These rules currently apply to UK-authorised funds such as UCITS or AIFs (alongside AIFMs and UCITS management companies), but will now capture all portfolio management services provided in accordance with mandates given on a discretionary client-by-client basis (as per MiFID), including model portfolios, customised portfolios and bespoke management services. I addition, these proposals also extend the SDR to private equity or other private market activities consisting of advising on or managing investments on an ongoing basis for the predominant purpose of investing in unlisted securities. By doing so, the FCA aims to ensure that portfolio management offerings marketed as sustainable investments meet sufficiently high standards and enhance trust in investment markets.
The SDR regime consists of labelling requirements, naming and marketing rules and disclosure requirements applying in respect of investment solutions making sustainability claims, as well as entity-level disclosures for certain firms.
These proposals are primarily aimed at bringing wealth management services provided to retail investors into the SDR framework. Consequently, there is only limited applicability of the requirements to investment managers providing services to professional clients only, although they may opt in to the 'labelling' regime and will be subject to the entity-level reporting requirements where relevant thresholds are met.
The proposed scope does not include services where clients are based overseas (i.e. those that either normally reside outside of the UK or have their registered office (or head office) outside of the UK). It also does not include portfolio management provided to a client that is a fund, or an Alternative Investment Fund Manager or management company for or on behalf of a fund (i.e. where the portfolio manager acts as a delegate). Otherwise, the rules apply to firms that provide portfolio management carried out from an establishment maintained by the portfolio manager in the UK.
The FCA has set out these proposals in consultation CP24/8 which is currently live. Responses to these proposals must be submitted by 14 June 2024 using the response form available here.
Labels
Where firms provide portfolio management offerings with an objective seeking to achieve positive sustainability outcomes, they may choose to use a label, provided certain qualifying criteria are met.
The FCA has created four labels which can be 'attached' to managed products or services, each in respect of particular sustainability objectives or investment approaches. The FCA has set these out, along with a description of their attributes as follows:
- Sustainability Focus
- The sustainability objective must be consistent with an aim to invest in 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 be consistent with an 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 will need to 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 supports delivery of the objective and helps to accelerate improvements in sustainability over time.
- Sustainability Impact
- The sustainability objective must be consistent with an aim to achieve a pre-defined, positive, measurable impact in relation to an environmental and/or social outcome.
- Firms must specify a theory of change setting out how they expect their investment activities and the product’s assets to achieve a positive impact.
- Firms must specify a robust method for measuring and demonstrating the positive impact of both the assets the product invests in and the firm’s investment activities.
- Sustainability Mixed Goals
- This is for products with a sustainability objective to invest at least 70% in line with a combination of the sustainability objectives for the other labels. Requirements for each of the other labels in which the product invests must be met.
These labels are not designed in a hierarchy and are aimed at helping investors to differentiate between varying objectives and investment strategies related to sustainability.
In order to use a label for an investment solution, the portfolio management offering must meet the general and specific criteria relating to that label on an ongoing basis in addition to preparing the required disclosures. These criteria must be reflected in the agreement or arrangement under which the portfolio management service is provided. On this basis, at least 70% of the overall arrangement would need to be invested in accordance with the sustainability objective as well as meeting other applicable qualifying criteria. Where strategies are pursued in which more than 30% of an arrangement follows financial objectives only, or indeed any other non-sustainability linked objective, the label would not be able to be used, however, the naming and marketing rules discussed below may still apply.
The FCA proposals require portfolio managers to be responsible for ensuring the applicable criteria are met, including where the management of any assets within portfolios are carried out by a third party. Further to this, although overseas funds remain out of scope of the regime and labels cannot be applied to them, managers will be responsible to assess such assets against the criteria in respect of in-scope products or services that invest in these.
Naming and Marketing rules
The naming and marketing rules restrict sustainability-related terms from being used in the naming and marketing of portfolio management offerings provided to retail investors unless a label is used in accordance with the above.
The FCA's proposed naming rules include:
- The portfolio management offering must have sustainability characteristics and its name must accurately reflect those characteristics, but the terms ‘sustainable’, ‘sustainability’, ‘impact’ and any variation of those terms must not be used.
- Firms must produce the same types of disclosures as required for labelled products.
- Firms must also produce a statement to clarify that the offering does not have a label and the reason why, and either publish this information (on the relevant digital medium) or provide it to the retail investor.
Alongside these, the FCA has set out the following marketing rules:
- Firms must ensure that financial promotions relating to an offering are consistent with its label and associated disclosures, where relevant.
- Firms that are not using a label for a portfolio management offering but are using sustainability-related terms in financial promotions relating to them must produce the same types of disclosures and statement as those required under the naming rules.
