The rise in the popularity of sustainable investing has created a new challenge for regulators: how can they ensure that the ESG-related claims made by investment companies—whether in fund names, marketing materials or financial disclosures—are underpinned by solid evidence, and do not risk misleading consumers?
In the UK, the Financial Conduct Authority (FCA) has started to implement its Sustainability Disclosure Requirements (SDR) and investment labels regime. This is a new regulatory regime that applies to investment companies, platforms and advisers, and is designed to help retail investors navigate the sustainable investment marketplace with confidence. Essentially, the measures introduced under the SDR should mean that investment funds that are marketed using terms related to sustainability do so accurately and transparently.
What are the FCA’s Sustainability Disclosure Requirements?
The SDR is made up of four main elements that govern the sale and marketing of sustainable investments in the UK:
Anti-greenwashing rule
The SDR includes a general ban on greenwashing – the practice of using misleading sustainability claims to increase sales. The anti-greenwashing rule applies to all FCA-authorised firms and is designed to ensure that sustainability-related claims are ‘fair, clear and not misleading’.
Naming and marketing rules
Sustainability-related terms (any variation of ‘sustainable’, ‘sustainability’ or ‘impact’) can only be used in product names if they use one of the four investment labels. For unlabelled products, the product’s name must accurately reflect the sustainability characteristics promoted by the product.
Product- and entity-level disclosures
Investment companies must provide regular, detailed information about how sustainability risks and opportunities are managed, at both the fund and organisational level. Information about sustainability features and approaches that is aimed at consumers should be easy to understand, while distributors and advisers must ensure such information is made available to their clients.
Sustainability labels for funds
Investment funds that meet specific requirements relating to their ESG credentials can apply to use one of four new sustainability labels (see below). For funds that do not use one of the new labels but are marketed as having sustainability characteristics, there are obligations that providers have to meet in terms of sustainability disclosures.
The SDR applies in the first instance to UK-based funds. The FCA will be consulting on its approach to overseas funds.
What are the new sustainability labels?
Among the most important aspects of the SDR are the new system of labels for sustainability funds, as well as the rules that apply to ESG investments that do not use one of the labels.
The four labels are:
Sustainability Focus: These funds invest in assets that are clearly demonstrated to be environmentally or socially sustainable.
Sustainability Improvers: This applies to funds that invest in assets that have the potential to become more environmentally or socially sustainable over time.
Sustainability Impact: Such funds should aim to have a pre-defined and measurable positive impact on the environment or society.
Sustainability Mixed Goals: This applies to funds that meet two or more of the sustainability objectives linked to the other three labels.
Any fund that is given one of these labels must also meet a number of general criteria. For example, it must have a sustainability objective that is explicitly included in its investment objective, and at least 70% of the fund’s assets must be invested in line with this sustainability objective. Relevant key performance indicators (KPIs) should be identified to measure the fund’s progress towards its objective, and the fund manager should explain what action it will take if insufficient progress is made.
The label system is voluntary and it is up to the fund manager to determine whether to apply for a label. Funds that are not covered by one of the four labels may still maintain some form of ESG-related goals, but they cannot use terms related to sustainability in their names and marketing material. Unlabelled funds must meet certain FCA requirements in terms of sustainability disclosures, and they are required to also publish a statement explaining why they have opted not to use one of the four labels.
What is the timeline for implementation of the SDR?
The FCA published the SDR framework in November 2023, with the measures being introduced gradually in 2024 and beyond.
31 May 2024: Anti-greenwashing rule applies to all FCA-authorised firms.
31 July 2024: Investment managers can begin to use sustainability labels.
2 December 2024: Rules on naming and marketing come into effect. Notices on overseas funds stating they are not subject to the SDR should be added from this date. A temporary extension is available to funds that use sustainability-related terms in their name and have applied for a label by 1 October 2024. These funds have until 2 April 2025 to comply.
31 July 2025: Funds that use a sustainability label to publish first annual reports from this date.
2 December 2025: Large asset managers (defined as those with above £50 billion in assets under management (AUM)) must make entity-level disclosures relating to sustainability.
2 December 2026: Entity-level disclosure requirements extended to firms with more than £5 billion AUM.
What are the implications for advisers?
As FCA-authorised firms, advisers are subject to the SDR’s anti-greenwashing rule and are also required to provide any relevant fund-level sustainability information to clients. Advisers and other distributors are required to include a notice on overseas investment products explaining that they are currently exempt from the UK’s SDR.
However, it should be noted that the FCA’s expectations for advisers remain a work in progress, particularly in relation to how sustainability is considered when providing investment advice and assessing suitability. Further guidance in this area is expected to be provided in due course.
The SDR does not as yet apply to portfolio management services. The FCA has consulted on the most suitable approach to take in this area, and its proposals are expected to be published at some point in the second quarter of 2025.
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