Extending the SDR regime

May 2024

When the FCA published its final rules on Sustainability Disclosure Requirements (SDR) in November 2023, it was notable that rules for portfolio managers did not feature — see a summary here. At the time, the FCA stated that it would address industry feedback and publish a further consultation.

The follow-up consultation paper(2.4MB) has now set out draft, reworked rules for portfolio management services. They are mainly aimed at firms providing wealth management services for retail investors but can also be used with professional clients. The FCA will publish final rules in the second half of 2024, with the labelling regime, naming and marketing rules, and disclosure requirements expected to take effect on 2 December 2024, subject to feedback.

This article summarises how the SDR would apply to portfolio managers and sets out next steps for impacted firms.

In its original 2022 consultation(2.1MB), the FCA had proposed that portfolio management services could use a sustainability label if 90 percent or more of the underlying portfolio invested in SDR-labelled funds. Firms would not have been required to produce the same disclosures as in-scope funds, but instead they would have made available the information on underlying labelled funds that made up portfolios.

In the new consultation, the FCA has radically revised its proposed rules and essentially aligned them with the final rules for fund managers in PS 23/16, with some nuances:

• Scope: Portfolio management firms with retail and professional clients would be able to use the four sustainability labels. However, only firms with retail clients would be subject to the naming and marketing rules. Importantly, the scope of the regime would be restricted to UK-domiciled clients and would exclude portfolio management services provided to funds or their management companies (meaning delegate managers may not opt in to use the labels — which may be disappointing for some).
• Timeline: The implementation timeline has been aligned to the existing timeline for fund managers — the key exception is that the labelling regime and associated disclosures would become available for portfolio managers on 2 December 2024 rather than 31 July 2024.
• Labels: Portfolio management services would be able to attain the four labels finalised under PS 23/16 if they meet the relevant criteria and the same 70 percent threshold as for fund managers. The key change compared to the original consultation is that firms would be required to perform an assessment of their portfolios' constituent funds and assets themselves — rather than simply relying on the status of underlying labelled products.
• Naming and marketing rules: These requirements would only apply where portfolio management services are marketed to retail clients — in that case they would apply in the same way as for fund managers. Services marketed to professional clients would be out of scope of these rules.
• Disclosures: Rather than making available others' disclosures (as under the original consultation), portfolio managers would need to produce their own disclosures if they use a label or use certain sustainability terms — including consumer facing, pre-contractual and ongoing disclosures. These disclosures would need to be published or provided to clients directly, depending on the nature of the relationship.
• Distributors: Distributors of portfolio management offerings would need to provide labels and disclosures to retail investors, in line with the rules for fund managers.

The FCA has also used the consultation to gather views on minor amendments to its requirements relating to the Task Force on Climate-Related Disclosures (TCFD) and existing SDR rules, for example to amend the definition of portfolio management, and to simplify and clarify the on-demand disclosure requirements for unauthorised AIFs.

It also announced that it will carry out a post-implementation review of the entire SDR and labelling rules in three years' time.

Overall, the draft rules represent a much more workable regime for portfolio managers. More effort and resources will be required compared with the previous proposals (i.e. the assessment of holdings, compliance with the naming and marketing rules, and production of disclosures), but these firms will have equal opportunities and agency as fund managers under the regime.

There are certain nuances for portfolio managers to work through on the labelling regime. They should consider whether to apply the chosen sustainability standard at the level of underlying funds or the funds' assets — but firms may welcome the possibility of performing the assessment at fund level without being required to perform a detailed look-through. Key performance indicators (KPIs) could potentially be measured at portfolio or asset level. And the stewardship approach, including engagement with managers of the underlying funds in the portfolio, should be carefully considered.

Although the relatively short lead-in time will make the labelling regime available soon, it may be a challenge for retail firms to comply with the naming and marketing rules within the compressed time period (particularly as the rules are not yet final).

Although the rules are still in draft, firms providing portfolio management services can take initial actions now to prepare:

1. Inform the SDR implementation programme by drawing on lessons learned from Consumer Duty implementation and outputs of SFDR post-implementation reviews. Groups that have fund management entities should consider joining up the implementation programme for portfolios with existing SDR fund management workstreams.
2. Identify in-scope entities and portfolios (split between retail and professional) and perform a portfolio classification exercise to understand potential alignment with the four SDR labels.
3. Decide whether to uplift and label portfolios that aim to achieve positive sustainability outcomes and perform a full impact and gap analysis. 
4. Identify where retail-facing portfolios use sustainability-related terms in their name or marketing materials — in particular, where the portfolios will not attain a label and there will be certain restrictions.
5. Review the approach to ESG governance and whether there are appropriate resources, organisational structures and technologies to support the firm's strategic goals under SDR.
6. Assess the adequacy of the approach to stewardship and whether appropriate technology for monitoring, recording and reporting engagement is in place (see further considerations here).

Firms wishing to input on the draft rules can respond to the FCA's consultation until 14 June.

• Anti-greenwashing rule: The FCA's final guidelines on the anti-greenwashing rule have been published and take effect on 31 May. Firms should be finalising reviews of their communications and compliance with the rule and guidelines.
  
• Overseas Funds Regime (OFR): Although the FCA paper adds no significant updates to the government's announcement that it plans to consult on extending the SDR to EEA UCITS in the OFR, the FCA has published a separate update. Its roadmap on implementing the OFR reveals that the government will consult in Q3 2024 on extending the SDR to OFR funds. Depending on the outcome, potential legislation would enter into force in the second half of 2025, with the FCA following a separate process to make final rules.
• Financial advisers: An industry framework for firms that advise on products that make sustainability claims is being developed by the Advisers' Sustainability Group (ASG) — a group convened in January 2024 by the FCA. It plans to develop voluntary good practice and recommendations by Q4 2024.
• Pensions and other investment products: The FCA is expected to provide feedback and consult on extending the regime to pension products in due course.
• UK Green Taxonomy: Eventually the SDR is intended to link up to the UK Green Taxonomy. Initially expected in 2023, there have been no signs of further progress and it is unclear when a consultation might be published.
  

KPMG in the UK has a dedicated Wealth and Asset Management practice with relevant ESG and sustainability expertise and experience that can assist you with implementing the SDR regime and complying with the anti-greenwashing rule.