Net Purpose Comments on the UK FCA’s Sustainability Disclosure Requirements (SDR)

Net Purpose Comments on the UK FCA’s Sustainability Disclosure Requirements (SDR)

At a high level, we believe that the FCA’s proposal is a positive step toward a more transparent and inclusive financial system that can facilitate capital allocation toward achieving financial returns, and measurable social and environmental outcomes. We also acknowledge the challenge of setting regulation in a fast-evolving landscape of sustainable investment strategies and believe that the FCA’s proposal is directionally right.

Author: Net Purpose– netpurpose.com

 

Net Purpose is a platform for sustainable investors.  We are on a mission to make impact measurement effortless for all investors by 2025 to accelerate our transition to a sustainable world.  

 

We wrote in a blog post here that we are encouraged by the direction of the FCA’s Sustainability Disclosure Requirements (SDR) and investment labels and would like to reiterate our support. We also welcome the opportunity to comment on the proposed guidelines and publish our response to the FCA’s call for comments below.  

 

At a high level, we believe that the FCA’s proposal is a positive step toward a more transparent and inclusive financial system that can facilitate capital allocation toward achieving financial returns, and measurable social and environmental outcomes.  We also acknowledge the challenge of setting regulation in a fast-evolving landscape of sustainable investment strategies and believe that the FCA’s proposal is directionally right.  However, we have comments on some trickier topics related to investor vs enterprise contribution, investor additionality, and the definition of “impact investing.”  We hope our response contributes to evolved thinking here and to steps toward a world where every investor can effortlessly measure social and environmental performances alongside financial returns.

 

Below, you can find our responses to questions 4, 5, 6, 7, 8, 9, 12, 14, 15, 16, 19 and 21 of the FCA’s public consultation on SDR and investment labels. The full list of questions can be found in Annex I. 

 

Responses to FCA questions

 

Q4: Do you agree with our characterisation of what constitutes a sustainable investment, and our description of the channels by which positive sustainability outcomes may be pursued? If not, what alternatives do you suggest and why. 

We agree with the characterisation of a sustainable investment, specifically (4.5): an investment product with “an explicit environmental and/or social objective (‘sustainability objective’) that is part of the investment objectives (i.e. sitting alongside the product’s financial return objective) and expressed in specific and measurable terms).”

Concerning the description of channels by which positive sustainability outcomes may be pursued: we note four channels in the proposed guidelines, which seek to differentiate strategies by types of investor contribution and to define investor contribution more clearly.  These channels are outlined in the definition of each sustainable investing label. Three of them are highlighted in Box 3 on page 25 (4.10, 4.29, 4.37, 4.43): a) by influencing asset prices and cost of capital; b) by active investor stewardship; c) through portfolio construction and asset allocation; and d) by investing primary capital in private or underserved markets.  

While we appreciate the clarity of definitions the FCA has proposed, we encourage the FCA to reconsider this framework in the long term.  In the short term, the channels can be a helpful tool to clarify the debate around enterprise and investor contribution if the channels are accurately assigned. More specifically:

In the long term: we believe sustainable strategies should be assessed on their achievement of sustainability objectives, not on the mechanisms (or “channels”) through which investors achieve these objectives. This would be more consistent with how we assess investors with financial objectives: based on the achievement of financial return, not on the processes or channels in place to achieve that financial return.  In this world, consumers could choose between a strategy that achieves a given environmental outcome or a given social outcome, just like they choose between strategies with different financial outcomes and risk / return. 

In the short term: we acknowledge that the data landscape is evolving (5.16) and that we are not yet in a world of full information on sustainability results to the extent we have visibility on financial results.  In this environment, channels can be a helpful framing. Still, we believe these should be applied consistently across sustainability labels and focused on the direct and core activities of investors across asset classes so as not to limit sustainable investing to one asset class: whether it be private markets or active vs passive strategies.

