EU, UK ESG fund disclosure catchup

A) UK-Sustainability Disclosure Requirements latest

1. Summary: SDR status, pending deadlines

Less than one year ago, the Financial Conduct Authority (FCA) published their Sustainability disclosure requirements (SDR) rules. Since then, UK firms within scope have faced a challenging implementation schedule.

So far, key SDR milestones have dealt with:

• The ‘anti-Greenwashing rule’ has been in place since 31 May;
• ‘Sustainability labels’ have been available for local firms “ready” to adopt, since 31 July.

On 2 December 2024, local asset managers face the next set of major ‘hard’ SDR deadlines.

• Naming and marketing rules: the use of ‘sustainability’-related terms in fund names & marketing materials permitted only if the product uses an SDR label, or complies with general FCA rules, which include:
• SDR consumer-facing disclosure [CFD]: unlabelled ‘sustainable’ products must produce a standalone, 2-page document providing clear, concise information to retail investors; plus:
• SDR pre-contractual disclosure [PCD]: firms must also disclose specific, detailed information in their fund prospectus (e.g. relating to the investment policy, strategy and any relevant metrics).
• Distributor rules: UK intermediaries must also provide access to the CFD and ‘prominently’ notify investors that overseas products are not subject to SDR labelling and disclosure rules.

2. SDR firm website updates

The most recent FCA updates to their ‘Sustainability disclosure & labelling regime’ webpage refer to:

a) ‘Investment labels’ section: ‘downloadable SDR labels’ content.

This provides distributors with access of the four investment labels and other information on their terms of use (e.g. FCA exclusive rights to the trademarked investment label logos, with unauthorised use prohibited).

b) ‘Naming and marketing’ section: ‘temporary flexibility’ update.

On 9 September, the FCA announced “temporary flexibility” for certain firms seeking to comply with their SDR ‘naming and marketing rules’, until 2 April 2025.  These were only available “in exceptional circumstances” for limited authorised UK products, provided:

• The current fund name had the terms ‘sustainable’, ‘sustainability’ or ‘impact’ (including variants);
• The firm intended either to use a label, or to change the name of that fund;
• The completed FCA application for approval of amended fund disclosures was filed before 2 Oct 2024.

NB: These temporary measures were not available to funds using other ‘relevant terms’ in their names (i.e. per ESG sourcebook rule 4.3.2). The FCA stated they expect all firms “to comply with the rules as soon as they can, without waiting until 2 April 2025”.

c) ‘Investment labels’ section: new ‘pre-contractual disclosure examples’ subsection.

On 1 November, the FCA published a document providing examples of pre-contractual disclosures; this contains 3 x tables, covering ‘Sustainability Focus’ and ‘Sustainability Improver’ labels.

The FCA say “these examples are based on our experience of applications to date and are non-exhaustive but are intended to aid applicants as they prepare their documentation“.

3. Interim FCA outlook

"It is a new regulation, and with every new regulation, we're kind of feeling our way,"
Emily Shepperd, FCA chief operating officer (6 November 2024)

On 2 October, an FCA spokesperson had told a conference that 10 labels had been awarded, so far.

Last week, it was reported the FCA have now received over 100 applications for SDR ‘sustainability’ product labels.

They also expect “some major names” to officially announce labels for their products …within the next two weeks.”

 4. FCA postpone OFR/SDR consultation

The new UK government has postponed a previously planned consultation on extending SDR to EU-UCITS funds.

The FCA separate Overseas Fund Regime (OFR) transition is now underway; last week, the first application ‘landing slot’ for UCITS fund operators within the temporary marketing permissions regime (TMPR) was allocated.

The OFR ‘roadmap’ issued in May 2024 stated an intention to consult on the application of the SDR regime to EU funds within the OFR during Q3-2024.  There were additional placeholders for:

• end-2024: UK government “to lay any legislation required to implement its decision on SDR and labelling for OFR funds”;
• 2025: FCA “likely to consult on rules and guidance” related to SDR and labelling for OFR funds;
• H2-2025: any legislative requirements related to SDR for OFR funds “likely to come into force”.

However, current challenges facing asset managers in securing SDR labels and preparing for the major 2 Dec 2024 deadlines (naming & marketing, disclosure rules) have reportedly led to a deferral of the SDR/OFR consultation.

NB: there is currently no indication per FCA OFR webpage [i.e. ‘Future policy initiatives’] when the consultation will be re-scheduled.

5. Still no news: SDR Distributor template

There’s still no news on a formal announcement of a new SDR information template, or if a revised version of the FinDatEx European ESG template [EET] is necessary, to assist local distributors meet their SDR obligations.

As before, the current EET v1.1.2 contains the 4 x FCA ‘sustainability’ product labels in the ‘ESG Label-Standard List’ tab; these link to EET field no.29 [20060_Financial_Instrument_ESG_Label_Or_Standard].

