Navigating the UK's new Sustainability Disclosure Requirements (SDR): What asset managers need to know

In the face of the financial industry's growing focus on sustainability and transparency, the UK's Financial Conduct Authority (FCA) is introducing a new framework called the Sustainability Disclosure Requirements (SDR). SDR represents a pivotal change in how investment products are evaluated, managed, and disclosed in one of the most important financial jurisdictions in the world.

With the first set of changes set to be effective in mid-2024, Hatim Baheranwala, Founder and CEO of alternative ESG reporting platform, Treety, unpacks the three new components: the anti-greenwashing rule (effective May 31st, 2024), the voluntary labelling system (effective July 31st, 2024), and sustainable entity reports (effective December 2025). He also delves into the deadlines associated with each element, ensuring you're fully equipped to navigate this new regulatory landscape.

What does the new SDR require asset managers to do?



The SDR can be simplified into 3 primary components:



1. Anti-greenwashing rule



This rule establishes a clear standard for all sustainability-related communications. It mandates that any claims, whether in marketing materials, official statements, or public disclosures, must be:

• Fair: All relevant information must be presented to avoid a one-sided or misleading portrayal of the product's sustainability impact.
• Clear: Information should be easy to understand, with technical terms explained in plain language.
• Not misleading: Claims must be demonstrably accurate and supported by robust evidence.

The scope of this rule is broad, encompassing a wide range of communications, including advertisements, promotional materials, and even routine information exchanges between financial firms and their clients.

2. Voluntary labelling system


To simplify investor navigation and rebuild trust, the SDR introduces four voluntary labels that asset managers can utilise on their products:

• Sustainability focus: These products’ assets are primarily selected for their environmental and/or social sustainability characteristics.
• Sustainability improvers: These products invest in assets with the potential for significant improvements in environmental and/or social sustainability over time.
• Sustainability impact: These products aim to generate a measurable impact on specific environmental and/or social issues.
• Mixed goals: These products combine elements of the above, investing in a mix of sustainable assets, improvement opportunities, and targeted impact initiatives.

Fund managers can apply these labels to their products and use them in all client communications, provided they meet specific criteria. These criteria cover areas such as investment strategy, reporting KPIs, governance and portfolio stewardship, as well as ongoing compliance and monitoring.

Fund managers must validate and document their adherence internally. Additionally, they are obligated to provide comprehensive disclosures to clients. This includes pre-investment information, ongoing updates, and general marketing materials.

While promoting products as "sustainable," "green," or "ESG" without a label remains possible, such unlabelled funds still face disclosure requirements. These include pre-contractual and ongoing reporting, along with a mandatory explanation from the manager for opting out of the labelling system.

3. Sustainable entity reports for larger asset managers


Asset management firms with over £5 billion in assets will be required to publish annual sustainability entity reports. These reports, aligned with the frameworks established by the Task Force on Climate-Related Financial Disclosures (TCFD) and the International Sustainability Standards Board (ISSB), must comprehensively detail:

• Sustainability risk management: The firm's strategies for identifying, assessing, and mitigating environmental, social, and governance (ESG) risks across its entire organisation.
• Sustainability opportunities: The firm's approach to identifying and capitalising on investment opportunities that promote positive environmental and social outcomes.

The reports will encompass the firm's overall operations and all the financial products they manage.

Who does SDR apply to?



The Sustainability Disclosure Requirements (SDR) apply in principle to all FCA-authorised firms, including fund distributors. This extends to non-UK managers of UK funds. However, the specific elements have varying applicability:

• Anti-greenwashing rule: This rule applies broadly. Any FCA-authorised firm making sustainability claims (or related terms) in client or prospect communications – including general statements, assertions, targets, strategies, and policies – must comply with the rule. Essentially, for managers under FCA jurisdiction, the only way to avoid falling into the purview of this rule is by not making any sustainability claims at all.


• Voluntary labelling: As the name suggests, this system is optional. Asset managers can choose to adhere to the labelling framework or not. However, it's crucial to remember the previous point regarding the use of sustainability-related terms for marketing financial products without an explicit label.
• Sustainable entity reports: This requirement applies only to larger asset managers with over £5 billion in Assets Under Management (AUM). Here, AUM is calculated annually based on a rolling three-year average.
   

When does SDR come into effect?