Specifically: of the four channels outlined, we believe that portfolio construction and asset allocation is the core way investors achieve financial returns and allocate capital to achieve social and environmental outcomes (c) above). In addition, investor stewardship is a key feature of active and passive investment strategies, and plays an important and urgent role in many sustainable strategies.  Having said that, we’d like to believe that sustainable investing can be relevant to smaller, retail and other passive strategies too. Finally: investing primary capital (d) above) only applies to companies operating in private markets and only applies to the Sustainable Impact label.  We strongly suggest this channel is broadened so as not to limit the scope of sustainable investing and Sustainable Impact investing to one asset class (more below).  

 

Q5: Do you agree with the proposed approach to the labelling and classification of sustainable investment products, in particular the emphasis on intentionality? If not, what alternatives do you suggest and why?

We are supportive of the three labels, the focus on intentionality, and the exclusion of ESG integration from sustainable investment labels.  We do not agree with the specific characterisation of the Sustainable Impact category, which we outline under Q6 below. 

With regards to the labels: we believe the three labels reflect, quite well, three evolving strategies in the sustainable investing landscape.  In our own words:

  • Sustainable Focus: strategies that invest in a wide variety of companies but seek to do so “more sustainably” than a generally diversified portfolio;
  • Sustainable Improvers: strategies that invest in less sustainable companies and seek to transition them to become more sustainable companies;
  • Sustainable Impact: strategies that invest in “high impact” companies that provide solutions to social and environmental problems, often via their products and services.

We are also supportive of the concept of intentionality: we believe, just like investors who intentionally invest to achieve financial returns, sustainable investors should intentionally invest to achieve social and environmental outcomes. With intentionality and measurement to track performance against this objective, it would be easier for consumers to distinguish a sustainable investment product from a traditional one, thus reducing general consumer trust. In the same way, it would only be possible for consumers to distinguish between traditional investment products if they report on their financial objectives and measure their financial return.

Finally, with regard to ESG integration: we are supportive of the proposal in 4.24 and 4.25 that strategies such as ESG integration or ESG tilts would not qualify for a sustainable investment label.  We believe this is a clear line in the sand to distinguish ESG products that (typically) measure financial risks from strategies that pursue positive and measurable social and environmental outcomes.  We agree that sustainable investment labels should be reserved for strategies that seek to achieve social and environmental outcomes.

 

Q6: Do you agree with the proposed distinguishing features, and likely product profiles and strategies, for each category? If not, what alternatives do you suggest and why? 

We comment on each of the labels in sections below.  Across labels, we suggest that all strategies be distinguished based on the assets they invest in (enterprise impact), with secondary considerations for investor contribution.  Currently, the Sustainable Impact category is defined based on the investor’s contribution only, and the Sustainable Focus and Sustainable Improvers categories are defined based on the assets they invest in as well as investor contribution. This should be rectified to put the Sustainable Impact category on a level field.

 

In particular, we welcome your views on: 

 

  1. Sustainable Focus: whether at least 70% of a ‘sustainable focus’ product’s assets must meet a credible standard of environmental and/or social sustainability, or align with a specified environmental and/or social sustainability theme? 

We are supportive of the intention of this label. But the 70% seems to be an arbitrary yardstick.  

On the one hand, we expect a Sustainable Focus strategy to invest 100% of their assets in more sustainable assets or companies.  On the other, achieving 100% allocation might be hard until data disclosure improves.  For example, the latest research from ESMA’s “EU Ecolabel here: Calibrating green criteria for retail” report funds identifies that, “using fund portfolio holdings and proxy data, we find that only 16 funds (0.5 % of our sample) meet the proposed minimum portfolio greenness threshold of 50 % and exclusion requirements.”

One alternative might be to allow funds to use this label and disclose the x% they have achieved and expected targets in the coming years. This would incentivise more fund managers to use the label and strive for higher sustainable allocations over time while preserving the integrity of the label and transparency for consumers. 

 

  1. Sustainable Improvers: the extent to which investor stewardship should be a key feature; and whether you consider the distinction between Sustainable Improvers and Sustainable Impact to be sufficiently clear? 

We are supportive of the inclusion of the Sustainable Improvers label.  In particular, its potential to recognise and enable capital allocation toward companies who are transitioning their assets to become more sustainable and are contributing to achieve climate and other goals.

