Sustainability Disclosure Requirements: Lessons learned so far

By Ramon Varela, 16 September 2024

It is now ten months since the first Policy Statement on the UK Financial Conduct Authority’s new Sustainability Disclosure Requirements (SDR) and investment labels was published. For those firms most impacted, it has been a period comprising of a significant amount of effort, lessons learned and, as most people dealing with the labelling process would agree, frustration.

During this time, at Avyse Partners we have published a series of blogs summarising the requirements of the regime, from a general overview,[1] to a more detailed breakdown on how to interpret the anti-greenwashing rule.[2] In this latest blog, in anticipation of the final SDR rules for portfolio management to land as a post-summer holiday treat, we are switching our focus for the wealth market.
  
Below, we provide a reminder on what already applies to wealth managers, an update on the practicalities of SDR implementation based on what we have learnt from working with clients in the asset management sector, and finally some thoughts on what comes next.

Where are we now? 

The anti-greenwashing rule (‘AGR’) 

The AGR and finalised guidance [3] took effect for all regulated firms on 31 May this year. In a nutshell, it requires any sustainability references made by a regulated firm to be:

• correct and capable of being substantiated
• clear and presented in a way that can be understood
• complete, not omitting or hiding any relevant information, and
• fair and meaningful in relation to comparisons to other products.

If you haven’t done so already, we’d recommend a deep dive through marketing materials and website content in particular, as well as updating guidance for financial promotions to ensure you don’t fall foul of the AGR. 

Requirements for distributors 

All distributors of sustainability products are required to ensure product-level information is made available to consumers, specifically:

• Where you distribute a sustainability product with a label to a retail client, you must display the label in a prominent place on your website (or communicate it using any other channels you may typically use), and provide access to the consumer-facing disclosure (‘CFD’) for the sustainability product.
• Where you distribute a sustainability product without a label to a retail client, but the product uses sustainability-related terminology in its name or marketing materials, you will still need to provide access to the product’s CFD.

Given asset managers have only been able to apply labels to their funds since 31 July, and that application windows are narrow (with FCA engagement ongoing for a lot of firms seeking labels), we’d recommend engaging with any fund providers you use. You can do this to confirm whether they plan to label or to figure out if any funds you use will be caught by the naming and marketing rules. This will help ensure you have the potential scope of any distributor disclosures clearly identified and monitored. 

Lessons learned from implementing SDR so far 

While the asset management sector has been grappling with the challenges of applying for a label, most market research signals that the opt-in to the labelling regime would be fairly limited in 2024, as the various players observe how peers are approaching SDR implementation.
 
For those who have opted to apply for a label already, we’ve seen a few challenges crop up that we think are useful for wealth managers to consider if they do choose to label products or services.

The evidence-based standard 

The FCA has provided firms with flexibility in determining their process to identify which assets they consider sustainable, so long as it meets their requirements (i.e., robust, evidence-based, and absolute). However, we are aware of challenges firms have faced in relation to convincing the FCA of the robustness of their selected standard where this is based on internally derived approaches. 

There has been a particular focus on how firms determine that their chosen approach is an absolute measure of sustainability, and what evidence they have based that on. When determining your sustainability standard, we recommend explicitly documenting these specifics to support in any FCA engagement. 

The independent assessment 

As a key part of the labelling requirements, firms must have an independent assessment of their chosen sustainability standard carried out to ensure it is fit for purpose. This may be done by a third party or internally, so long as the person or function carrying out the assessment is adequately skilled and sufficiently independent of the investment process.
 
A number of firms we have engaged with have struggled to identify who that relevant body would be internally. It requires sufficient expertise to demonstrate appropriate challenge of the standard and sustainability concepts, but no conflict through exposure to involvement in supporting investment teams (e.g. internal environmental, social and governance (ESG) teams who work with investment managers to establish ESG/sustainability processes, or support on engagements or reporting etc.). 

Where this is an issue, having the initial test of the standard carried out by an external party may be more appropriate, giving firms time to establish new governance forums to oversee SDR compliance, or to recruit or upskill existing staff to perform this role in the future. 

Referencing external sources 

The Regulator has made clear that using the United Nations Sustainable Development Goals (‘SDGs’) as a broad investment approach or primary reporting tool for your key performance indicators (KPIs) is not sufficient to meet the SDR labelling requirements due to the extremely broad nature of the SDGs. 

Since the key difference between ESG and sustainable investments lies between non-financial risk management and achieving sustainable outcomes, the latter likely requires forward-looking data to take a more prominent role. International standards such as the EU and (eventually) UK taxonomies, as well as KPIs from frameworks such as the International Sustainability Standards Board (ISSB) or the Global Reporting Initiative (GRI), may serve as more constructive references.

Consistency in approach 

We’ve seen the FCA challenge firms on the strength of the connection between the stated sustainability objective, the KPIs used to report on achievement of that objective, and how any stewardship activities carried out support the meeting of the objective. Wealth managers seeking labels must ensure that the objective clearly aligns with the definition of sustainability which the portfolio manager outlines.
 
In addition, any KPIs selected to demonstrate performance against the objective should be relevant and specific to the objective (and that they would allow a customer to see where the sustainability objective has not been met, as well as where it has been met and how). And finally, stewardship activities should be evidencing and supporting this, noting the FCA does acknowledge the different challenges wealth managers face regarding stewardship activity.

Overlapping regulatory requirements 

Due to the regulator’s continued focus, we can’t fail to mention the links between SDR and the Consumer Duty.  When implementing SDR we highly recommend reflecting on the four Consumer Duty outcomes for all aspects. 

We may focus particularly on consumer understanding, where there likely needs to be an internal training programme to uplift adviser knowledge and understanding on the sustainable product landscape and potential changing customer preferences. 

Nevertheless, other areas such as how you have considered price and value when developing any new sustainability-focused offerings will form part of key interlinkages between the two rules. 

In a nutshell, the FCA is eager for labelled products and services to be watertight, clear and precise, and most importantly, be easy for retail customers to understand and trust.   

What next? 

In recognition of the challenges around the naming and marketing implementation of SDR, the FCA announced last week that it has decided to offer ‘limited temporary flexibility’ for compliance by certain firms, pushing the deadline back from 2 December 2024 to 2 April 2025.[4]

Having said that, given the material aspects of the regime are unlikely to change, we’d still recommend getting started. Here are five key questions we believe you should begin to ask yourself ahead of kicking off your SDR implementation: 

1. Are you comfortable that you are already compliant with the anti-greenwashing rule and aware of the status of any products you distribute that you may need to publish or make available sustainability-related information on?
2. Have you performed an initial gap analysis against the proposed SDR rules to identify where any significant work will be required?  
3. Have you assessed your existing products and services to determine whether any will be eligible for a label, or caught by the naming and marketing rules?
4. Is there a requirement to carry out internal education sessions across all levels to ensure those involved in governance activities are equipped to adequately oversee SDR compliance (and are client-facing advisers equipped to tease out and translate customer preferences regarding sustainability into suitable products and services)?
5. Do you have sufficient resource with sustainability skills and experience to support implementation, including specific activities such as the independent assessment of any sustainability standard?