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B) EU SFDR latest

1. SFDR Level 1 status

Last time around, we summarised the European Supervisory Authorities (ESAs) joint advice to the EU Commission (EC) on how to improve the Sustainable Finance Disclosure Regulation (SFDR) legal framework.  This includes:

• A formal product classification system: replacing informal SFDR ‘article 8’ [“light-green”] and ‘article 9’ [“dark-green”] product types;
• “At least” two official SFDR product categories: ‘sustainable’ and ‘transition’;
• Improved legal definition of ‘sustainable investments’: aligned with the Taxonomy regulation [TR];
• ‘Relevant documentation’ for product disclosures:g. “essential information… in the form of a Key Investor Document” presented to retail clients, plus “more detailed information” for professional investors;
• Disclosure information provided to investors in a digital format: enabling data layering;
• Mandatory, ‘minimal’ Principal Adverse Impacts (PAI) disclosure: for all financial products;

It is currently expected the newly appointed EU Commission will formally introduce their proposed ‘SFDR II’ Level 1 amendments to the EU Parliament and Council during Summer 2025 (i.e. ahead of ‘Trilogue’ due process).

NB: this is borne out in the ‘Sustainable Finance implementation timeline’, recently updated by the European Securities and Markets Authority (ESMA), who form part of the ESAs.

2. SFDR Level 2 RTS: missing in action?

Following their EC mandate to review the PAI indicators and other product disclosures, the ESAs delivered a 221-page ‘final report’, including draft revised SFDR ‘Level 2’ technical standards, on 4 December 2023.

On 21 January this year, the acting head of the EC’s Asset Management unit met with the Economic and Monetary Affairs Committee [ECON] of the EU Parliament; she informed them the EC were “unlikely” to keep their mid-March 2024 deadline to adopt the latest draft SFDR RTS. Although the EC were doing their “very best to adopt” this “as soon as possible”, she cited the “the length and complexity of the text” and “internal transition backlogs that need to be covered within the existing EC mandate”.

Since then, there has been no further official EC statement on this subject.

Another reminder that if/when the new Commission choose to adopt the draft SFDR RTS, a formal co-approval from both the new EU Parliament and Council is required, to enable legal publication.  This additional scrutiny period may last between 3-6 months. Moreover, industry sources had noted the EC’s previous readiness to provide firms with a transition period of “at least one year” (i.e. once the final approved SFDR RTS was legally published).

NB: there is no ‘SFDR L2’ placeholder in ESMA’s latest Sustainable Finance timeline (alongside the signposted ‘mid-2025’ SFDR Level 1 legal review), i.e. despite draft RTS co-authorship (and substantial interim impact, if adopted).

3. ESAs publish SFDR PAI

On 30 October 2024, the ESA’s published their third annual report, covering SFDR PAI disclosures.

The latest recommendations and examples of ‘good and best practices’ are based on three difference sources:

• Qualitative assessment no.1: 65 x actual SFDR Entity-level PAI statements; and
• Qualitative assessment no.2: European ESG Template (EET) product disclosure data (via Morningstar);
• Analysis of NCA survey responses [i.e. attached per ‘Annex II’].

This is the first time the ESAs have taken “authentic” Entity-Level PAI content (per current RTS) into consideration.

They point to “significant improvements” in the quality of product PAI disclosures, “although the share of products disclosing SFDR PAI information remains quite low”.

Looking ahead, the ESAs recommend the EC to consider “the high value of the PAI disclosures” within their SFDR Level 1 ‘comprehensive assessment’.  They re-iterate their opinion that PAI disclosure should be based on the size of Financial Market Participants’ total investments (i.e. not the current 500-employee threshold).

NB: curiously, there is only one mention (i.e. footnote, page 13) of the ESA’s draft SFDR RTS Final report, delivered to the EC last December. This contained almost 70 pages of proposed Level 2 PAI disclosure changes, following their mandate to review and advise on the same specific area directly covered in their latest annual report.

 4. ESMA ESG fund naming rules latest

a) ESMA translated guidelines now published

Aside from the draft SFDR Level 2 adoption, most EU firms are now pre-occupied in the effort to align their products with ESMA’s guidelines on ‘Fund names using ESG or sustainability-related terms’.

These were issued to mitigate the general risk of ‘greenwashing’ within the ‘sustainable’ investment funds industry;

they are relevant to “all fund documentation and marketing communications addressed to investors or potential investors for UCITS and AIFs”.

Ongoing, products using ‘sustainable’-related terms in their fund name must meet an 80% investment proportion threshold, directly aligned with their stated environmental, social or sustainability objectives; they must also exclude investments in certain companies operating in weapons, tobacco and fossil fuel industries.

The translated versions of ESMA’s ‘Level 3’ guidelines were published on 21 August.

They will begin to apply on 21 November 2024, for all newly created EU funds.

Pre-existing funds have until 21 May 2025 to align their current fund names, and investment objectives.

b) NCA status, per ESMA

Local EU regulators were given until 21 October to confirm their intention to comply with these guidelines, ongoing.