We also support investor stewardship as a potential feature but do not believe it defines the category in isolation.  Rather: these strategies should also be assessed on their ability to achieve measurable improvements in social and environmental outcomes over time, and investor stewardship is one way to achieve these results.  We would also recognise investors with limited engagement capabilities with companies, but allocate capital toward these transition plans in the Sustainable Improvers category. 

We think the distinction between the Sustainable Improvers and Sustainable Impact labels is sufficiently clear, if edits are made to the Sustainable Impact label below. In our words: the Sustainable Improvers label is for strategies investing in less sustainable companies to help them become more sustainable. Sustainable Impact strategies invest in “high impact” companies already providing positive solutions to social and environmental problems. 

 

  1. Sustainable Impact: whether ‘impact’ is the right term for this category or whether should we consider others such as ‘solutions’; and the extent to which financial additionality should be a key feature?

We believe ‘impact’ is the right term for this category.  However, the FCA’s Sustainable Impact label definition does not align with the Global Impact Investing Network’s (GIIN’s) definition of impact investing, or the IFC’s Operating Principles for  Impact Management, and we would suggest the definition is amended to align.  

The major issue with the definition of the Sustainable Impact category is its focus on the investor’s contribution to impact only, vs also recognising enterprise contribution to impact (4.7).  It also seems to exclude listed market investors from investing for impact, which is inconsistent with the GIIN’s work on how impact can be achieved in listed markets here. Finally, the definition is not consistent with the United Nation’s (UN’s) ambition to mobilise $5-$7 trillion to achieve the Sustainable Development Goals, or the $4 trillion OECD funding gap outlined here.  If implemented, this label would limit impact investing to private and underdeveloped markets, and marginalise an enormous cohort of listed investors mobilising billions toward companies providing solutions to environmental and social problems, that can help us achieve the SDGs. 

We believe the Sustainable Impact category could be amended to align more with impact investing standards.  Specifically: 

  1. We agree with the description that these products seek to achieve a positive, measurable contribution to real-world sustainability outcomes (4.38); 
  2. We agree that sustainable impact products will invest in solutions to environmental and/or social problems, with a clearly articulated theory of change (4.39); and
  3. We agree that social and environmental outcomes should be measured using evidence-based KPIs and industry standards (4.40).

However, we disagree with the following features:

  1. Investor contribution (4.38). We disagree that the defining characteristic of the Sustainable Impact category is investor contribution. Rather, the defining feature of these strategies is that they invest in companies, projects or assets that provide solutions to social and environmental problems (already articulated in 4.39).  This is different to the two other labels due to the types of companies or assets they invest in;
  2. Financial additionality. We do not believe the Sustainable Impact category should be limited to investors deploying new capital (4.41) or investors investing in underserved markets (4.39).  While there is significant potential for Sustainable Impact strategies to achieve outcomes in private and underserved markets, hundreds of companies are providing solutions to social and environmental problems that need financing at later stages of their growth, e.g. from listed market investors. There is at least $200 billion is already active in listed impact strategies;
  3. Measurement of investor contribution (4.40). Finally, in line with the above, measuring social and environmental outcomes should seek to measure enterprise impact (at the company and portfolio level) as a priority rather than only the investor’s contribution (4.40).  This is in line with globally accepted standards such as the IRIS+ framework at the GIIN.

We recommend that the objective of the Sustainable Impact label be amended to focus on investing in assets that achieve a pre-defined, positive and measurable impact. The primary channel for achieving impact would be portfolio construction, and a secondary channel is investor stewardship or investing new capital in private or underserved markets.  

 

Q7: Do you agree with our proposal to only introduce labels for sustainable investment products (ie to not require a label for ‘non-sustainable’ investment products)? If not, what alternative do you suggest and why? 

Yes, we think this makes sense for now.

 

Q8: Do you agree with our proposed qualifying criteria? If not, what alternatives do you suggest and why? In your response, please consider:

  • the criteria strike the right balance between principles and prescription 
  • the different components to the criteria (including the implementing guidance in Appendix 2) 
  • whether they sufficiently delineate the different label categories, and; 
  • whether terms such as ‘assets’ are understood in this context? 

