Some of the FCA's original proposals have been deferred for further consultation, in particular the rules for managers of discretionary portfolios including model portfolio services.
As consumer protection measures, there are considerable gaps in the FCA's new rules. In particular, though the FCA recognises that advisers have a key role to play in supporting consumers making investment decisions about sustainability options, no regulatory toolkit has yet been proposed to support advisers. Instead the FCA is setting up an independent working group for the advice industry to work together to build on existing capabilities in sustainable finance, including how the SDR and labels should be used by advisers. Pending the output of that work, advisers will have to navigate a path for themselves.
An "elephant in the room", which is side-stepped in the FCA's policy statement, is the question whether a fund deploying an FCA sustainability label will be a suitable investment for an average retail investor looking to save for retirement, given the reduction in financial return that can be the result of following sustainability objectives.
"Early" 2024 - FCA consultation on extending its proposals to discretionary portfolio strategies.
The FCA has accepted consultation feedback that its proposals for portfolio management were not suitable. It will consult "in early 2024" on following a similar approach for portfolio management to that taken in its rules for UK funds, with a focus on portfolio management undertaken for UK retail clients. Discretionary portfolio managers will need to consider these proposals carefully.
31 May 2024 – Anti-greenwashing rule in force
The FCA's anti-greenwashing rule will apply to all authorised firms. It sits in Chapter 4 of the ESG module of the FCA Handbook, where ESG 4.3.1R provides that: "A firm must ensure that any reference to the sustainability characteristics of a product or service is: (a) consistent with the sustainability characteristics of the product or service; and (b) fair, clear and not misleading."
Text is also added to the FCA's general financial promotion and customer communication rules reminding firms of their obligations under ESG 4.3.1R.
Some have questioned what a specific anti-greenwashing rule really adds to the FCA's powers, given the existing requirement that financial promotions should be fair, clear and not misleading. In practice, this new rule is signalling the regulatory priority that the FCA now gives to tackling greenwashing, with the aim of protecting consumers, increasing their trust in sustainability-related claims and creating a level playing field for firms whose products and services genuinely represent a more sustainable choice, thus encouraging the flow of capital into products that can drive positive change.
The rule applies to all communications about financial products or services which refer to the environmental and/or social (i.e. ‘sustainability’) characteristics of those products or services. Sustainability-related references can be present in, but are not limited to, statements, assertions, strategies, targets, policies, information, and images. The rule applies to all communications, not just communications to retail clients/consumers.
The FCA is also consulting on draft guidance on the FCA's expectations of firms under the anti-greenwashing rule (GC23/3) (the "Draft Guidance"). The deadline for responses to the consultation is 26 January 2024 and the final guidance will come into force on the same date as the rule.
The Draft Guidance says the FCA expects firms to ensure their sustainability-related claims are:
- correct and capable of being substantiated;
- clear and presented in a way that can be understood;
- complete – they should not omit or hide important information and should consider the full life cycle of the product or service; and
- fair and meaningful in relation to any comparisons to other products or services.
31 July 2024 – Rules on fund labelling and accompanying disclosures commence
The FCA rules provide for four optional labels – Sustainability Focus, Sustainability Improvers, Sustainability Impact, and Sustainability Mixed Goals – aimed at assisting consumers to differentiate between different sustainability objectives and different investment approaches to achieve those objectives. The Sustainability Mixed Goals label has been introduced to address feedback in the FCA's previous consultation that funds investing in a blend of strategies would otherwise not qualify for a label, which could leave a significant number of existing funds with sustainability objectives outside the FCA's regime.
These rules apply to UK managers of UK funds only.
Importantly, where the strategy to pursue the sustainability objective is likely to have a material impact on the financial return, firms must disclose the extent to which the strategy may have affected, or be expected to affect, the financial return.
The rules set out general criteria that must be met in order for products to use an investment label, together with specific criteria relating to each particular label. Firms must also make required disclosures.
The general criteria cover the following:
- Sustainability objective: all products using a label must have, as part of their investment objectives, a sustainability objective to improve or pursue positive environmental and/or social outcomes. Firms must identify and disclose whether pursuing the positive sustainability outcomes may result in material negative outcomes.
- Investment policy and strategy: at least 70% of the product’s assets must be invested in accordance with its sustainability objective and selected using a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability. There must be an independent assessment to confirm the standard is fit for purpose but this can be obtained either by internal processes or from third parties, provided that the chosen method is independent from the manager’s investment process.
