Sustainability Disclosure Rules In The UK: Extending The FCA’s Regime To Portfolio Managers – Fund Management/ REITs

In our previous alert The FCA’s Sustainability Disclosure
Requirements and Labelling Regime (SDR): A Flexible Regime for UK
Private Fund Managers, we examined the final framework under
policy statement PS23/16, on Sustainability Disclosure
Requirements (SDR) and investment labels.

The FCA is now consulting (CP24/8, open for comment until 14 June 2024) on
bringing portfolio management products and services into scope of
the SDR from December 2024. It has also published its finalised
guidance FG24/3 on the anti-greenwashing rule, which
applies at the same time this rule comes into force, on 31 May
2024.

CP24/8 extends the SDR and labelling regime to UK portfolio
managers. This includes those performing services relating to UK
portfolio management services provided to clients on a
discretionary (and/or advisory for private markets) basis. It will
encompass those who design and manage model and/or customised
portfolios as well as those who provide bespoke portfolio
management services. It is not, however, intended to apply to UK
delegated advisers/portfolio managers of funds.

The Current Regime

The FCA’s Environmental, Social and Governance sourcebook
(ESG), extended to include the SDR, contains an anti-greenwashing
rule; a voluntary labelling regime for products with a
sustainability objective as part of their investment objective;
product disclosure requirements; sustainability entity reporting;
retail investor-specific requirements on naming and marketing; and
consumer-facing product-level disclosures.

Apart from the anti-greenwashing rule (that applies to all
FCA-authorised firms), initially the SDR applies only to full-scope
and small authorised alternative investment fund managers (AIFMs)
whose business is carried out from an establishment maintained by
the firm in the UK and in relation to authorised and unauthorised
alternative investment funds (AIFs), including unlisted AIFs and
feeder funds.

Implications of Extending the Regime: Industry and Firms

The proposed extension to portfolio managers would, the FCA
estimates, capture about 400 firms in the UK serving 2.4 million
customers and managing £1.4 trillion assets (making up a
relatively small 13% of the £11 trillion assets under
management (AUM) in the UK’s asset management
industry).¹ The extended regime is designed to improve
competition and integrity in the sustainable investment market and
align with the broader government ambition of a transition to a
more sustainable economy. A separate HM Treasury consultation is
expected to follow on how to bring non-UK funds marketed in the UK
into the SDR framework under the Overseas Funds Regime. Pension
products, insurance-based investment products, and financial
advisers are also expected to be brought within scope in due
course.

This is an important time to take stock of how the proposals are
likely to affect a portfolio manager’s structures and products
as well as what actions portfolio managers must take so they can
comply when SDR is broadened. Under SDR, label use is designed for
products marketed to retail investors (in which case the naming and
marketing and disclosure rules also apply) but can also be used for
products offered to professional investors. The FCA is seeking
feedback on the appetite for using labels for professional clients
and when offering bespoke services, therefore contemplating how
widely these rigorous standards are expected to be adopted. We
expect those who do choose to apply a label to use it across the
board to maximize the expected benefits. But the extent to which
this actually happens will be market-led.

Proposed Scope of Portfolio Management

For the purposes of the new limb of SDR “sustainability
in-scope business,” portfolio management is that carried out
from a UK establishment and in respect of UK and non-UK
investments. Services provided to non-UK clients are not caught,
and neither is delegated portfolio management to a client that is a
fund, an AIFM, or a management company on behalf of a fund. The FCA
requests feedback as part of its consultation on whether portfolio
management activities carried out from an overseas branch should be
caught.

A proposed expansive “portfolio management” definition
(aligned with the Task Force on Climate-related Financial
Disclosures (TCFD) rules in ESG2) captures managing investments as
well as private equity and other private-market activities
consisting of either advising on investments or managing
investments on a recurring or ongoing basis in connection with an
arrangement, for which the predominant purpose is investment in
unlisted securities. This differs from the October 2022 SDR and
investment labels consultation (CP22/20) that proposed that portfolio
management services would fall within scope only if 90% or more of
the value of all a manager’s investment products qualify for
the same label (in which case the manager would make disclosures
for each of the underlying products available to consumers).
Following feedback, the FCA concluded that this approach was not
workable given that most portfolios are diversified and unlikely to
invest only in UK funds with labels. The 70% threshold (applied to
the gross value of the assets within the portfolio that are
invested in accordance with the sustainability objective and other
labeling criteria) now proposed also aligns with the wider SDR
regime applicable to UK AIFMs.

How the SDR and Labelling Framework Will Apply to Portfolio
Management

In a change to the original proposals, the SDR framework and
labeling regime is proposed to be applied to portfolio management
on a consistent basis with the rules that apply to other in-scope
firms under PS23/16, as set out in broad terms below.

• General content requirements and restrictions in the
  form of a general anti-greenwashing rule, with supporting
  finalised guidance on which the FCA has consulted (see below) that
  require sustainability-related claims to be consistent with the
  sustainability characteristics of the product or service and be
  clear, fair, and not misleading. FCA-regulated UK portfolio
  advisers (of UK or non-UK AIFMs) will already be subject to this
  from 31 May 2024, in respect of financial promotions in the
  UK.




