Update - 31 March 2023
This article was originally published on 7 February 2023. Since then, the FCA has published an update to its Sustainability Disclosure Requirements (SDR) and investment labels consultation. In view of the significant scale of the response to the consultation, the FCA intends to publish the Policy Statement in Q3 this year, with the proposed effective dates to be adjusted accordingly. This has been pushed back from 30 June 2023 when the rules were initially expected. The FCA is understood to be considering adjustments to issues including: the approach to the marketing restrictions, some of the specific criteria for labels and clarification around how different products, asset classes and strategies can qualify for a label, including multi-asset and blended strategies.
Following the closing date for submissions to the FCA CP22/20 consultation on 25 January 2023, the FCA has attracted government scrutiny over their proposals for a UK regime for financial services sustainability disclosure requirements (SDR).
The SDR proposals will apply to all FCA regulated firms and include:
- More mandatory disclosures.
- An ‘anti-greenwashing’ rule.
- The option for firms to attach sustainable investment labels to products (if they meet the proposed criteria).
The main aim of the proposed regulations is to combat the growing number of greenwashing claims concerning financial products, to protect consumers and to rebuild their trust in the financial market.
It is expected that some firms may make changes to their products to meet the criteria for being a sustainable investment, whilst other funds may choose to operate without sustainability disclosure labels. Hence, most of the requirements will not come into force until June 2024 to provide firms with sufficient time to consider their products against the proposed labelling criteria required and choose whether to label their products accordingly (although the anti-greenwashing rule will potentially take effect as early as June 2023).
This has raised concerns amongst the Treasury sub-committee on financial services regulation (the sub-committee) that the proposals could discourage investors from participating in sustainable investments. In reality, the proportion of funds which would have to adapt their marketing to meet the qualifying criteria for SDR is not yet known, with current figures given by the FCA not reflective of actual expectations. The FCA have reassured the sub-committee that the sustainable labelling criteria will provide a structured framework against which firms can assess their products. The FCA further state that strengthening consumers’ trust in sustainable investment products will lead to increased provision of such products. It has also assured the sub-committee that it will take enforcement action for poor behaviour impacting consumers, market integrity or competition. This includes the failure to make necessary disclosures or where firms have misleading labels.
The FCA does not foresee an increase in fees charged by firms and distributors for sustainable investment products as a result of the new regime.
The proposals are merely a start and expansion of the regulations is expected as the FCA has made it clear that they would like to see all UK products, including overseas retail investment products, made trustworthy to consumers. In that regard, the FCA is currently working with the Treasury to consider additional labelling and disclosure rules to foreign products.
The proposed measures, once implemented, should enhance consumer protection by bringing greater transparency, clarity and consistency to climate disclosure obligations. However, the fundamental concern for directors, officers and their insurers should be the increased regulatory scrutiny and the risk of regulatory action in the event of breaches of the new requirements. Such breaches could include a failure to provide mandatory disclosure, mislabelling of investment products or providing inaccurate information about the environmental or social credentials of their products or firms.
Given the expected complexity and breadth of the SDR, particularly, the new ‘anti-greenwashing’ rule, which would require all regulated firms to ensure that the naming and marketing of financial products and services in the UK is clear, fair and not misleading and consistent with the sustainability profile of the product or service, even assiduous firms could attract the FCA’s intervention.
The defence costs of responding to FCA investigations into such breaches, either as an individual, or as an entity, are often covered under D&O policies (subject to policy terms and conditions). Even though any resulting fines are unlikely to be indemnifiable, the level of defence costs involved in defending regulatory investigations can be significant, particularly with larger firms.
Underwriters may wish to consider whether and when their policies will respond to such costs and tighten up their wording to avoid misunderstandings. Even where a policy contains an extension for self-reporting to regulators, there may still be a lack of clarity over the precise stage at which the cover will be triggered.
A further possible consequence for companies and their directors and officers is an increased risk of litigation.
As companies are obliged to make greater disclosures on environmental and sustainability issues, it leaves them open to accusations that those targets have not been met. Investors and activist groups could hold companies to the claims made in their annual reports about their environmental initiatives and may pursue directors and the entities for making false representations or a failure to meet the goals they set for themselves.
Shareholders could also use an FCA finding of breach to support claims of their own. A failure by the board of directors to comply with SDR, for example, making inaccurate or misleading representations about the stainability related features of investment products or services, could lead to derivative claims by shareholders that they breached their duty of care to the company, damaged the entity’s reputation and contributed to a fall in the value of the entity’s shares.
Such claims could trigger sides A and B if directed at the individual directors, or if there is a need for public relations and/or other crisis management firms, whereas firms are likely to look to any side C cover obtained for shareholder claims against the entity.
Entities that demonstrate their focus on ESG issues have often been viewed favourably as being better risks. However, the introduction of the FCA’s new SDR exposes those entities to increased regulatory risk. The more an entity portrays itself or its products as having impressive environmental credentials, the more it will run the risk of falling foul of the FCA’s requirements and expose itself to regulatory investigations and litigation. Insurers of directors’ and officers’ liability policies should expect to see a greater number of claims under policies for the costs of responding to these investigations.
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