It called for the SFDR to introduce an additional category of financial products to differentiate genuine impact products from other sustainability-focused financial products.
The SFDR is currently being implemented, and it’s unlikely that this additional category would be introduced any time soon. But Brexit means that the UK is now (sort of) free to set its own course for sustainable finance regulation – and a recent consultation from the UK Financial Conduct Authority (FCA) shows encouraging signs.
The consultation relates to policy proposals in two areas. First, Sustainability Disclosure Requirements (SDR) for companies to report on sustainability risks, opportunities and impacts which build on the Taskforce for Climate-Related Financial Disclosures (TCFD) recommendations, the forthcoming UK Green Taxonomy and the International Sustainability Standards Board’s planned sustainability reporting standards. Second, Sustainable Investment Labels for financial products which complement the SDR disclosures and are directed to retail investors.
There are two aspects of these policy proposals that give cause for optimism:
- First, the proposed disclosure requirements recognise that retail consumers and institutional investors need different kinds of information. The FCA is proposing a tiered approach to disclosure that recognises that institutional investors and other stakeholders may want granular and detailed information, but typical investment language and sustainability metrics are too complex for most retail investors, who need information laid out in simpler terms.
- Second, the potential labelling system differentiates between impact investment products (that aim to deliver positive environmental or social impact) and other types of sustainable investment products such as transitioning and aligned investment products (which can have varying degrees of sustainability). Creating this separate category is the best way to foster the growth of impact investment products. And this approach can also help consumers by mitigating the risk of mis-selling, greenwashing and poor market practice.
Taken together, these measures will do a lot to help consumers better navigate the market for sustainable financial products and figure out where to put their savings.
Figure 1: FCA’s proposed approach to sustainable product classification and labelling system
At the same time, because many UK firms are also subject to the SFDR, the FCA recognises a need to articulate how financial products classified under the SFDR map against the proposed UK framework. The current proposals envisage mapping the UK Responsible and Sustainable Transitioning categories (see Figure 1 above) to the EU Article 8 category of financial product (i.e. those which promote environmental or social characteristics). While this may be technically correct, it runs the risk of leading to policy incoherence and hurting investors because the UK Responsible category is not considered Sustainable. Therefore, these proposals would mean that an investment product can be classed as Responsible (i.e. not sustainable) in the UK and at the same time as Article 8 (somewhat sustainable) in the EU. And considering how sustainable finance/responsible investment have been somewhat synonymous terms in the last 10 years, there’s also a risk that many consumers may not appreciate the difference between these categories of investment product.
This is one example of an inherent tension for UK policy makers. Through seeking to match the ambition of EU sustainable finance policy, UK policy makers will be keen to observe what’s happening with EU regulation and avoid repeating the same mistakes. But they also need to remember that UK firms may also be subject to EU regulation and will benefit from clear mapping between the two frameworks.
It will therefore be interesting to see how this tension will play out for policy makers developing the forthcoming UK Green Taxonomy. Considering the controversies surrounding the EU Taxonomy (especially the extension to gas and nuclear proposed in the recent draft Taxonomy Complementary Delegated Act), there is a risk that here too certain activities designated as green according to the EU framework will not be considered green under the UK framework.