Castlefield response to FCA Sustainability Disclosure Requirements consultation

By Ita McMahon

We recently submitted our response to the Financial Conduct Authority’s (FCA) consultation on Sustainability Disclosure Requirements (SDR).

We’re broadly supportive of the measures outlined in the consultation. Indeed, our view is that they would bring rigour to the industry by introducing a labelling scheme for funds with solid sustainability credentials.

In the interests of transparency, we’ve made our full response publicly available below.


Response to Consultation Paper 22/20: Sustainability Disclosure Requirements (SDR) and investment labels

Castlefield Partners Limited
January 2023

Overview, Scope and Timing
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?

Yes, although we do have some concerns that the proposed regime could disadvantage smaller asset managers with relatively fewer resources to comply with the measures. Nevertheless, and despite being a smaller asset manager ourselves, we are supportive of the proposed scheme.

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

We anticipate that many fund managers may need to formally amend fund investment policy and strategy documents to meet the requirements of the labelling scheme. The amendments may require regulatory approval so any timeframe should take account of the FCA's capacity to approve large volumes of fund materials.

It's likely that larger firms with more resources would be able to make the necessary changes to fund materials more quickly than their smaller counterparts and be at the front of the queue for approval. As such, we would urge the FCA to ensure a fair playing field for accessing the labelling scheme when it first launches.

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.

As a "small" asset management firm, some of the cost-benefit analysis estimates for both one-off and ongoing costs appear to omit figures for businesses of a smaller size, particularly where the firm expects to make use of the sustainability labelling. We would also note that whilst costs are lower for smaller firms in absolute terms, the impact on a lower income-generating entity is likely to be more pronounced.

Nevertheless, we do see the benefit of the labelling scheme, and the requirement of firms of all sizes to assess their own fund names and market their funds to an appropriate consumer-type, in a way that avoids greenwashing.

Classification and labelling
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.

Broadly speaking, we agree with the definition of sustainable investing; it will be critical to the regulation’s effectiveness to require sustainability objectives to be defined and outcomes measured.

In particular, we are pleased to see that funds using ESG integration strategies alone will fall outside the labelling scheme. It is our view that such strategies can result in products containing holdings that retail consumers find surprising. Excluding these strategies from the fund labelling scheme will help to eliminate one source of greenwashing risk within the sector.

However, we note that the Consultation Paper does include comparison with both EU SFDR and SEC terminology and, in fact, illustrates a way to map from one set of terminology to another, which could ultimately add to consumer confusion as the three schemes are not directly comparable. "Integration" and "impact" are specifically two terms that can mean differing approaches across these different regimes.

Greater explanation of these channels/routes to sustainable investing would be beneficial. In addition, it is worth noting that the labels and the strategies that they represent can exist concurrently in one fund.

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 design principles and the emphasis on intentionality.

The approach has the potential to work well for single strategy equity funds, particularly where the investment focus is on large cap companies in developed markets. These companies have the resources to provide the ESG data needed to enable investors to measure fund performance. Arguably, they also have resources available to make the changes needed to improve sustainability performance.

This is less likely to be the case for smaller listed/quoted companies. As such, it may be necessary for the FCA to allow for a lighter touch on sustainability KPI measurement and reporting for funds that invest in smaller listed/AIM quoted companies.

In addition, more guidance from the FCA is needed on how the labelling scheme would work for (a) non-equity funds, where opportunities for engagement may be more limited, and (b) fund-of-fund products, which may comprise of funds with different labels or contain a combination of labelled and non-labelled funds.

We would also welcome increased specificity of which funds would be suitable for inclusion, and more detail on the parameters for inclusion in each fund category.

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: a. 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? b. 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? c. 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? 103 CP22/20 Annex 3 Financial Conduct Authority Sustainability Disclosure Requirements (SDR) and investment labels.

We are broadly supportive of the product profiles and strategies.
In order to ensure successful adoption of the labels, we urge the FCA to provide more examples of:

  • funds that would sit in each category so that investors are more likely to see how their fund might sit within the labelling scheme
  • credible standards of environmental and social sustainability for the Sustainable Focus category.
  • clear and measurable targets for the Sustainable Improvers category, not least because it is much easier to set environmental KPIs (given the availability of data) and much harder to set social goals.It is also much harder to aggregate social performance at fund level: environmental metrics remain the same from company to company but there is much greater variation on social performance, as much depends on a company’s products, services, etc. Moreover, there is less standardisation of social metrics, even on common workforce indicators such as health and safety.