• Product disclosure requirements, including
  rules on the use of four nonhierarchical voluntary
  sustainable-investment-branded labels for managers who
  wish to use these labels. The labels are Sustainability Focus,
  Sustainability Improvers, Sustainability Impact, and Sustainability
  Mixed goals. For each label, the product must have a sustainability
  objective as part of its investment objective and at least 70% of
  product assets, subject to some exceptions, must be invested in
  accordance with the product’s sustainability objective, with
  reference to a robust, evidence-based standard that is an absolute
  measure of environmental or social sustainability. The portfolio
  manager is responsible for ensuring all assets within its portfolio
  meet the criteria, including those managed by a third party. The
  FCA points out that where clients want more than 30% of their
  arrangement to pursue only financial objectives, the portfolio
  manager would not be able to use a label but may be subject to the
  naming and marketing rules. It also sets out some specifics of how
  portfolio managers should apply the labeling criteria — for
  instance, they are responsible for selecting KPIs at the level most
  appropriate for the portfolio. When a portfolio invests in a
  labelled fund, the portfolio manager is still responsible for
  determining the standards and asset selection. In our previous alert we discussed in greater detail
  the labels and criteria (that portfolio managers are also subject
  to, as for UK AIFMs in scope) that apply.




• Product disclosure requirements, including
  pre-contractual disclosures to investors, and ongoing disclosure
  information. The consultation proposes that portfolio managers will
  be required to either publish the information or provide it to
  clients directly, meaning the information would not therefore be
  subject to the specific provisions for UK AIFMs of unauthorised
  unlisted AIFs (whose ongoing disclosures can be provided to
  investors on demand on an annual basis).




• Sustainability entity report is required for
  those portfolio managers with AUM of more than £5 billion
  (based on sustainability in-scope business, as described above).
  This report must be based on the TCFD recommendations for
  governance, strategy, risk management, and metrics and targets. The
  International Sustainability Standards Board, Sustainability
  Accounting Standards Board, and Global Reporting Initiative may be
  relevant for the purpose of these disclosures, as may other
  reporting frameworks.




• Retail investor/client-specific consumer-facing
  disclosures and naming and marketing rules ensuring that
  the use of sustainability-related terms are accurate. A portfolio
  manager not using a label but still in scope will have to produce
  the same disclosures as funds that do have a label, alongside a
  prominent statement to clarify that its product does not use a
  label and why.




• Labels and consumer-facing disclosures will
  need to be provided by distributors of portfolio management
  offerings (e.g., financial advisers, platforms, etc.) to retail
  investors.

Timing

The FCA proposes that the rules for portfolio managers come into
force from 2 December 2024 and the remaining implementation dates
(ongoing product level and entity-level disclosures) are aligned.
The phased outcome would therefore be as set out below.

Those portfolio managers that market sustainable investment
products and may have a competitive advantage in applying an FCA
label may welcome the short time scale that the FCA intends to
bring them into scope. In their feedback, others may request a
longer lead-in time to achieve compliance as well as consider if
and how they want to use a label for future funds.

Final Anti-Greenwashing Guidance

The FCA found that feedback to this consultation was broadly
positive, and it has responded in its final guidance to requests
for further sector-specific examples and clarity on its
expectations. The FCA reminds firms that it has worked closely with
the Competition and Markets Authority and Advertising Standards
Authority to ensure consistency in this area and that other FCA
principles and the Consumer Duty also apply to
sustainability-related claims a firm may make.

Although a non-UK fund manager can (for now) market its products
into the UK without having to comply with SDR, and a UK portfolio
manager acting as a delegate as an EU AIFM/EU AIF remains outside
scope, the anti-greenwashing rule will still be relevant for
financial promotions made in the UK. Therefore, all FCA-regulated
firms will want to carefully review their communications and
marketing materials to ensure that their sustainability claims are
fair, clear, and not misleading, and consistent with the
sustainability characteristics of that product or service. For
instance, a firm will want to make sure that it has a robust
product governance framework in place so that it can substantiate
any sustainability claims made in respect of specific products and
services.

Practical Steps

In anticipation of the final rules taking effect as well as the
proposed extension to portfolio management, firms and managers
should be thinking about the following key topics (in addition to
the action point on the anti-greenwashing rule discussed
above):

• The extent that the firm/manager and its products are in
  scope




• How and if the labels may apply to the firm/manager’s
  existing products




• Whether the firm/manager wants to use a label for its future
  products and, if so, any changes it may have to make to do so




• The information to be disclosed and what information needs to
  be gathered to comply — including any challenges with data
  availability and how those challenges can best be managed




• Inter-operability (i.e., Sustainable Finance Disclosure
  Regulation disclosures and US Securities and Exchange Commission
  fund name requirements, EU anticipated guidelines on fund names and
  proposed ESG labels).

How this is to be approached will also have to be considered
alongside the expectation that the rules are likely to apply to
overseas products in due course.

Footnote

1. References taken from CP24/8.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.