However, as of now, ESMA have yet to issue the customary ‘Guidelines compliance table’ in relation to this specific Level 3 document; there is also no mention of the fund naming guidelines in the latest ‘Notifications of Compliance with Guidelines Overview Table’, updated by ESMA last week (5 November).

c) Latest key NCA activity

i. Luxembourg: CSSF

On 21 October, the CSSF informed local market participants of Circular 24/863, which has applied ESMA’s Guidelines into the Luxembourg regulatory framework.  They will now grant a ‘priority processing procedure’ (PPP) to existing UCITS /AIFs that limit the update of their Prospectus to either:

• a name change of at least one sub-fund, or
• minor adjustments to the specific ESG engagement/SFDR pre-contractual disclosure.

This process cannot be used by funds requiring significant changes to align with ESMA’s guidelines, e.g. incurring revised investment objective / policy, a portfolio re-balancing, negative impact to current investor expectations (returns, ESG engagement), and / or any impact to fund risk profile, or costs.

ii. Ireland: CBI

On 30 October, the Central Bank of Ireland published details of their ‘streamlined filing process’ for local UCITS/AIFs seeking a change of name (including updates to fund prospectuses, supplements, SFDR annexes) to align with ESMA’s Guidelines. These cover:

• pre-existing ‘sustainable’ products: with filings per transition period[21 Nov 2024 to 21 May 2025];
• new products, created after 21 Nov 2024: expected to apply with ‘standard protocol’, immediately.

There are three local ‘portal’ use cases: ‘change to fund name only’, ‘change to SFDR-related disclosures’ and ‘reclassification of funds’. Firms must also certify compliance with the Guidelines via attestation (submitted with the request seeking a change of fund name).  10 business days should be allowed, before an attestation is requested in respect of the name change.

d) ESMA ESG fund naming Q&A pending?

According to Reuters, ESMA are considering “changes or clarifications to their fund naming guidance”, in response to rules deemed ambiguous by the industry. This includes the obligation for specifically named products to “invest meaningfully in sustainable investments”, alongside general conflict with the EU Green Bond standard).

The Luxembourg Times had also reported the CSSF calling for ESMA to “issue clarifications/Q&As as soon as possible”, given the imminent risk of “diverging interpretations and market fragmentation”.

5. EU commissioner in-waiting pledges to ‘improve’ SFDR

“The current misuse of the framework as a pseudo labelling regime poses greenwashing and investor protection risks and does not provide an accurate categorisation of products. A simple categorisation system could facilitate investor understanding and avoid misleading ESG claims.”
Maria Luís Albuquerque, designate for Director General of EC-FISMA (22 October 2024).

The recent comments of the proposed EU commissioner for financial services has attracted much press attention.

In her responses to European Parliament members, Maria Luís Albuquerque cited “misuse” of the current SFDR framework; she favours gauging feasibility of a sustainability-related categorisation system for financial products.

Ms. Albuquerque stated that SFDR disclosures “must be coherent with the other disclosures under the wider sustainable finance framework”.  Acknowledging “climate change and environmental degradation are a global challenge”, she would actively seek to “continue the work in international fora and with partner jurisdictions to facilitate interoperability between our frameworks…in particular on taxonomies and sustainability disclosures”.

However, she believes the EU does “not need significant new requirements or regulations, but we probably need to adjust existing ones and fine-tune requirements and regulations to make them fit for purpose. Targeted reviews should also be carried out to simplify and facilitate the application of the framework.”

Other proposals include making EU Taxonomy ‘Do no significant harm’ disclosures “easier to apply”, and that “full use” is made of the EU Single Access Point (ESAP), via “further facilitated data flows and machine-readability.”

C) latest ESG Market trends, opinion

1. SFDR product landscape as at end Q3-2024

Morningstar’s latest must-read SFDR article 8 / 9 products quarterly report is now available.

Latest Q3-2024 EU fund trends include:

• ‘Sustainable’ products: QTR inflow/outflows
  • Article 8 funds: +EUR 38 billion inflow
  • Article 9 funds: -EUR 2 billion outflow**
  • Article 6 funds: +EUR 96 billion inflow

• ‘Sustainable’ products: market share per AUM
  • Article 8 funds: EUR 5.6 trillion [56.0%]
  • Article 9 funds: EUR 0.3 trillion [3.3%]
  • Article 6 funds: EUR 3.8 trillion [40.7%]

**NB: This is the fourth consecutive quarterly net redemption for ‘dark-green’ SFDR article 9 products.

Overall, ‘actively managed’ SFDR Article 8/9 funds recorded inflows of EUR 24.5 billion, while ‘passive’ sustainable products saw inflows of EUR 11.4 billion. However, these are said to “pale in comparison” to the ‘non-sustainable’ EUR 96 billion inflow during the last three months.

Morningstar also compute that so far this year: 104 x SFDR ‘sustainable’ products have changed names: 42 funds “added” ESG-key terms; 42 funds “removed” ESG-key terms, while 20 funds “swapped” ESG-key terms.

Ongoing, they now expect “changes to the universe of sustainable funds to intensify in the coming months ahead of looming deadlines for new anti-greenwashing regulations, including the EU’s fund naming rules”.

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Article written by Mark Kilbride