The Sustainability Disclosure Requirements (SDR) are being phased in with several key implementation dates:

• Anti-Greenwashing Rule: Effective from May 31^st, 2024. This rule applies to all FCA-authorised firms and restricts how they can communicate sustainability claims to clients and prospects.
• Voluntary labelling: Available for use starting July 31^st, 2024. Asset managers can choose to adopt the labelling framework for their products from this date onwards.
• Product naming and marketing: Regulations governing how financial products can be named and marketed using terms like "Sustainability," "ESG," and "Green" will come into effect on December 2^nd, 2024. This applies to both labelled and unlabelled products.
• Ongoing disclosures: The first set of ongoing disclosures for all relevant financial products must be published by December 2^nd, 2025. These disclosures will provide investors with regular updates on the sustainability aspects of the products.
• Sustainable entity reports: Reporting requirements are tiered based on asset size under management (AUM).
  Firms with over £50 billion in AUM must publish their first reports by December 2^nd, 2025.
  Firms with AUM between £5 billion and £50 billion have a later deadline of December 2^nd, 2026 for their initial reports.
   

How do asset managers ensure SDR compliance?

The new Sustainability Disclosure Requirements (SDR) pose both challenges and opportunities for asset managers. Here at Treety, based on our observations of SFDR implementation in the EU, we offer some best practices to help you navigate compliance:

1. Define your sustainability strategy: Clearly decide whether your organisation will offer products with sustainability characteristics and ESG positioning. The SDR eliminates ambiguity – you either embrace sustainable finance or choose not to participate.
2. Opting out? Consider the impact: If you decide to forgo sustainability integration, ensure all your financial products avoid any communication related to ESG or sustainability. Be aware that this might affect fundraising with certain sustainability-focused investors like pension funds. Remember, for asset managers with over £5 billion in AUM, publishing a Sustainability Entity Report remains mandatory.
3. Building an ESG team (if applicable): If you choose to offer ESG or sustainability-focused products, designate a team responsible for ensuring SDR compliance. This team may comprise existing compliance personnel, but likely needs members with expertise in ESG investing.
4. Taking action:

• Compliance audit: Conduct a comprehensive audit of your existing communications to ensure compliance with the anti-greenwashing rule. 
• Labelling strategy: Decide which products will utilise sustainability labels and by when. Similarly, determine timelines for any sustainability claims made without explicit labels.
• Policy and process development: Before launching labels or sustainability claims, implement the necessary policies, strategies, target KPIs, and a reporting framework. This includes establishing processes and tools for timely disclosures and reports. Additionally, educate investment teams to ensure their decisions and portfolio engagement align with your sustainability claims.
• Sustainability entity reports (for >£5 billion AUM): While the deadline is over a year away, learning from the EU's SFDR implementation suggests early preparation is key. Start gathering data for the first report well in advance. This allows ample time for your organisation, underlying portfolio funds, and entities to build the necessary data collection capabilities – a crucial step to avoid reputational and compliance risks when the report is due.

By following these best practices, asset managers can proactively approach SDR compliance and demonstrate their commitment to responsible investing.
 

Why is SDR being introduced?



The FCA recognises that many investors in UK funds, particularly consumers, are increasingly interested in aligning their investments with positive social and environmental impact. However, a history of misleading sustainability claims ("greenwashing") within the financial sector has eroded trust in asset managers' ability to deliver on their sustainability promises. A significant portion of investors, roughly 70%, believe many so-called sustainable investments fall short of their advertised goals (Source: Boring Money Sustainable Investing Report 2022).

Recognising this challenge, the Financial Conduct Authority (FCA) undertook consultations with industry stakeholders, considered the development of similar regulations globally, and has now presented the Sustainability Disclosure Requirements (SDR) as a solution.

The FCA's policy statement clearly outlines the core objective of the SDR: to ensure that financial products marketed as sustainable accurately reflect their impact and possess the evidence to substantiate those claims.

“...our aim with this Sustainability Disclosure Requirements (SDR) and investment labels regime is simple – financial products that are marketed as sustainable should do as they claim and have the evidence to back it up.”
 

Need support with implementing SDR and SFDR regulatory changes?

At Ocorian, alongside our fund administration services, we provide ESG reporting through our partnership with Treety, ESG reporting specialists in the alternative investment space. Treety simplifies the process of gathering and managing ESG data across your investment teams and portfolio companies. The platform ensures data quality and helps you meet reporting deadlines consistently.

We also have a team of ESG experts in our regulatory and compliance division to help you assess the impact of SFDR on your business and ensure you are well-placed to implement each of the amendments when they come into force.

Please contact us for a free demonstration of our ESG reporting or a consultation with one of our ESG specialists.