There is increasing scrutiny globally on the role of finance in driving sustainable business activity, amidst the climate emergency and the wider focus on how business operations impact people and the environment.
In this broad context, law and regulation has been developed that applies to so-called sustainable investments. In this guide, we look at the frameworks that have been put in place in the UK and EU and what they mean in practice for fund managers.
Sustainability disclosure requirements in the UK
New UK sustainability reporting standards in line with international standards are expected to be outlined by the UK government in 2025. These are expected to have effect on an economy-wide basis over time. Until then, the only sustainability disclosure requirements (SDR) in effect in the UK are those that have been imposed on fund managers by the Financial Conduct Authority (FCA) – though the regulator intends to extend similar requirements to providers of portfolio management services too.
Sustainability labels
In the UK, the FCA’s SDR introduced a set of four voluntary sustainability labels that funds can use to indicate their sustainability objective and how they invest in sustainable assets.
The labels are:
- Sustainability Focus;
- Sustainability Improvers;
- Sustainability Impact; and
- Sustainability Mixed Goals.
Each label has specific criteria that funds choosing to apply that label must meet. They must adopt a robust, evidence-based standard of sustainability, and measure and report on key performance indicators (KPIs). There are, however, some operational challenges that fund managers will have to overcome if adopting one of the four sustainability labels:
|
Label |
Product specific criteria |
Operational challenges |
|---|---|---|
|
Sustainability Focus |
Assets must be environmentally and/or socially sustainable according to a robust, evidence-based standard. |
The FCA has not defined what constitutes a sustainable asset.
Fund managers should ensure their methodology clearly explains how assets contribute to a positive environmental and/or social outcome. |
|
Sustainability Improvers |
Assets must have the potential to meet the robust, evidence-based standard over time.
Fund managers must identify a period of time by which the product or assets are expected to meet the standard.
Fund managers must identify interim targets for improvement.
Fund managers must obtain evidence demonstrating an asset’s potential to meet the standard. |
Specifying both time and targets is prone to forecasting error.
This might involve a different concept of target state sustainability – i.e. operating sustainability versus sustainable business.
Obtaining evidence may be difficult if investing indirectly via a third-party fund.
Firms aiming for product-level improvement should beware of ‘paper decarbonisation’ – where efforts to decarbonise are documented but are only superficial or theoretical in practice. |
|
Sustainability Impact |
Investments must aim to achieve a pre-defined, positive, measurable impact.
Fund managers must specify a “theory of change”.
Fund managers must specific a method to measure and report on the impact. |
The FCA does not define these terms, although there are some well-defined market practices.
Although the FCA did not follow through on proposals to require that investments provide additional financial benefits that would not have occurred without the investment in order to qualify for the Sustainability Impact label, fund managers still need to describe both investor and asset contribution to achieving impact. |
|
Sustainability Mixed Goals |
Fund managers must identify the proportion of assets under each objective.
Fund managers must meet the requirements for at least two of the three other labels. |
Meeting multiple label requirements across different assets may be challenging.
The FCA has indicated that funds can be treated as assets but that a sustainability label itself is not an absolute measure of sustainability. The fund of funds manager remains responsible for ensuring adherence to SDR labelling criteria. |
Disclosure requirements
Under the FCA’s SDR regime, a set of disclosure requirements also apply to both labelled and unlabelled funds that use sustainability-related terms in their names or marketing materials. These include entity-level disclosures on the governance, strategy, risk management, and metrics and targets of the fund manager; product-level disclosures on the sustainability objective, policy, strategy, KPIs, and impact of the fund; and consumer-facing disclosures that explain the meaning and implications of the sustainability label or terms used by the fund.
Naming and marketing restrictions
The SDR also include a set of naming and marketing restrictions designed to prevent funds from using potentially misleading or confusing sustainability-related terms in their names or marketing materials, unless those funds comply with the disclosure requirements and use a sustainability label, if applicable. The naming and marketing restrictions apply only to retail funds, while institutional funds are subject to a general anti-greenwashing rule that prohibits any false or misleading statements or omissions on sustainability matters.
Distributors
A set of rules for distributors is also included as part of the SDR regime. The rules require distributors to communicate the sustainability label of the funds they distribute, provide access to the consumer-facing disclosures, and attach a notice to any overseas fund that is not subject to the UK SDR regime.
Implementation timeline
The SDR is being implemented in phases over a three-year timeframe. The anti-greenwashing rule took effect on 31 May 2024 and the new labelling regime came into effect on 31 July 2024. The naming and marketing restrictions and the consumer-facing disclosure requirements take effect from 2 December 2024. The final set of rules come into force on 2 December 2026, when the sustainability entity reports are due for all fund managers with more than £5 billion in assets under management. Fund managers and distributors need to consider the impact of the SDR on their products and processes and the compliance challenges and market opportunities that the regime brings.