We agree with the proposed qualifying criteria, which require each strategy to set: 1) a sustainability objective; 2) an investment policy and strategy; 3) Key Performance Indicators; 4) Resources and Governance; and 5) Stewardship approach.  We believe this broadly reflects the investment process and other industry standards. 

 

Q9: Do you agree with the category-specific criteria for: 

  • The ‘Sustainable focus’ category, including the 70% threshold? 

See response to Q6 a) above.  In addition, it will be important for the FCA to specify what constitutes a “credible standard” of social and environmental performance, but we agree with the FCA’s proposal for reporting parties to use robust, independently assessed, evidence-based, and transparent standards (4.30). 

  • The ‘Sustainable improvers’ category? Is the role of the firm in promoting positive change appropriately reflected in the criteria? 

See response to Q6 b) above.

  • The ‘Sustainable impact’ category, including expectations around the measurement of the product’s environmental or social impact? Please consider whether there are any other important aspects that we should consider adding. 

See response to Q6 c) above.  

We suggest the Sustainable Impact label be assessed, like other labels, on the assets it invests in, not only the investor’s contribution to impact. The qualifying criteria should also be amended, which would bring 4.56 more in line with guidelines for disclosures in 5.50:  

Investment Policy and Strategy (4.56, Principle 2 and 5.50): “The firm must specify: 

  • a theory of change in line with the product’s sustainability objective, emphasising how the asset aims to contribute to addressing environmental and/or social problems; 
  • a robust method to measure and demonstrate that the asset’s activities have had a positive environmental and/or social sustainability impact;
  • its escalation plan should the real-world outcome no longer plausibly be achievable, including potential divestment of assets (no change).”

There is no change required to the description of Key Performance Indicators (4.60, Principle 3).  We note, however, that industry standards for impact measurement focus on measuring enterprise impact at the enterprise and portfolio level, not investor’s contribution as a distinct set of metrics.  Measuring impact at the portfolio level and enterprise level could be added explicitly to the definition and might speak to the focus on investor contribution. 

 

Q12: Do you agree with our proposal to build from our TCFD-aligned disclosure rules in the first instance, evolving the disclosure requirements over time in line with the development of future ISSB standards?

We agree with the proposal to align disclosure rules with evolving ISSB standards. However, given the focus of TCFD on climate-only disclosures and the single materiality nature of proposed ISSB frameworks, we wish to highlight the importance of other themes for achieving the Sustainable Development Goals. We encourage the consideration of GRI standards, IRIS+ standards for impact measurement, SFDR, and the SDGs as reference reporting standards.  

 

Q14: Do you agree with the proposal that we should not mandate use of a template at this stage, but that industry may develop one if useful? If not, what alternative do you suggest and why? 

We agree with not mandating a template at this stage, but we suggest the FCA take active steps toward establishing a template by considering existing best practice standards. Product-level sustainability reporting will be highly data-intensive, which creates monumental challenges for viewers if reporting formats are not standardised as it reduces the comparability between reports. We believe adopting commonly used data reporting formats such as the XBRL taxonomy format used in financial reporting can drastically improve the comparability of reported data, increase ease of data digestion for consumers, and thereby, strengthen general consumer confidence in reported data. 

 

Q15: Do you agree with our proposals for pre-contractual disclosures? If not, what alternatives do you suggest and why. Please comment specifically on the scope, format, location, content and frequency of disclosure and updates.

We agree, subject to amendments to the Sustainable Impact category suggested in Q9. 

 

Q16: Do you agree with our proposals for ongoing sustainability-related performance disclosures in the sustainability product report? If not, what alternative do you suggest and why? In your response, please comment on our proposed scope, location, format, content and frequency of disclosure updates. 

On reporting content, we agree, subject to the amendments to the Sustainable Impact category suggested in Q9.  

On reporting location, we agree with the proposal that the reports should be displayed prominently on the main website of the reporting entity. We agree that all contents, supporting data, and documentation should be easily accessible and clearly sourced. 