Provided that 70 % of the gross value of the product’s assets are invested in line with the sustainability objective, the product may invest in other assets for liquidity and risk management purposes. There are some limited exceptions to the 70% threshold for products during their ‘ramp up’ phase and where products fall back below the threshold.
Firms must identify and disclose any assets held in the product for reasons other than the sustainability objective, explaining why they are held. A product must not include any assets in conflict with the objective. For index-tracking products, an index must be used that aligns with the criteria for the relevant label.
Firms must set out an escalation plan to be able to take action when assets do not demonstrate sufficient progress towards the sustainability objective and/or KPIs. Assets subject to such action remain within the 70% threshold. The rules do not require divestment from assets as part of the escalation plan.
- KPIs: firms must identify KPIs to measure progress against the sustainability objective. The FCA's rules do not prescribe the KPIs to be used.
- Resources and governance. Firms must ensure there are appropriate resources, governance and organisational arrangements to support delivery of the sustainability objective.
- Stewardship. Firms must identify and disclose the stewardship strategy needed to support the delivery of the sustainability objective, including activities they expect to take and outcomes they expect to achieve.
Concerns have been expressed that the 70% threshold is too high for a diversified product suitable for retail investors. There are also concerns that until common standards appear, verification of standards and comparison of products may be difficult, so there may still be greenwashing risks. The FCA has confirmed that firms can use a methodology or approach that is determined by industry practice, an authoritative body or their own proprietary standards.
The specific criteria for the labels include the following:
- Sustainability Focus
The sustainability objective must be consistent with an aim to invest in a minimum of 70% of assets that are environmentally and/or socially sustainable, determined using a robust, evidence-based standard that is an absolute measure of sustainability.
- Sustainability Improvers
The sustainability objective must aim to invest in assets that have the potential to improve environmental and/or social sustainability over time – determined by their potential to meet a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability. Firms must identify the period of time by which the product and/or its assets are expected to meet the standard, including short and medium-term targets. They must also obtain robust evidence to satisfy themselves that the assets have the potential to meet the standard. Firms’ investor stewardship strategy must help to accelerate improvements in sustainability over time. It is for firms to decide how to treat products or assets that have met their target(s) for improvement.
- Sustainability Impact
The sustainability objective must aim to achieve a pre-defined positive measurable impact in relation to an environmental and/or social outcome. A theory of change must be specified setting out how the firm expects their investment activities and the product's assets to achieve a positive impact, this can be applied at product or asset level. A robust method must be established for measuring and demonstrating the positive impact of both the assets the product invests in and the firm's investment activities. This can be quantitative or qualitative, provided that it is robust and details of the impact achieved are clearly disclosed in ongoing product-level reporting. Firms are not required to invest new capital for their products to qualify for a Sustainability Impact label. The FCA's criteria acknowledge the role that the product’s assets may have in contributing to positive impact alongside the investor’s contribution.
- Sustainability Mixed Goals
The sustainability objective must be to invest at least 70% of assets in accordance with a combination of the sustainability objectives for the other labels. Firms must identify and disclose the proportion of assets invested in accordance with any combination of the other labels. However, the requirements for each of the other labels must be met as regards the proportion of assets relevant to that label. For example, for a product invested in assets that are already sustainable together with assets with the potential to improve over time, a firm may use the Sustainability Mixed Goals label but will need to meet the specific criteria (and associated disclosures) for the Sustainability Focus and Sustainability Improvers labels, respectively, for the proportion of assets that are sustainable or improving.
Where a fund uses a label the manager must ensure that the following required disclosures are published: a consumer-facing disclosure; a pre-contractual disclosure; a public product level sustainability report; a sustainability entity report. The contents of these disclosures are prescribed by the FCA's rules. While the consumer-facing disclosure, as the name suggests, is aimed at retail customers, the other disclosures and reports must contain more detailed information intended for institutional investors and retail customers who want more information.
The consumer-facing and pre-contractual disclosures must be published at the same time as the label is first used. Their prescribed contents include the sustainability label (with prescribed words as a descriptor); any material effect (including expected effect) on the financial risk and return of the product as a result of the investment strategy; the product’s progress towards achieving its sustainability objective (together with a summary of the relevant metrics calculated using the most up-to-date data available at the time of preparing the disclosure); any material negative environmental and/or social outcomes that may arise when pursuing the product’s sustainability objective.
