Legal Spotlight: Asset owners brace themselves for strict new FCA sustainability rules
New disclosure rules are expected to impact asset owners and managers alike. London lawyer Penny Simpson scrutinises the details for Net Zero Investor
Following the introduction of new guidelines at EU level, new FCA-guarded sustainability disclosure requirements are expected to significantly impact asset owners and managers alike. Lawyer Penny Simpson, partner at Freeths, zooms in on the details.
Following the Corporate Sustainability Reporting Directive, which entered into force across the EU last month, Member states now have 18 months to implement the CSRD into national law following publication in the Official Journal of the European Union.
The CSRD represents an accumulation of recent movements in the EU to require further corporate reporting on environmental factors, including on biodiversity and ecosystems.
Under the CSRD, the requirements of the Non-Financial Reporting Directive will be expanded in relation to the social and environmental information that companies will have to report.
These obligations will affect a broader set of larger companies, as well as listed SMEs, which will now be required to report on “sustainability matters”.
Companies subject to the CSRD, including some non-EU based companies trading within the EU, will be required to report according to European Sustainability Reporting Standards - the first set of which are expected to be adopted by the European Commission by mid-2023.
One of the factors likely to be included in those standards is nature and biodiversity.
Implementation of the CSRD will take place in four stages. Although reporting under the CSRD will not begin to commence until 2025 (based on 2024 data), affected companies should start preparations now.
Similar movements within the UK
The UK transposed the NFRD into national law through the Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016 (by inserting new sections into the Companies Act 2006.
In relation to environmental reporting, s414CB is, however, vague. It requires the contents of companies’ non-financial statement to contain information on “(a) environmental matters (including the impact of the company’s business on the environment)”.
Following the NFRD’s approach, there is no specific requirement to include reporting on biodiversity impacts or natural capital impacts.
The European Commission did publish guidelines to accompany the NFRD which do in fact refer to biodiversity and natural resources.
Nevertheless, as this guidance is not mandatory and the NFRD and 2016 Regulations are silent on the issue, there is no legal requirement in the UK for the large companies, subject to the 2016 Regulations, to report their impacts on biodiversity and natural resources.
Various biodiversity-related voluntary measures and initiatives have since been alluded to, such as further development into the Taskforce on Nature-Related Financial Disclosures, which is referred to in the Government’s response to the Dasgupta Review in 2022.
Other recent developments include the agreement in relation to a new Global Biodiversity Framework.
The GBF has four long-term goals for 2050 which are underpinned by 23 targets, one which includes “Corporate reporting on risks, dependencies and impacts on biodiversity” (Target 15).
Whilst this target is not framed to make such disclosure mandatory, it is no doubt consistent with recent movements in the EU.
Mandatory biodiversity sustainability reporting in the UK
Although some climate-related mandatory reporting exists within the UK, it is clear from the above that sustainability reporting in relation to biodiversity is not yet mandatory.
However, in the UK government’s policy paper “Greening Finance, a Roadmap to Sustainable Investing”, published in October 2021, the government recognised new Sustainability Disclosure Requirements as a key element supporting the transition to net zero.
SDR will cover corporate disclosure; asset manager and asset owner disclosure; and investment product disclosure. In essence, the SDR regime will require those firms and companies that are in-scope to make sustainability disclosures and report on environmental impact, whilst working to stay aligned with The International Sustainability Standards Board (ISSB) and The UK’s Green Taxonomy.
Greening Finance suggests that many UK companies, not solely those offering financial services, will eventually be subject to SDR, stating that “SDR is based on an economy-wide framework covering corporates, asset managers, asset owners, and investment products,” and that “The government’s aim is for SDR to be a fully integrated regime that works smoothly across all sectors of the economy…”
The government intends to implement the framework of the UK SDR through legislation and relevant government departments, whilst regulators will set sector-specific requirements.