On reporting scope, we fully agree with the proposal that all in-scope firms must report on all in-scope products. We also encourage the inclusion of baselines as part of sustainability product reporting (5.62). We believe baselines serve as great comparators for fund performance for both institutional and retail investors, which can further propel the progress on integrating sustainability into investment practices. We agree with the proposal that the baselines can be built from a core set of climate-related metrics. Still, we also encourage the inclusion of other non-climate metrics (biodiversity, human rights, etc.) into the baselines where relevant. We believe these metrics can derive from future ISSB frameworks and will provide a more comprehensive assessment of products’ sustainability performance. 

 

Q19: Do you agree with how our proposals reflect the ISSB’s standards, including referencing UK-adopted IFRS S1 in our Handbook Guidance once finalised? If not, please explain why? 

We agree with the proposal to align with ISSB S2 and other upcoming thematic-specific standards, including referencing the UK-adopted IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information in the Handbook Guidance. Subject to the scope and status of ISSB, however, we suggest that other frameworks be acknowledged that can tackle different areas of sustainability reporting.  The IRIS+ framework at the GIIN has a specific set of tools supportive of Sustainable Impact strategies and investors.   

We also agree with the efforts to align with other regulatory frameworks currently underway, outlined in 5.109.

 

Q21: Do you agree with our proposed product naming rule and prohibited terms we have identified? If not, what alternative do you suggest and why? 

We are comfortable with the proposed list of prohibited terms (Page 74, Link).  Also, we are comfortable that the ‘Sustainable Focus’ or ‘Sustainable Improvers’ products are prohibited from using the term ‘impact’ in the naming of these products, though we caution against prohibiting the use of the word “impact” more broadly than this.  

In particular, the term “impact measurement” is used to describe a set of activities that all sustainable strategies should pursue: to measure their impact on the environment and society and to invest in enhancing their positive impact and reducing their negative impact. The word “impact” is embedded in the terminology of performance measurement for sustainability, and we believe performance measurement should apply to all sustainable labels.  

 

Annex I:

FCA Sustainability Disclosure Requirements (SDR) and investment labels

All Questions for response

Deadline: 25/01/2023

Q1: Do you agree with the proposed scope of firms, products and distributors under our regime? If not, what alternative scope would you prefer, and why? 

Q2: Do you agree with the proposed implementation timeline? If not, what alternative timeline would you prefer, and why? 

Q3: Do you agree with the proposed cost‑benefit analysis set out in Annex 2. If not, we welcome feedback in relation to the one‑off and ongoing costs you expect to incur and the potential benefits you envisage. 

Q4: Do you agree with our characterisation of what constitutes a sustainable investment, and our description of the channels by which positive sustainability outcomes may be pursued? If not, what alternatives do you suggest and why. 

Q5: Do you agree with the proposed approach to the labelling and classification of sustainable investment products, in particular the emphasis on intentionality? If not, what alternatives do you suggest and why?

Q6: Do you agree with the proposed distinguishing features, and likely product profiles and strategies, for each category? If not, what alternatives do you suggest and why? In particular, we welcome your views on: 

  1. Sustainable Focus: whether at least 70% of a ‘sustainable focus’ product’s assets must meet a credible standard of environmental and/or social sustainability, or align with a specified environmental and/or social sustainability theme? 
  2. Sustainable Improvers: the extent to which investor stewardship should be a key feature; and whether you consider the distinction between Sustainable Improvers and Sustainable Impact to be sufficiently clear? 
  3. Sustainable Impact: whether ‘impact’ is the right term for this category or whether should we consider others such as ‘solutions’; and the extent to which financial additionality should be a key feature?

Q7: Do you agree with our proposal to only introduce labels for sustainable investment products (ie to not require a label for ‘non‑sustainable’ investment products)? If not, what alternative do you suggest and why? 

Q8: Do you agree with our proposed qualifying criteria? If not, what alternatives do you suggest and why? In your response, please consider: 

  • whether the criteria strike the right balance between principles and prescription 
  • the different components to the criteria (including the implementing guidance in Appendix 2) 
  • whether they sufficiently delineate the different label categories, and; 
  • whether terms such as ‘assets’ are understood in this context? 

