EU and UK regulatory regimes diverge on sustainable investment products, with differences in disclosure frameworks, labelling, anti-greenwashing rules, sustainability objectives, asset thresholds, and taxonomy alignment
Supervisory authorities in the European Union and the United Kingdom have introduced regulations to address growing concerns that sustainable investment products may not be as green as they claim.
The EU’s framework, set out in the Sustainable Finance Disclosure Regulation (SFDR), has been around much longer than the UK’s Sustainable Disclosure Regime (SDR), which includes a new anti-greenwashing rule that will shortly come into effect.
At their core, the two regimes differ. The EU’s SFDR is a disclosure framework, whereas the British SDR is a labelling regime. When the European Commission issued its SFDR consultation last year, it said the legislation acted as a labelling regime for Article 8 and Article 9 funds. (Article 6 funds must explicitly label themselves as non-sustainable.)
Comparing what greenwashing means
The UK’s new anti-greenwashing rule, coming into effect on May 31, has raised questions for market participants, given its broad scope. It requires all sustainability-related claims to be “fair, clear and not misleading.” While limited to financial promotions, the rule is much wider, as sustainability claims can exist in different ways, including assertions that institutions make about themselves.
The accompanying guidance consultation from the UK’s Financial Conduct Authority (FCA) outlined what firms must do to comply with the anti-greenwashing rule, such as ensuring that sustainability references are correct and can be substantiated. This will challenge firms by requiring them to build an evidence base to support assertions made in all manner of communications, including stakeholder presentations.
Another challenge is that communications must be complete and should not omit important information. Given the rules’ applicability to all firms, each will need to be prepared to address completeness across a broad range of interactions by calibrating communications to client-specific needs.
From the EU perspective, anti-greenwashing has been an integral part of financial services policies. Outside the financial sector, two of the most recent and visible initiatives have been the proposed Green Claims Directive and the proposed Greenwashing Directive.
In the financial sector, there is not only the SFDR, but the European Securities and Markets Authority (ESMA) has proposed guidelines on fund names using environmental, social & governance (ESG) or sustainability-related terms. Compared to the UK regime, the EU financial sector does not have a dedicated anti-greenwashing rule.
Variations on the objective of sustainability
Another significant difference is the sustainability objective. Under the UK’s SDR, all products using a label must have a sustainability objective, which is an explicit statement of intention to invest “with the aim of directly or indirectly improving or pursuing positive environmental and/or social outcomes.” Such objectives must be clear, specific, and measurable.
On the other hand, the EU’s SFDR identifies three financial product categories, each with a different transparency obligation, but these do not have a sustainability scope.
Market participants are required to objectively assess their financial product’s ESG and sustainability characteristics to apply the correct transparency obligations for their category. However, the EU Commission’s consultation asked whether labels were preferable, and it will be interesting to see if there is any re-alignment with the SDR.
How sustainable asset thresholds and taxonomy alignment differ
A further important difference concerns sustainable asset thresholds. In the UK, the SDR provides that for each label, at least 70% of assets must be invested according to a robust, evidence-based standard that is an absolute measure of environmental and/or social sustainability.
Article 9 of the EU’s SFDR establishes a sustainability threshold for so-called dark green funds, but there is no specific link to an evidence-based standard. Instead, these funds need to justify the proportion of their investments that is not aligned with their sustainability characteristics. They are not confined to a fixed minimum percentage of their portfolio being aligned with these characteristics.
There are also variations in terms of taxonomy alignment. The UK aspires to develop its own green taxonomy, although there have been delays. The EU has its own green taxonomy to help companies and investors identify environmentally sustainable economic activities, but it does not have a social sustainability taxonomy.
The UK remains a strong advocate of the International Sustainability Standards Board (ISSB), which issued its first standards in June 2023. The FCA has said it will consider updating product-level disclosure requirements once the UK Green Taxonomy is in use and may issue entity-level disclosure requirements that align with future ISSB standards.
Additionally, the FCA said it will consult on updating its Taskforce on Climate-Related Financial Disclosures (TCFD) rules for listed companies to reference the ISSB standards. (The 45th edition of the Primary Market Bulletin set out the FCA’s proposed approach to implementing the standards. The ISSB standards build on the TCFD framework, which has been consolidated into the International Financial Reporting Standards Foundation.)
The EU has instead developed the European Sustainability Reporting Standards (ESRS), although it has sought to ensure alignment between these and the ISSB standards. In Q&As issued last summer, the Commission stated: “The EU goes further than any other major jurisdiction to date in terms of integrating the ISSB standards into its own legal framework.”
Looking ahead
It will be interesting to see how the EU’s SFDR regime changes in light of the Commission’s consultation. Some member states have already faced calls to create labels. For instance, the Netherlands Authority for the Financial Markets advocated the creation of three new sustainable products: transition products, sustainable products and sustainable impact products.
Developments in the United States, such as those from the U.S. Securities and Exchange Commission and the state of California, will also be key influences.
This article was written by Simon Lovegrove, the Global Director of Financial Services Knowledge, Innovation and Product for Norton Rose Fulbright; and Haney Saadah, Managing Director of Risk Consulting for Europe, Middle East and Asia for Norton Rose. Both are based in London.