In doing so, Greening Finance notes that “…relevant regulators and government departments will determine the precise scope and timing of requirements, and the reporting detail, subject to relevant consultation processes and other statutory requirements.”
The UK government believes that SDR will “bring together new and existing sustainability reporting requirements for business, the financial sector and investment products”, thereby enabling “sustainability information to flow from companies in the real economy to the financial sector and its financial products.”
Ultimately, SDR will build on and “streamline” the requirements of the Task Force on Climate-Related Financial Disclosures and the government has stated that the intention is to combat “greenwashing” by firms to ensure that consumers and investors can make more informed decisions.
According to Greening Finance, the new Green Taxonomy will constitute a set of criteria that can be used to ascertain whether an economic activity may be regarded as “sustainable” in the UK.
The “protection and restoration of biodiversity and ecosystems” is listed in the policy paper as one of the six environmental objectives of the Green Taxonomy.
The government had indicated that it would base the taxonomy on the EU counterpart and legislate by the end of 2022, but this has since been delayed.
Once implemented, SDR will also mandate “double materiality” in respect of some of their reporting requirements, which means that in-scope firms/companies may be required to outline both how sustainability issues impact the company and also how the company’s activities impact society and the environment.
At present, it is clear that the UK’s financial regulator, the Financial Conduct Authority (FCA) regards itself as responsible for developing and implementing elements of the SDR and the accompanying labelling system.
Recently, the FCA published its consultation paper on Sustainability Disclosure Requirements and investment labels and the FCA intends to publish final rules by the end of the first half of 2023.
In summary, the FCA’s proposals include sustainable investment labels; consumer‑facing disclosures; detailed disclosures targeted at a wider audience (eg institutional investors and consumers seeking more information); naming and marketing rules; requirements for distributors; and a general ‘anti‑greenwashing’ rule applied to all FCA-regulated firms.
The FCA has suggested that the core elements of its regime as outlined above, labelling and classification, disclosure and naming and marketing rules, will apply to asset managers initially.
However, the FCA is seeking views on expanding the regime to FCA-regulated asset owners in respect of their investment products.
They are also proposing targeted rules for the distributors of investment products to retail investors in the UK.
In relation to labelling, however, the FCA is proposing that firms can choose whether or not to label their products, but will need to meet the proposed qualifying criteria to do so. This suggests that the labelling aspect of the proposals will be voluntary.
It is also clear that the FCA is envisaging that FCA-regulated firms will need to increase their reporting in relation to biodiversity.
The FCA revealed that in order to help firms determine the content of disclosures that may be useful for clients and consumers, they are proposing to add Handbook guidance.
Of particular interest, the FCA refers specifically to biodiversity, suggesting that guidance may include that “Firms should consider disclosing the sustainability-related topics that they have prioritised in their governance, strategy and risk management, and the rationale for doing so.
For example, a firm managing assets likely to be impacted by measures to protect biodiversity may set out how and why it has prioritised the management of biodiversity-related risks and opportunities…”
As highlighted above, it is evident that the government envisages that the SDR regime will apply across the entire economy, not just the financial sector, and that the FCA is progressing the SDR agenda in its financial sector.
But the FCA’s developments only represent one aspect of SDR implementation. It is of concern that we have no information as to how or when the SDR and the legislation required to underpin it will be rolled out in relation to other sectors more generally.
We are not aware of any legislation that has been developed by the government in order to implement SDR more generally.
We are concerned that the UK is not keeping up with sustainability (including biodiversity) reporting requirements emerging from the EU, in terms both of timeframe and scope.
SDR are yet to be finalised and so far we only have information as to how the FCA intends to take matters forward in their sector.
Whilst the FCA plans are welcomed, there is no clarity as to what is happening in other sectors.
Whilst the government has set out its plan for how the new requirements will be implemented after Royal Assent of primary legislation, it has not announced when we can expect this legislation.
It is to be hoped that the government does not procrastinate further development into this seemingly crucial regime.