Q9: Do you agree with the category‑specific criteria for: 

  • The ‘Sustainable focus’ category, including the 70% threshold? 
  • The ‘Sustainable improvers’ category? Is the role of the firm in promoting positive change appropriately reflected in the criteria? 
  • The ‘Sustainable impact’ category, including expectations around the measurement of the product’s environmental or social impact? Please consider whether there any other important aspects that we should consider adding. 

Q10: Does our approach to firm requirements around categorisation and displaying labels, including not requiring independent verification at this stage, seem appropriate? If not, what alternative do you suggest and why? 

Q11: Do you agree with our proposed approach to disclosures, including the tiered structure and the division of information to be disclosed in the consumer‑facing and detailed disclosures as set out in Figure 7? 

Q12: Do you agree with our proposal to build from our TCFD‑aligned disclosure rules in the first instance, evolving the disclosure requirements over time in line with the development of future ISSB standards?

Q13: Do you agree with our proposals for consumer‑facing disclosures, including location, scope, content and frequency of disclosure and updates? If not, what alternatives do you suggest and why? 

Q14: Do you agree with the proposal that we should not mandate use of a template at this stage, but that industry may develop one if useful? If not, what alternative do you suggest and why? 

Q15: Do you agree with our proposals for pre‑contractual disclosures? If not, what alternatives do you suggest and why. Please comment specifically on the scope, format, location, content and frequency of disclosure and updates. 

Q16: Do you agree with our proposals for ongoing sustainability‑related performance disclosures in the sustainability product report? If not, what alternative do you suggest and why? In your response, please comment on our proposed scope, location, format, content and frequency of disclosure updates. 

Q17: Do you agree with our proposals for an ‘on demand’ regime, including the types of products that would be subject to this regime? If not, what alternative do you suggest and why? 

Q18: Do you agree with our proposals for sustainability entity report disclosures? If not, what alternatives do you suggest and why? In your response, please comment on our proposed scope, location, format, content, frequency of disclosures and updates. 

Q19: Do you agree with how our proposals reflect the ISSB’s standards, including referencing UK‑adopted IFRS S1 in our Handbook Guidance once finalised? If not, please explain why? 

Q20: Do you agree with our proposed general ‘anti‑greenwashing’ rule? If not, what alternative do you suggest and why? 

Q21: Do you agree with our proposed product naming rule and prohibited terms we have identified? If not, what alternative do you suggest and why? 

Q22: Do you agree with the proposed marketing rule? If not, what alternative do you suggest and why? 

Q23: Are there additional approaches to marketing not covered by our proposals that could lead to greenwashing if unaddressed?

Q24: Do you agree with our proposals for distributors? If not, what alternatives do you suggest and why? 

Q25: What are your views on how labels should be applied to pension products? What would be an appropriate threshold for the overarching product to qualify for a label and why? How should we treat changes in the composition of the product over time? 

Q26: Do you consider the proposed naming and marketing rules set out in Chapter 6 to be appropriate for pension products (subject to a potentially lower threshold of constituent funds qualifying for a label). If not, why? What would be an appropriate threshold for the naming and marketing exemption to apply? 

Q27: Are there challenges or practical considerations that we should take into account in developing a coherent regime for pension products, irrespective of whether they are offered by providers subject to our or DWP’s requirements? 

Q28: To what extent would the disclosures outlined in Chapter 5 be appropriate for pension providers ie do you foresee any challenges or concerns in making consumer‑facing disclosures, pre‑contractual disclosures and building from the TCFD product and entity‑level reports? 

Q29: Do you agree that the approach under our TCFD‑aligned product‑level disclosure rules should not apply to products qualifying for a sustainable investment label and accompanying disclosures? Would it be appropriate to introduce this approach for disclosure of a baseline of sustainability‑related metrics for all products in time? 

Q30: What other considerations or practical challenges should we take into account when expanding the labelling and disclosures regime to pension products? 

Q31: Would the proposals set out in Chapters 4‑7 of this CP be appropriate for other investment products marketed to retail investors such as IBIPs and ETPs. In your response, please include the type of product, challenges with the proposals, and suggest an alternative approach.

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