Actions for fund managers and distributors
Fund managers and distributors should consider:
- carrying out a regulatory impact assessment to determine which activities and entities are in scope of the SDR;
- identifying which of their products are institutional-facing versus retail-facing, to determine which rules apply to which, as institutional products are not in scope of the naming and marketing restrictions. This product classification workstream should be quite straightforward for the majority of products as it is information that will be tracked by compliance teams already but is important to get this correct to avoid mistaken actions subsequently;
- undertaking a deep dive into the labelling requirements. The amount of implementation effort required will depend on the split of institutional versus retail funds and whether the manager wants to label or not;
- reviewing marketing materials and policy for both retail and institutional funds, with a view to complying with the naming and marketing restrictions in respect of the former, and the anti-greenwashing rule for both types of fund;
- conducting a disclosure classification exercise. This should largely build on the product classification exercise, but due caution should also be paid to retail funds not just using sustainability-related terms in fund names but also or instead using sustainability-related terms in marketing materials, as this might inadvertently bring those funds into scope of the consumer-facing disclosure requirement;
- the extent to which they need to uplift their existing TCFD entity report to comply with the sustainability entity report requirements. There is much less guidance on the required contents of that entity report, which means firms may wish to carry out gap assessments against the ISSB, SASB and GRI standards together with a light materiality assessment to set parameters for disclosures;
- assessing any prospective disclosures against any internal greenwashing guidelines or other policies to ensure they meet regulatory standards. The FCA has published guidance on its anti-greenwashing rule to support firms in this regard.
Overall, the implementation programme needs to be clearly structured. Resourcing needs will depend on how many products are in scope of SDR and how ambitious firms are when seeking labels for their products. Additionally, large asset managers that may be in scope of the EU CSRD reporting regime from 2026 in respect of financial year 2025 may wish to combine their sustainability entity reporting workstream with their CSRD implementation efforts.
The EU Sustainable Finance Disclosure Regulation (SFDR)
The Sustainable Finance Disclosure Regulation (SFDR) is an EU regulation that aims to promote transparency and accountability in the financial services sector in relation to environmental, social, and governance (ESG) factors.
The SFDR requires fund managers, advisers, and intermediaries to disclose how they integrate ESG criteria into their investment decisions, risk management, and product design. The SFDR also introduces a classification system for financial products based on their sustainability objectives and impacts. It applies to certain financial market participants and financial advisers who offer financial products in the EU.
The SFDR introduces three key concepts: sustainable investment; sustainability risk; and sustainability factors:
Sustainable investment is an investment that contributes to an environmental or social objective, without harming any of those objectives or good governance practices.
Sustainability risk is an ESG event or condition that could negatively affect the value of an investment.
Sustainability factor is a factor related to environmental, social and employee matters, human rights, or anti-corruption and anti-bribery matters.
The SFDR requires financial market participants and financial advisers to disclose on their websites and in pre-contractual documents how they integrate sustainability risks and impacts in their investment decisions and advice. They must also disclose information about the environmental or social characteristics or the sustainable investment objective of their financial products, as well as the methodologies and indicators used to measure and monitor them. This requirement also applies to non-EU products and services that are distributed in the EU.
Firms within the scope of the SFDR are required to consider how sustainability risks are incorporated into the investment decision-making process and how the remuneration of individuals is consistent with sustainability issues. In some cases, firms subject to the SFDR have made strategic changes to the way they operate prior to making the required disclosures under the SFDR.
The SFDR mandated the three European supervisory authorities in financial services – the European Banking Authority, the European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority – to develop regulatory technical standards (RTS) and guidance to supplement the regulation and provide more details on the content and presentation of the disclosures.
The RTS cover aspects such as the principle of "do no significant harm", the sustainability indicators and adverse impacts, and the taxonomy-related disclosures for financial products that promote environmental characteristics or objectives.
The European Commission is in the process of reviewing the SFDR and held a consultation in late 2023 with stakeholders with a view to introducing some reforms to the existing SFDR framework. A May 2024 report it published shed light on some of the feedback it received to its consultation and gives some clues as to what reforms may follow:
- there was widespread support for the broad objectives of the SFDR to strengthen transparency around sustainability in the financial services sector and to harmonise sustainable finance disclosures across the common market;
- there were split views across respondents regarding the relevance of entity-level disclosures under SFDR;
- there was some support for setting uniform disclosure requirements for all financial products offered in the EU, with additional disclosures for products making sustainability claims;
- there was strong support for a voluntary product categorisation system for financial products under SFDR. The introduction of such a system would be a significant difference from the current disclosure-oriented approach. However, there was no clear preference regarding the two proposed product categorisation systems;
- there was strong support for a specific category for products with a transition focus.
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