Institutional investors, asset managers and distributors continue to address the various practical issues arising from the EU disclosure requirements and are contemplating how they will implement the developing UK rules. Along with bond issuers and investment banks, they will also need to navigate the growing number of green product labels being designed by regulators.
The aim of the EU Sustainable Finance Disclosures Regulation (SFDR) was to introduce mandatory disclosure requirements for certain types of investment products. It was not intended to introduce marketing labels, although references to “Article 8” and “Article 9” products have become commonplace within the industry. Regulators are now developing mandatory labels for products, which will be in addition to disclosure requirements and will impact the use of existing labelling frameworks.
The EU Green Bond Standard (GBS) Regulation is being debated by the co-legislators — for more details see Sustainable finance and the capital markets. The legislative proposal for an EU Ecolabel was also expected to see the light of day last year but has been delayed due to ongoing work on Level 2 rules under the EU Taxonomy Regulation and SFDR. Meanwhile, an increasing number of national regulators are expressing concerns about how investment products are being marketed and are taking action. In the UK, in addition to the new Sustainable Disclosure Regime (SDR), the FCA has proposed a set of mandatory product labels.
It seems likely that firms will need to comply with an increased number of national product labelling requirements over the next couple of years until an EU Ecolabel is in force. Pan-European operators will also have to adopt the new UK labels for any products manufactured or marketed in the UK. Meanwhile, we may see further commentary from regulators about what is required for a product to fall within SFDR Articles 8 and 9.
Existing official green labels
The Nordic Swan label was established in 1989 and covers nearly 60 non-financial goods. The first funds were labelled under the framework in 2017. To be able to use the label, products must opt out of the worst companies and industries (certain sectors are specifically excluded), opt for more sustainable businesses and act transparently. At least 90% of a fund's portfolio must be assessed in order for a fund to use the label.
The Luxflag was launched in 2011 and is specific to investment funds. A fund must:
- Invest at least 75% of its portfolio in environment-related sectors
- Incorporate ESG considerations in investment decision process
- Seek a return on investment
The rubric does not yet refer to the Taxonomy Regulation but is expected to do so when Level 2 rules are in force. It does, though, refer to SFDR and that funds must make the appropriate Article 8 or 9 disclosures. This underlines that existing frameworks should not be directly read across to SFDR product categories. In particular, a fund can be eligible to use the Nordic Swan or Luxflag labels but not comply with the Article 9 requirements.
The French “Doctrine” was introduced in March 2020 for new or amended funds and in March 2021 for existing funds. The rules require consistency between what is said within marketing material and what is done in terms of ESG portfolio management. The AMF has said that it considers the Doctrine to be complimentary to the SFDR but that it will reassess it in the light of the final SFDR Level 2 rules and when the EU Eco-label is introduced.
The EU Ecolabel will apply more widely
The EU Ecolabel will apply to all packaged retail investment and insurance-based products (PRIIPs), that is investment funds, insurance-based investment products, and bank structured products and structured deposits. It will refer to the EU Taxonomy Regulation. Although the draft Ecolabel regulation has yet to be published, the December 2019 Technical Report (PDF 3.85 MB) of the Commission's Joint Research Committee indicates the detailed mandatory and optional criteria that might be introduced for the different types of products. For example, bond funds will have to be invested at least 70% in bonds that comply with the new GBS, whereas an operationally complex “three-bucket” approach was suggested for equity funds.
The report suggests that the label will be awarded to goods and services that are supplied for distribution, consumption or use in the EU, whether in return for payment or free of charge. Financial products that are considered as “services for distribution or use” will be within scope. Consequently, the EU Ecolabel will be awarded to the financial service being provided by the manufacturer of the green financial product, rather than to the financial product. However, the EU Ecolabel logo will be able to figure on the promotional material of the financial product itself.
It is not yet known whether there will be a mandatory requirement for external review, as introduced in the GBS Regulation. Given regulators' concerns about how firms are interpreting the SFDR Article 8 and 9 categories, it seems likely that we will see increased use of mandatory external review going forward.
New national initiatives
Meanwhile, national regulators are acting on their concerns. For example, the German regulator is proposing (PDF 78.1 KB) to introduce guidelines for German sustainable investment funds. The guidelines will specify the minimum content to be included in such funds' terms and conditions. They will apply to funds referencing sustainability in their name (“ESG”, “sustainable”, "green" etc) or being promoted as sustainable, including in a prospectus or other marketing materials. Three options are proposed, all of which refer to SFDR and the Taxonomy Regulation:
- A minimum investment in sustainable assets of 75%
- Pursuit of a sustainable investment strategy, e.g. by using a "best-in-class" approach to the entire portfolio or by applying sustainability criteria and factors to at least 75% of the fund's assets
- Replication of a sustainable index
The German industry has expressed concerns that the guidelines will apply only to funds domiciled and authorised in Germany and not to other funds marketed into the country.
The Central Bank of Ireland (CBI) is taking a supervisory approach. It set out its expectations in a letter (PDF 4.41 MB) sent to CEOs of financial services firms in November 2021. It is expected to launch a thematic review in the second quarter of this year that will examine whether fund disclosures are in compliance with SFDR. Depending on the findings of the review, the CBI will consider whether additional supervisory engagement, policy guidance or other clarifications are required.
UK labelling framework emerges
There is a clear appetite for sustainability labelling. The FCA's latest Financial Lives survey (published in February 2021) found that:
- 80% of respondents wanted their money to do some good, while also providing a financial return
- 71% wanted to invest in a way that is protecting the environment
- 71% would not put their money into investments which are unethical
The FCA sought feedback (484 KB) until early January 2022 on both the new UK SDR and a mandatory set of sustainable investment labels, and is scheduled to consult on draft rules in Q2 2022. SDR will mirror SFDR in requiring both entity and product disclosures, but there will be both consumer-facing disclosures and more detailed disclosures that might be of greater interest to professional investors and intermediaries. Certain investment products will be required to display a label reflecting their sustainability characteristics.
The FCA acknowledges that many UK firms and their products are subject to SFDR in respect of their cross-border EU business. It therefore sought views on the extent to which the UK requirements can remain as consistent as possible with SFDR, while reflecting the needs of the UK market. It is also considering how overseas funds marketing into the UK should be treated, including in respect of the incoming Overseas Funds Regime.
Other than for funds not marketed as sustainable (equivalent to SFDR Article 6), the FCA has proposed four labels:
- Responsible - may have some sustainable investments
- Three types of Sustainable products:
- Transitioning - sustainable characteristics, themes or objectives; low allocation to Taxonomy-aligned sustainable activities
- Aligned - sustainable characteristics, themes or objectives; high allocation to Taxonomy-aligned sustainable activities
- Impact - objective of delivering positive environmental or social impact
The Responsible and Sustainable Transitioning categories would be equivalent to SFDR Article 8, and Sustainable Aligned to SFDR Article 9. Sustainable Impact would comprise a (small) subset of SFDR Article 9 products.