FCA SDR - where are we now?

As we approach the second half of 2024 and the incorporation of the Anti-Greenwashing Rule this Friday (31/05), there has been a significant amount of progress made in the UK sustainable finance space, with the UK FCA’s Sustainable Disclosure Requirements (SDR) taking centre stage. With these developments and deadlines looming, firms are actively working to meet the various requirements and understand how their product suite fits with the new Rules, and investor demand.

While the UK benefited from second-mover advantage to observe and learn from the EU’s sustainable finance implementation, asset managers still face several challenges and problem areas associated with SDR. Most recently, the FCA published its Final Guidance for the Anti-Greenwashing Rule and launched its long-awaited Consultation on Extending SDR to Portfolio Management on 23rd April (23/04), which was followed by HM Treasury’s SDR Implementation Update on 16th May (16/05), elaborating on key elements of SDR and the interaction SDR will have in the financial services sector. There are plenty of issues that firms are facing as we begin to hit SDR effective dates.

To help your thinking, Devlin Mambo have compiled a list of five key questions we are consistently being asked:

    1.  Do the various Rules work in harmony?

Despite the notion of interoperability across SDR, SFDR and other sustainable finance regulations, we still have far to go from achieving harmony. This is particularly pertinent when evaluating overseas funds that do not fall in scope for SDR’s labelling regime but are subject to the EU Sustainable Finance Disclosure Regulation (SFDR). Overseas funds already account for a significant proportion of funds with sustainability-related terms sold in the UK – 1,666 compared to 356 domestic funds – yet are not permitted from using SDR labels, creating confusion and uncertainty around the requirements of these funds going forward. With HM Treasury recently announcing the UK Government’s plans to consult on the inclusion of funds under the OFR in Q3 2024, there will still be uncertainty around the interoperability and stance of overseas funds until 2025.

    2.  Is an SDR label commercially beneficial?

What was initially seen as a ‘commercial advantage’ in the shape of fund flows for early adopters of labels is now moving toward a more educational benefit to firms. The demand for SDR-labelled funds has not yet mirrored that of SFDR when it was first launched, where firms benefited from significant inflows for the first Article 8 and 9 funds. Despite this, a more tactical approach to early adoption is being undertaken across the market. SDR early adopters are applying for SDR label(s) for “dark green” funds, which they perceive as meeting the criteria for one of four SDR labels. By doing so, firms can take advantage of the FCA’s soft launch application process and develop a more practical understanding and awareness of the application stages and FCA thinking. Firms can then apply this knowledge when rolling out label applications across their fund ranges.

    3.  Reporting alignment or more misalignment?

As part of SDR, in-scope UK firms will be required to conduct TCFD reporting on a calendar year basis, as well as SDR reporting for products which have labels. This additional reporting has been noted as problematic by a proportion of firms and market participants who are looking to minimise multiple reporting requirements. Unless the product has a year-end of 31^st December on the first year of reporting, TCFD and product level SDR reporting will not be aligned. This will cause dual-reporting for firms on similar metrics at different times during the year. The fix is likely an interim SDR report at the end of the year to align to TCFD reporting, however there is no getting away from multiple reports to ensure alignment.

    4.  Can you align cross-border marketing?

One of the notable characteristics of the FCA is the principle-based nature of their Rules – which unfortunately creates issues with clarity for SDR label application and criteria. Many firms are likely required to rename sustainable funds to comply with the UK SDR Naming and Marketing Rules.

Similarly to the interoperability issue, firms applying for labels are posed with the challenge of aligning their marketing materials for the same underlying portfolios in different jurisdictions. The naming and marketing of funds must consider UK SDR-labelled fund requirements, any EU fund requirements (under SFDR article 8 or 9), and other international fund Rules. All funds will have different sustainability Rules and regulatory requirements in their respective home jurisdictions which dictate how they can be marketed; however, it may not necessarily be clear why there is a difference between those products to the clients of the firm, especially when created from the same pool of underlying assets.

    5.  What are firms concerned about for SDR?

With the Anti-Greenwashing Rule implementation deadline approaching and the recent publication of the Anti-Greenwashing Final Guidance by the FCA, this remains a relatively minor distraction compared to some of the larger impact deadlines coming later in the year. A key issue is meeting the four criteria for sustainability references under the Anti-Greenwashing Rule, along with ensuring that the COBS Rules for promotions being ‘clear, fair, and not misleading’ are being adhered to. We expect most compliance focus on training, new marketing materials, and those which will continue to be used for a significant period of time, like the website.

Other impact areas have been widely discussed in the groups we run and by industry participants we engage with. The main concern remains the Naming and Marketing Rules, and their interplay with labelling. This will require a lot of consideration and analysis for firms across not only their existing/new UK products, but firms overseas domiciled products as well. The key issues relate to picking the right label to match the asset mix for existing funds, whilst ensuring there is a limited, or well communicated explanation of any, change to the asset mix when under a label.