UK sustainable disclosure: FCA publishes plans for portfolio managers

The regulator’s proposals, which are currently open to consultation, closely resemble rules that fund managers are already subject to under the SDR regime. It seems likely, therefore, that the proposed new rules are very likely to be adopted in the same or similar form as they are in now, when the FCA comes to adopt its final policy statement.

Below, we consider what the proposed rules state and consider how the new regime will impact portfolio management in practice.

Summary of the proposals

Scope

The proposals would apply both to institutional-facing and retail-facing portfolio management business, although the FCA states that they are aimed primarily at wealth management services for individuals and model portfolio solutions for retail investors.

However, the proposals would only bring into scope UK portfolio management services and would carve out services provided to overseas clients. Additionally, the rules would not apply to portfolio management provided to a fund.

Investment labels and firm requirements

The FCA proposes to apply a similar approach to labelling for portfolio management as is shortly coming into force in relation to funds. This, it said, is to create a level playing field. Financial products can only be labelled as sustainable in certain circumstances. In brief:

• to use a label, portfolio management services must meet both the general and label-specific criteria on an ongoing basis;
• the portfolio must have an explicit sustainability objective which is clear, specific and measurable;
• at least 70% of the gross value of the portfolio must be invested in accordance with the sustainability objective;
• the portfolio must not invest in assets which conflict with the sustainability objective;
• KPIs must be selected to demonstrate progress towards achieving the sustainability objective.

The FCA’s labelling regime provides for four sustainability labels to be used – sustainability focus; sustainability improvers; sustainability impact; and sustainability mixed goals. Portfolio managers would be able to use any of those labels for their portfolios, assuming they satisfy the criteria for doing so.

Although the FCA’s rules are intended to be used by portfolio managers offering services to retail clients, institutional-facing offerings could also voluntarily opt into using a label.

The FCA also proposes to apply the same firm requirements as currently apply to fund managers. In brief:

• the manager must identify any negative sustainability outcomes which may arise when pursuing the sustainability objective;
• the manager must develop an investment policy and strategy which is sufficiently clear for clients and consumers to understand how the portfolio is invested;
• the manager must carry out an independent assessment of its robust, evidence-based standard of sustainability;
• the manager must identify assets held for reasons other than to pursue the sustainability objective, such as cash or derivatives;
• the manager must have an escalation plan – although the proposals are not clear on what that means in the context of portfolio management;
• the manager must have appropriate resources, governance and organisational arrangements sufficient to deliver the sustainability objective and must ensure the same on the part of any managers of external funds in which the portfolio is invested;
• the manager must identify a stewardship strategy – although, again, it is not clear from the proposals what that means in the context of portfolio management.

Naming and marketing rules

The FCA is also proposing to extend the naming and marketing rules applicable to fund management to portfolio management, which only apply in respect of retail business. Portfolio management services offered to institutional clients would not be in scope of the naming and marketing rules.

Disclosure requirements

To put fund management and portfolio management on an equal footing, the FCA is proposing that portfolio managers produce the same disclosures, including consumer-facing disclosures, detailed product-level disclosures – both pre-contractual and ongoing – and entity-level disclosures.

Where portfolio managers do not make their offerings publicly available, they must provide the disclosures directly to clients. Therefore, portfolio management will not be subject to the on-demand disclosure regime – a point of difference in respect of the disclosure rules for fund management.

In relation to entity-level disclosures, portfolio management would be brought within the definition of “sustainability in-scope business”, meaning that firms should recalculate their assets under management (AUM) to determine whether they exceed the relevant thresholds.

Distributors

The FCA is proposing to keep the requirements for distributors the same as under the existing SDR rules.

Timelines

The FCA has proposed 2 December 2024 as the date at which portfolio managers could start to use labels and the naming and marketing rules would come into effect. This brings it into line with funds. The dates for entity-level disclosures under SDR would remain the same – firms with AUM greater than £50 billion will need to produce entity-level disclosures by 2 December 2025, while firms with AUM greater than £5 billion will need to start producing entity-level disclosures by 2 December 2026.

In practice, this is a very short implementation timeline, although the FCA is estimating that the similarity of the rules means it will be easy for managers to take appropriate action in advance of the 2 December 2024 milestone.

Our view is that it is very likely these rules will be adopted as set out in the FCA’s consultation paper and therefore managers of retail-facing portfolio management offerings should start to take action now. Managers of institutional facing offerings could choose to begin their implementation if they want to label their services by 2 December 2024. Whether the FCA will extend the regime to portfolio management provided to funds, alternative investment fund managers and management companies may form future consultation.

Practical issues

Although the consistency of the FCA’s proposals for portfolio management may come as some relief to managers given industry’s push back to the divergent proposals set out during the original SDR consultation process, there are some important practical issues for managers to consider, particularly when investing in external funds.

Investing in funds

The FCA states that where a portfolio manager invests in other funds they should be treated as ‘assets’ and apply the criteria accordingly.

Importantly, the manager may invest in both UK and overseas funds. Ultimately, it is the responsibility of the portfolio manager to determine whether a fund meets the general and label-specific criteria in accordance with its robust, evidence-based standard of sustainability. The FCA states a sustainability label is not an absolute measure of sustainability and therefore fund managers will need to conduct due diligence on labelled and other funds.

While portfolio managers may welcome the option to treat a fund as an asset rather than conduct a look-through to the underlying assets of the external fund – which is a requirement under the EU’s equivalent rules that has been a serious operational challenge – this does require firms to have suitable fund due diligence methodologies.

Managers will need to consider the investment policy and strategy of the external fund and assess the resources, governance, and organisational arrangements of the external fund manager to deliver the sustainability objective.

Selecting KPIs

When investing in external funds, a manager has less control over the achievement of KPIs selected to demonstrate progress towards the sustainability objective. Therefore, extra care should be paid by portfolio managers investing in external funds when selecting KPIs so as not to jeopardise use of the sustainability label or to trigger escalation plans in the event external funds do not demonstrate adequate progress.

The FCA has left open the option to select KPIs at the portfolio level or individual fund level.

Stewardship and escalation

In its attempt to ensure consistency between the rules applicable to fund management and portfolio management, the FCA has proposed to extend the stewardship and escalation plan requirements. However, its suggestion that portfolio managers consider engaging with external fund managers and take appropriate escalatory action provides little in the way of meaningful guidance. Any such policy for stewardship and escalation is likely to be symbolic and will not have a material impact on the management of the portfolio.

Portfolio managers should also take care when defining their sustainability objective and what would constitute an asset or fund conflicting with the same, as they may discover external funds inadvertently crossing into that territory. This would require escalation or a reconsideration of the use of the label.

The process ahead

The FCA’s consultation closes on 14 June. We expect industry to flag these and other practical issues in responses. Pending industry feedback on certain pinch points, we expect these proposals will largely come into force as drafted ready to apply from 2 December.