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UK’s SDR Puts Data and Governance at Heart of Compliance

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Asset managers and manufacturers of financial products sold in the UK have been told they must have adequate data, governance and technology in place to comply with the national regulator’s sustainable disclosure recommendations (SDRs), published this week.

The requirement from Financial Conduct Authority (FCA) puts data, metrics and ratings at the centre of the highly anticipated regulations, whose publication had been timed to coincide with the COP28 environment summit in the United Arab Emirates.

Data will be needed to substantiate compliance with a newly added anti-greenwashing measure requiring the use of “clear and not misleading” sustainability claims. It will also come into play if funds choose to be labelled according to new naming rules.

“Firms must have in place appropriate resources, governance, and organisational arrangements, commensurate with the delivery of the sustainability objective,” the FCA stated in its 201-page report. “This includes ensuring there is adequate knowledge and understanding of the product’s assets and that there is a high standard of diligence in the selection of any data or other information used (including when third-party ESG data or ratings providers are used) to inform investment decisions for the product.”

UK Milestone

The SDR is the UK’s first substantial piece of regulation and sets out “to provide greater transparency, consistency, and in turn, trust, in the market for sustainable investment products”. It aims to remedy what the FCA describes as a lack of confidence in global sustainability markets, which it nevertheless estimated would grow to US$36 trillion in global assets under management within two years.

“By improving trust in the sustainable investment market, the UK will be able to maintain its position at the forefront of sustainable finance, and capture the benefits of being a leading international centre of investment,” FCA director of ESG Sacha Sadan wrote.

The announcement stole headlines before the COP28, and ahead of the UN climate summit’s “finance day” when delegates discuss initiatives to harness the heft of private capital in the pursuit of reducing global temperatures.

On the same day a group of large financial institutions, including JP Morgan and Natixis, announced they had created an advisory organisation to advance investment into solutions to meet the UN’s Sustainable Development Goals (UNSDGs). As well, the Global Sustainable Investment Alliance (GSIA) published its latest annual global investment review, the highlight of which was that more than US$30 trillion had been allocated to sustainable investments.

Data Concern

The much-anticipated SDR, whose publication had been delayed from March due to the volume of industry feedback, was greeted with widespread applause from the financial sector, which will be expected to begin providing ESG data and metrics in line with the regulation by the end of July.

The FCA said it had revised other parts of its proposed rules, initially issued in January, to address issues raised by industry participants during a consultation period. Nevertheless, some observers have warned that the data challenge it presents could make compliance with the regulation difficult.

“These regulations are poised to create a significant ripple effect, amplifying the need for precise ESG reporting across all organisations,” said Stuart Wallis, executive director at green energy firm PowerUp Off-Grid Services. “The ramifications will extend far and wide – inaccurate ESG data not only jeopardises direct investments but can also cast a shadow on the share prices of listed companies.

“As fund managers increasingly shift their investments toward sustainable firms, there’s a looming risk of potential share price losses,” Wallis warned in a LinkedIn post.

Others were confident that compliance could be achieved with data and infrastructure that institutions had put in place to meet obligations under other ESG-linked regulations, especially the EU’s Sustainable Finance Disclosure Regulation (SFDR).

“Given that SDR is not highly prescriptive, firms may be able to leverage aspects of existing data capabilities and content from SFDR disclosures to meet some of the requirements and to react more quickly once the final rules are published,” wrote KPMG.

Four Labels

Under the SDR, funds and other financial products can opt into its new labelling regime, which will entitle them to use sustainability terms in their names and marketing. Those self-declaring as having a “sustainability focus” must have at least 70 per cent of investments that meet a “credible standard of environmental and/or social sustainability” or align with a specific ESG theme.

Alternatively, they can label themselves as “sustainability improvers”, with objectives to increase their sustainability over time. “Sustainability impact” products would set out to achieve a stated specific objective that will have a measurably positive environmental outcome.

The fourth label, “sustainability mixed goals”, has been added following criticism during consultations on the SDR that funds with a variety of objectives had not been considered.

Those that choose to adopt either of the labels must submit to regular reporting to demonstrate continued compliance with their designation.

Observers said the new label addition would help to close a loophole in the regulation.

The announcement also put to bed speculation that overseas fund managers would be in scope; the SDR will only apply to UK-authorised fund managers and removes portfolio managers from its scope. The final rules will also require:

  • Preparation of consumer-facing product-level disclosures by the end of 2025
  • New naming and marketing rules restrict the use of sustainability-related terms unless they have opted to use one of the four labels by December next year
  • Compliance with the new anti-greenwashing rule by the end of May

“This is an important moment in our industry’s efforts to build greater confidence and trust among retail investors in the UK’s evolving sustainable investing market,” said James Alexander, chief executive of the UK Sustainable Investment and Finance Association (UKSIF). “We believe that the new investment labels can address concerns often raised by savers over their funds’ sustainability claims and profile.”

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