise the link that the investment activities of a firm have with any real sustainability outcome of related products. Both elements of the equation are considered of critical importance under UK SDR. Accordingly, to qualify under a sustainability label, investment products will have to clearly specify in their investment strategy how the actions taken by the firm contribute to the positive sustainable outcomes. By way of example, this would also include any value added in the construction and operation of a portfolio.
Lastly, under UK SDR we see an interesting stance on the use of ESG integration in investment strategies. According to the UK regulator, the consideration of ESG risks, opportunities and impacts on the future financial performance of investable assets is increasingly becoming part of the traditional fiduciary duty and general risk management obligation owed by an investment firm to its clients. The fact that ESG integration takes more and more a central role in investment strategies that pursue otherwise an objective that is financial in nature, affects its perception of being a truly sustainable investment approach per se. Purely ESG integration strategies, where there is no contribution to a sustainable objective, will be excluded from the labels. The same goes also for investment strategies essentially based on exclusion and negative screening or other plain vanilla ESG integration approaches.
Following the feedback from the initial consultation on the UK SDR, the labels are now 4 and are somehow comparable to the labels to be introduced under SFDR II.
Marketing Rules and Naming
For the UK SDR being essentially consumer centric and label driven, it poses necessarily much more emphasis on fund naming and marketing rules, integral part of its regulatory architecture. The existence of product labels makes rules on fund naming and marketing necessary from the outset. As mentioned, certain shades of ESG in investment strategies do not qualify for the purposes of the labels under the UK rules. Without rules on fund naming and marketing, products adopting an ESG exclusion filter in their strategies, for instance, could freely use ESG terms in their name. This would heighten risks of greenwashing. Consumers might be led to believe by the name of these products that they are sustainable when they are not (and do not qualify for a label accordingly). There are different measures adopted to achieve this goal, for all the in-scope products under UK SDR offered to retail investors only.
The first measure is a catch-all anti-greenwashing rule that is applicable to all FCA authorised firms. The ability to cover the widest scope possible of firms is necessitated to ensure that also authorised firms that approve financial promotions for third parties are captured. The rule requires that all regulated firms shall ensure that naming and marketing of financial products and services is clear, fair, not misleading and also consistent with the sustainability profile of the product or service.
Secondly, we also have rules on the product name and marketing. Products that have a label can use sustainability related terms in their names. Only the term impact is reserved to products of a specific label. The product name and marketing rules have been slightly relaxed after a consultation run by the FCA on the proposed rules. To take care of products that do not meet the label eligibility but nevertheless have a sustainable element or characteristic to their strategy, it is possible for these products to reflect in their name these characteristics, provided that terms like sustainable and impact and all their variations are not used. These firms must also produce all the same disclosures that a labelled product would be required to produce. In addition to that, for these products there shall be statements to the extent that they are not labelled and the reasons for that.
For the label eligibility being linked for all labels to a proportion of at least 70 per cent of sustainable investments making up the portfolio, there will ultimately be no significant mismatch in terms of portfolio construction compared to European funds based on the proposed thresholds under the forthcoming rules on use of ESG in fund names.
UK SDR Impact on EEA UCITS
Given the essentially consumer centric nature of the new sustainability disclosure rules in the UK, the role played by distributors is central to the accomplishment of their aims and goals.
Distributors will be requested under the new rules to ensure for in scope products, where a label is assigned, that it gets communicated to investors and displayed prominently on the product documentation, which should include all the required accompanying consumer-facing disclosures. The rules are designed to cater also for instances where distributors have no digital interaction as such with their customers. The label and related disclosures will have to be provided in the medium used for the interaction with the specific client, be that digital or analogue.
In cases of EEA or European retail products, pending a decision on whether these can avail themselves of a UK label under the Overseas Fund regime, distributors will also be required to display prominently a notice to the extent that these products are based overseas and are not subject to UK labelling and disclosure requirements. This notice comes in addition to the additional disclaimers imposed on these funds under the Overseas Fund regime for what concerns the unavailability of the recourse to the ombudsman or the compensation scheme.
The Overseas Fund Regime is still a work in progress and so is the possibility to extend the new UK rules on sustainability disclosure and related labels also to EEA UCITS. Whilst it seems that the process to re-open the UK fund market to EEA funds is at an advanced stage, there will be visual elements to distinguish the UK from the EU retail funds imposed both by the rules of the Overseas Fund Regime and the ones on the sustainability disclosures. We are yet to see the full extent of the marketing and perception implications, yet we must not exclude a more favourable perception bias towards UK retail products compared to EU products in the UK market going forward.