The UK’s Financial Conduct Authority (FCA) has introduced a fourth label for sustainable funds as as it releases final rules for sustainability-related financial disclosures, anti-greenwashing measures and fund-labelling.
In response to market feedback that funds which take a varied ESG strategy may find it difficult to fit into one of the three labels originally proposed, the FCA has added a “mixed-goals” label.
The mixed goals label will sit alongside the original three labels, which cover transition funds under the improvers label, impact funds and funds which hold sustainable assets.
Funds under any of the other three labels must invest at least 70 percent of their assets in line with the criteria, but mixed-goals funds can hit the 70 percent threshold by investing in a combination of criteria. For instance, a fund could invest both in sustainable assets and transitioning assets.
However, mixed-goals funds will also have to disclose in line with multiple label standards for the assets in each category.
Minor label changes
The other labels remain largely unchanged from the previous consultation, but the FCA has made some changes in response to feedback.
On the general level, funds may no longer hold assets that are in conflict with their sustainability objective, defined as “investments that a reasonable investor might consider” to be so. Under the previous proposal, they would only have been required to disclose these assets.
Funds seeking any of the labels will have to meet common basic requirements, such as identifying sustainability KPIs and ensuring adequate resourcing and governance to support achievement of the fund’s objective.
In response to investor feedback, stewardship-related requirements have been dropped from the “improvers” label, with products now required to invest in assets which have the potential to improve their environmental or social sustainability.
Entity-level stewardship strategies should “support delivery of the objective and help to accelerate improvements in sustainability over time”, but the emphasis on the product level of achieving sustainability goals via stewardship has been removed.
The FCA has also left it up to investors to decide what happens to assets in the fund when they achieve the required improvements, a question that came up in consultation responses.
The “sustainable focus” label, which would require funds to hold a certain percentage of assets in line with an environmental or social standard, has kept the threshold at 70 percent despite many respondents saying it was too high, too low or not needed.
However, the FCA replaced the term “credible” in the description of standards for the label with “robust, evidence-based standard that is an absolute measure of sustainability”. The regulator also clarified that managers’ internal standards can be used.
For the impact label, references to “real-world” impact have been removed among a number of other changes and clarifications.
The FCA said it estimated around 45 percent of funds using sustainability-related terms would use one of the labels.
The disclosure regime sets out requirements for consumer-facing, pre-contractual and ongoing product-level disclosures, which include details of stewardship strategies, fund level sustainability KPIs and label-specific disclosures, as well as some basic entity-level disclosures.
After significant market pushback, the FCA’s final naming and marketing rules ban non-labelled funds from using the terms “sustainable”, “impact” or “sustainability”. Other terms are allowed, however, provided the firm also discloses on similar lines to a labelled fund and prominently explains that the product both does not have a label and why.
Such a fund must also have sustainability characteristics which reflect the name, the regulator said, and 70 percent of assets should be aligned with these.
Some concerns were raised over the use of index names in passive funds. The FCA said managers can choose not to use the name of a benchmark if it does not meet requirements and that benchmark administrators are subject to the anti-greenwashing rule.
Cleaning up greenwashing
The greenwashing rule requires references to the sustainability characteristics of a product or service to be consistent with actual characteristics, as well as fair, clear and not misleading. The FCA is consulting until late January on more detailed guidance on this rule.
Examples given of potentially rule-breaking conduct in the guidance include claiming a fund is “fossil-fuel free” despite it having revenue thresholds for fossil fuel activities higher than zero, or material promoting a green bond which does not mention that money can be spent on improving the efficiency of fossil fuel extraction.
The requirements will be implemented in stages. The first to apply will be the anti-greenwashing rule, which comes into force at the end of May 2024, while fund-labelling and disclosures will be applicable from the end of July. This will be followed by the introduction of naming and marketing rules at the beginning of December.
Product and entity-level disclosures for firms with more than £50 billion AUM will come into force in early December 2025. Firms with more than £5 billion will face the same requirements from December 2026.
James Alexander, CEO of UKSIF, said the group was “pleased to see a number of important revisions to the regime to address potential implementation challenges and promote greater transparency”, but urged the FCA to convene an industry group to help investors understand implementation.
Alexander also called on the FCA to engage with regulators overseas to promote international harmonisation. The FCA’s policy document provides an updated mapping of relationships between the SDR and the EU’s SFDR, as well as how the FCA categories align with proposed categories in the EU’s SFDR reform.
“We continue to support greater alignment and compatibility between the [EU and UK] regimes,” it said.