- Where a portfolio or managed service does not use a label but invests in certain funds that do have labels, the manager may explain that certain investments within the 'product' are labelled. However, it must not be implied that the whole portfolio is 'sustainable' and anti-greenwashing rules must be adhered to.
Disclosure requirements
Consumer-facing disclosures
In addition to the labelling regime and naming and marketing rules, the FCA proposals require that portfolio managers must produce consumer-facing disclosures summarising the key sustainability characteristics. These must be produced for both labelled offerings and those that use sustainability-related terms in their names and marketing.
These disclosures are required to be a new standalone document provided to investors alongside other key information documents. The FCA is not suggesting a specific template for this information, but to promote consistency, does set out categories of disclosures firms are required to make. These include:
- either the sustainability objective and label, or the statement to clarify that the portfolio management offering does not have a label;
- the investment policy and strategy (including what the portfolio will and will not invest in);
- relevant KPIs and/or metrics;
- details of where a consumer can access other relevant sustainability and non-sustainability-related information; and
- for the ‘Sustainability Mixed Goals’ label only, the proportion of assets invested in line with each of the other relevant labels.
These disclosures must be reviewed and updated annually and, for portfolio management offerings with labels, must be updated to reflect progress towards achieving the applicable sustainability objective.
Where provided in hard-copy form, such disclosures must not exceed two pages, and otherwise must be made available in a prominent place on the relevant medium when shared digitally. This includes that, for labelled products or services, the disclosures are no more than 'one mouse click away' from where the label is presented. The FCA recognises that not all portfolio managers make their managed offering information public and, where this is the case, proposes that the disclosures are provided directly to retail clients.
Detailed product-level disclosures
The proposals also require that portfolio management offerings which use a label or sustainability related terms in their naming and/or marketing must include sustainability information in their ongoing 'product-level' disclosures annually and, for products or services without a label, in their pre-contractual disclosures by 2 December 2024.
The information required to be disclosed for products or services using a label will be broadly associated with the qualifying criteria for the applicable label, and will be the same information as is required under the existing rules for UK authorised funds. This includes disclosing how the portfolio manager determines the assets the portfolio invests in, and the evidence-based standard of sustainability that it uses.
For the ‘Sustainability Mixed Goals’ label, the disclosures must include the proportion of assets invested in line with each of the relevant labels, and the information required for those labels.
The pre-contractual and ongoing 'product-level' disclosures for portfolio management offerings that do not use a label must, at a minimum, include information relating to the investment policy and strategy and any relevant metrics.
As with the consumer-facing disclosures, 'product-level' disclosures must be made available in a prominent and easily accessible place on the digital medium where the product or service is offered. Similarly, where portfolio managers do not make information on their offerings publicly available, they must provide the information required in these disclosures to their clients.
Entity level disclosures
In addition to the consumer and 'product-level' disclosures, firms with over £5 billion AUM are required to annually disclose entity-level information in line with the Task Force on Climate-Related Disclosure's (TCFD) four pillars. This includes:
- their governance around sustainability-related risks and opportunities;
- the actual and potential impacts of sustainability-related risks and opportunities on their businesses, strategy and financial planning;
- how the firm identifies, assesses and manages sustainability-related risks; and
- the metrics and targets used to assess and manage relevant sustainability-related risks.
In these proposals, the FCA has stated that firms which use labels or sustainability-related terms in their names and/or marketing of portfolio management offerings must also include details on their resources, governance and organisational arrangements for them.
In respect of these entity-level disclosures, firms may cross-refer to disclosures made in a group, parent-level or other relevant reports, provided the information is clearly signposted and other cross-referencing requirements are met.
Implementation
Subject to feedback received in response to the consultation, the FCA is proposing for these rules to be effective from 2 December 2024 for portfolio managers. For ongoing 'product-level' disclosures, where a label is used by a portfolio manager, these reports are required by 2 December 2025.
The implementation of the requirement for entity-level disclosures will be aligned with the broader SDR timetable. Larger firms with AUM greater than £50 billion will be subject to these measures from 2 December 2025 and smaller firms, with over £5 billion in AUM, one year later in 2026.
Although designed to improve consumer experiences in the market for sustainable investments, these proposals create additional burdens for providers of managed services when seeking to offer 'sustainable' managed products and services. DWF's wealth management regulatory team, supported by our internal Regulatory Consulting, ESG Sustainability and Investment Funds capabilities, is well-positioned to advise affected firms when considering the implications of these proposals on investment management offerings, and to provide assistance to ensure compliance with these measures as they are implemented.
We would like to credit the author Simon Lewin for writing this article.
