The UK Financial Conduct Authority (FCA) has published a discussion paper on new sustainability disclosure requirements (SDR) for asset managers and FCA-regulated asset owners, and on a new classification and labelling system for sustainable investment products.
The proposals, which came alongside a flurry of announcements and publications from the FCA and Bank of England during COP26’s finance day, are said to be a simpler version of EU requirements under the Sustainable Finance Disclosure Regulation (SFDR).
“Given how controversial the EU rules have been, this is our opportunity to act as one nation rather than having to get the agreement of 27 other countries,” said Victoria Hickman, senior lawyer in Linklaters’s sustainable futures team. “We also have the EU experience to draw upon. The UK is moving forward with its commitment, while listening to criticism that the industry has raised on how the European programme has worked out.”
Product classification, in particular, has been controversial in the EU regime, according to Hickman. The UK is now proposing a simpler framework.
“There are three different product types in the SFDR, and it’s been quite difficult to understand how products fit within at least two of these categories,” she said. “From the information we have so far in the UK, the five buckets of product labels seem to be more intuitive and clearly defined, which will please the industry. The interrelatedness of SFDR with the EU taxonomy has and continues to be complicated, and that complexity has held back the EU regime enormously.”
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This, Hickman continued, is something that UK policymakers are acutely aware of and would have considered in developing the new rules.
“The UK is seeking to improve on what has come before, whilst also having an eye to the fact that firms will potentially be subject to requirements from other jurisdictions,” said Kelly Sporn, senior policy advisor in Allen & Overy’s international environment, climate and regulatory law group. “As anyone involved in financial services since the global financial crisis would know, regulatory divergence can be expensive for firms and coming up with regional solutions to a global problem is a tricky balance to achieve.”
For Lorraine Johnston, partner at Ashurst, the FCA’s announcement is the starting gun for the UK’s financial services to get ready for green labelling. “The potential approach set out in the discussion paper is a much more pragmatic, practical and workable framework compared to what we have seen from the Europeans,” she said. “But we can’t downplay the amount of work that will be needed in the next few years."
Global approach
The FCA has also adopted a more international approach to disclosure requirements than the EU regime, building on from the roadmap introduced in November last year. The roadmap set out an indicative path towards future mandatory climate-related disclosures, in line with recommendations from the Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures (TCFD).
“The UK has made tremendous strides in being ahead on the TCFD piece, which is important in determining its direction of travel with its own disclosure regime,” said Hickman. “Although a lot of details still need to be ironed out, the industry is pleased that the UK has followed a global approach closer to Iosco [International Organisation of Securities] and the IFRS [international Financial Reporting Standards] — not least because it is extremely difficult for firms to comply with myriad regimes.”
Creating as much harmonisation as possible is not only better for individual institutions, but also for driving the ultimate objectives of the disclosure framework, Hickman continued. “If you have a variety of different regimes pursuing similar aims but using different metrics, then you are just multiplying the data problem, which is already huge,” she said. “Inconsistency is very unhelpful when trying to develop trust in the market for these products and grow their use. In order for this to be maximised, the products need to be transparent and reliable.”
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The FCA’s proposals also consider a three-tiered disclosure system comprising product labels, consumer-facing disclosures and detailed disclosures. “The scope of the labelling regime is unclear and the FCA does not indicate whether these will apply to all products marketed into the UK, or only to those marketed by UK-authorised firms,” said Nish Dissanayake, partner at Herbert Smith Freehills. “The scope of the disclosure obligations is also not entirely clear, although the discussion paper indicates that these will apply to UK-authorised asset managers and FCA-regulated asset owners — as is the case with the FCA’s TCFD-aligned disclosures.”
According to Sporn, the paper is part of a broader cross-government and cross-regulator group developing the regime. “It’s no surprise, given the FCA’s statutory remit, that they have focused particularly on how usable disclosures will be for consumers,” she said. “There is no real detail yet on what specifically will need to be reported, although this is likely to depend in part on the development of the international sustainability reporting global baseline, which was explicitly mentioned in the government strategy.”
Time is off the essence
Given the urgency of climate change, a key concern is also how long it will take before the rules are finalised and firms begin to comply with the disclosure requirements.
“Next year does represent quite a big year in terms of reporting timetables beginning, but it will take some time,” said Hickman. “Getting the proposals off the ground, from consultation level into actual rules that firms have to implement, is a slow process.”
The discussion paper is open until January 2022 and will be followed by a consultation paper in Q2 2022, which means the final rules may not emerge until late 2022 or even early 2023.
“The real work will start now in terms of disclosure that is meaningful and transparent to enable finance to play its part in the net zero transition,” said Anna-Marie Slot, global ESG and sustainability partner at Ashurst. “Key to the success will be rapid action from the taskforce, and not more consultation.”
See also: COP26 – IFRS’ new international sustainability disclosure standards broadly welcomed
Other sources also raised concerns around the plethora of green finance regimes that firms are already implementing. “With most UK financial services firms already having to comply with an alphabet soup of ESG disclosures, many will be concerned as to what these commitments actually mean,” said Neil Robson, partner at Katten Muchin Rosenman. “Ultimately, whether this initiative is successful will turn on the wider financial markets’ buy-in.”
The scope of the regime may also evolve over time, which will be key for firms to keep an eye on. "The UK has announced a much more effective and efficient reporting requirement on financial services firms and set out an approach that is clearly much more logical and arguably comprehensible than our neighbours’ across the Channel,” said Johnston. "These obligations will initially bite on asset managers, asset owners and listed companies, but it would not come as a surprise if they were extended to other financial services firms in short order."
