A regular briefing for the alternative asset management industry.
Last week, the UK regulator, the FCA, issued its long-awaited and twice-delayed rules on sustainability disclosures for asset managers. The Sustainability Disclosure Requirements (or SDR) will mandate additional sustainability reporting for most asset managers, and will sit alongside a labelling regime. The labels are linked to the disclosure requirements but, unlike the EU's SFDR, also include strict rules and minimum standards for those who wish to use them. (Our detailed note on the new regime is here.)
Perhaps the most important takeaway for private markets firms is that the regime is quite narrow in scope. It only applies to UK fund managers – including those authorised by the FCA to manage alternative investment funds – and the labels can only be used for their UK funds. The regime does not apply at all to the many private capital firms that have a non-UK (for example, Luxembourgish or Irish) manager. That's true even if the non-UK manager delegates important functions to a UK firm, which is common, and even if the non-UK fund targets UK investors. It seems likely that some of the rules will be extended to firms with that model in future – and there will be a consultation on that next year – but, for the moment, a very significant proportion of the private capital world will be largely unaffected by these rules, and will not have the option to adopt a UK label.
The limitations do not end there. Even for UK-regulated firms, most of the provisions – including the labels – are clearly designed with retail investors in mind; they will have much less impact on firms that target institutional (so-called "professional") investors. It is true that all UK authorised managers will be subject to a new "anti-greenwashing" rule, and those with assets under management of £5 billion or more will have to make some new, firm-level sustainability disclosures (to supplement the TCFD disclosures that are already required). The labels, on the other hand, will be voluntary for everyone (unless a firm wants to use the term "sustainable" or "impact" in the name of a retail-facing fund). They will be available to UK managers who do not market to retail investors, but whether UK firms with an institutional client base will opt to use the labels remains unclear.
One reason institutional funds might not use a label is because the FCA has set the bar quite high. There will be three main labels to choose from: Sustainability FocusTM, Sustainability ImproversTM, Sustainability ImpactTM and (in response to feedback) a fourth, Sustainability Mixed GoalsTM, which will allow firms to mix these three themes. The rules that will apply to a labelled product are extensive, including a requirement that at least 70% of the fund's investments meet the criteria applicable to the label used. Labelled products will also be subject to more detailed disclosure rules and will attract regulatory oversight of the accompanying minimum standards.
Many will welcome the retail-centric nature of the rules. It is, of course, in stark contrast to the EU's SFDR, which currently applies the same rules to institutional and retail funds. The UK regulator has evidently taken the view that strict rules are not needed by professional investors, who ought to be able to read and understand the detail of a fund manager's ESG strategy. The fact that all UK-regulated managers will be subject to the anti-greenwashing rule, reiterating that sustainability disclosures must be "clear, fair and not misleading", should give further comfort to institutional investors in that regard.
The UK is continuing to focus on financial materiality in line with emerging international sustainability reporting standards, at least for now.
Meanwhile, UK private capital firms – who are still grappling with the (continually evolving) disclosure requirements under the SFDR – should focus on the changes that are going to affect them. UK-regulated firms with more than £5 billion of assets under management are already subject to TCFD reporting requirements (with the first reports published this year for the largest firms, and reports due next year for those with between £5 billion and £50 billion under management). Firms with a fund management license will now need to add disclosures on other material ESG topics, using the same headings: Governance, Strategy, Risk Management, and Metrics and Targets. These firms will have to report at manager level, but some may also have to prepare product-level disclosures if investors request them.
For entity level reports, the UK is continuing to focus on financial materiality in line with emerging international sustainability reporting standards, at least for now. It is not adopting the EU's double materiality approach, nor its Principal Adverse Impacts (PAI) regime – although it does suggest that the PAIs may be useful as a tool to identify "harm" when making product level disclosures. Instead, the FCA points firms towards global standards to help determine what should be disclosed in the entity-level report: the TCFD's supplementary guidance for asset managers, the IFRS sustainability disclosure standard (IFRS S1), the SASB Standards, and the GRI.
Firms with between £5 billion and £50 billion of assets under management will need to produce their first (non-TCFD) report by 2 December 2026, covering 12 months. In practice, managers may decide to begin their first reporting period on 1 January 2025 (to align with their TCFD report) or perhaps later in 2025 if they do not feel ready to collect the required data by January.
The rules are complex and could have been written more clearly. Still, many in the industry will welcome the fact that the UK regulator has taken the time to listen to the market and to respond to feedback – even if that did mean that publication of the final rules came later than originally anticipated. The additional disclosure obligations imposed on firms are relatively light – although not unimportant – and non-UK firms and portfolio managers have been given a reprieve (even if only temporary). But for UK firms that want to use labels – or to use sustainability related terms in funds aimed at retail investors – there will now be a clearer framework to regulate that.
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