The product level sustainability report must be published 12 months after the label is first used and annually thereafter. The requirement to produce entity level reports is being phased in, with asset managers having above £50bn AUM producing their first reports by 2 December 2025 and asset managers with above £5bn AUM required to produce first reports by 2 December 2026. The entity-level disclosure rules apply to UK firms, capturing their approach to managing sustainability risks and opportunities in respect of UK and overseas funds managed from the UK.
2 December 2024 - Naming and marketing rules come into force for managers of non-labelled funds
For managers of non-labelled funds use of the following terms in naming and promoting funds for retail clients will be restricted: ‘ESG’ (or ‘environmental, social and governance’); ‘environment’, ‘environmental’ or ‘environmentally’; ‘social’ or ‘socially’; ‘climate’; ‘sustainable’ or ‘sustainability’; ‘green’; ‘transition’; ‘net zero’; ‘impact’; ‘responsible’; ‘sustainable development goals’ or ‘SDG(s)’; ‘Paris-aligned’; and any other term which implies that a sustainability product has sustainability characteristics.
Note that the rules, as presently formulated, place these restrictions on fund managers only.
These terms can only be used in a product's name if the following conditions are met:
- the product has sustainability characteristics and a name which accurately reflects those characteristics and does not in its name use the terms ‘sustainable’, ‘sustainability’ or ‘impact’ or any other variation of those terms to refer to the sustainability characteristics of the product;
- the manager must produce: (a) a consumer-facing disclosure; (b) a pre-contractual disclosure (or Part A of a public product-level sustainability report in circumstances where the product does not have pre-contractual materials that relate to it); and (c) Part B of a public product-level sustainability report.
- the manager must publish an explanation as to the purpose of a sustainability label; a statement that the product does not use a sustainability label and a brief explanation why the product does not use a sustainability label, on the relevant digital medium in a prominent place at which the sustainability product is offered.
According to the accompanying FCA guidance, the sustainability characteristics of the sustainability product should be material to that product "for example, at least 70% of its assets should have sustainability characteristics".
For managers making financial promotions about a non-labelled product, the restricted terms can only be used if the manager provides the disclosures referred to in the second and third bullets above. If the manager is communicating the financial promotion to retail clients through other means than the relevant digital medium, it must take reasonable steps to ensure that the required disclosures are communicated.
Rules for distributors
Distributors must communicate the labels and provide access to consumer-facing disclosures to retail investors, either on a relevant digital medium for the product or using the channel they would ordinarily use to communicate information. They must keep the labels and consumer-facing disclosures up to date with any changes that the firm makes to a label or the disclosures.
By 2 December 2024 distributors must also ensure that a notice is applied to relevant overseas funds marketed to retail investors making clear that the FCA rules on sustainability labels and disclosures do not apply. The notice must be in a prominent place on the relevant digital medium, along with a link to the FCA webpage setting out more information for consumers, or communicated through the channel the distributor would ordinarily use.
Distributors and advisers are also subject to the anti-greenwashing rule and must therefore ensure all sustainability-related references comply with that rule.
Impact on existing retail products and investors
It remains to be seen to what extent UK fund managers will adopt the FCA's labelling regime for existing products. It can be expected that there will be a significant number of funds that have been marketed as having sustainable elements and have existing retail investors, that either do not qualify for or choose not to adopt an FCA label. This does not mean that such funds were mis-sold (though some funds may have been) but retail investors could well feel that there is something wrong with an existing investment that they thought was green but which does not qualify for or choose to adopt a label. They may wish to switch their investment to a labelled fund. Such investor concerns could be mitigated to an extent by the required consumer disclosures that accompany the naming and marketing rules for unlabelled funds but those do not come into force until December 2024 and managers and financial advisers need to be prepared to deal with questions and concerns from retail investors well ahead of that.
In its Policy Statement the FCA plays down such concerns, even though they prompted the Treasury Sub-Committee on Financial Services Regulation to write to the FCA in March 2023 asking for a new cost benefit analysis estimating the costs to consumers of the proposals, including switching costs. In response, the FCA states that the new rules are designed to give consumers better information to support their investment decisions and do not require consumers to switch. According to the FCA, following the introduction of the regime any choice to switch from an unlabelled product to a labelled one will be an individual consumer’s decision, and will likely be based on several factors, which may include consideration of switching costs. Consequently the updated CBA does not include the monetary costs of consumers switching.
The FCA has stated that to ensure consumers correctly understand what the labels represent, it will focus on consumer understanding through its communications and engagement, along with information on the FCA website. However, as regards comfort for investors in existing sustainable funds that may not subsequently adopt a label, the information provided on the FCA's current consumer webpage is limited.
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