As a more general point, the consultation paper assumes that ESG data is readily available from companies when that is often not the case. We would welcome clarity from the FCA on the extent to which estimated data is acceptable when reporting on performance against KPIs.

Sustainable Focus: turning specifically to the Sustainable Focus category, we would like to see more clarity on whether in-house frameworks covering multiple environmental and social themes would be acceptable for this label, provided that the fund has at least 70% alignment.

As noted above, we would also welcome some examples of credible standards of environmental and/or social sustainability. In addition, we would like to see a statement from the FCA that the use of rating providers' scores alone would not be a sufficiently robust framework.

In terms of the 70% threshold, we think this provides the right balance for equity funds and allows for the flexibility that fund managers need for diversification etc. However, from a consumer perspective, 70% might seem low. As such, we would encourage the FCA to include a brief comment on the rationale for the 70% threshold in its client-facing communications. The FCA could add further reassurance on the remaining 30% of the fund by explaining that the unexpected holdings disclosure rule applies across the whole fund.

Sustainable Improvers: in this category, we agree that stewardship should be a key feature. However, we'd caution against any assumption that engagement leads directly and quickly to positive outcomes; it can often take time and does not always result in success.

We understand the rationale for linking engagement to KPIs and outcomes but we feel this may lead to investors engaging on a very narrow band of issues, and on “easy wins” where investors can demonstrate a causal link between their engagement and an outcome. In our view, investors play an important role in engaging on a broad range of material ESG issues, including emerging issues or complex issues that companies may not be addressing yet in full.

Asking a company to include more ESG data in its corporate reporting is an “easy win”; asking a company to address modern slavery issues, or to improve the nutritional profile of its product range is a much more complex request, but arguably more important.

We need to make sure that the focus on engagement and outcomes does not deter investors from taking on more difficult ESG engagements where the causal link between ask and outcome is harder to prove.

Sustainable Impact: we think this is the correct term for this category, but it would be helpful to understand whether these funds will prioritise providing positive environmental/social outcomes above financial considerations to investors. If so, how will this be communicated to consumers?

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?

No. Given the high levels of interest in sustainable investing (see data on pg 10 of the Consultation Paper which states that 81% of adults surveyed by the FCA would like the way that their money is invested to do some good as well as provide a financial return), a label or statement denoting non-sustainable products seems sensible. It would also help to meet the FCA's stated objected of increasing transparency around sustainable investing.

Moreover, many firms seek to integrate ESG criteria within their investment processes but may not intend to invest sustainably or work towards sustainable outcomes for investors. The opportunity to make that explicit through a “non-sustainable” label would increase the effectiveness of the labelling scheme.

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?

Under the sustainability objective, there is the requirement to monitor and report on performance against the objective. We are supportive of this in principle, but social performance will be harder to aggregate at fund level due to the lack of data standardisation.

In addition, as the type of social issues varies from company to company, aggregation of performance at fund level will be difficult.

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.

Sustainable Focus: As mentioned above, we would like to see more clarity on whether in-house frameworks would be acceptable for demonstrating alignment with sustainability themes. In addition, the examples given are of funds that have a single sustainability theme. We are keen to understand whether funds with broader sustainability themes, e.g. spanning several social and environmental themes would be eligible for inclusion in the Sustainable Focus category.

Sustainability Improvers: under this label, any company would be suitable for investment providing the fund manager can make the case that future sustainability improvements are likely. In our view, this leaves this label category open to greenwash.

We would like to see a higher bar for entry whereby fund managers would only be able to include assets in a Sustainable Improvers fund if those assets have set material sustainability targets – i.e. have already made some commitment to making change.

This would potentially encourage companies which are seeking investment to make meaningful commitments to sustainability targets, as part of a plan to raise capital and/or reduce their cost of capital.

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?

We agree with the proposed approach at this stage. Independent verification may become necessary at some point, particularly if allegations of greenwash continue.

However, this would place a larger cost burden on smaller investment firms, potentially eroding competition and scope for innovation in investment objectives/research offered to investors.

In the absence of verification, industry commentators may fill the gap by rating labelled funds which, although useful, may be skewed to particular viewpoints.

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?

Yes, we are very supportive of the proposed ‘unexpected disclosures’ rule. We would welcome guidance on how to treat a company that by its nature is not controversial but becomes so due to negative press coverage. e.g. a food retailer that receives negative press coverage regarding allegations of misconduct in its supply chain.

We would also recommend that ‘unexpected disclosures’ are reported in the sustainability product report and that this disclosure should include the names and descriptions of the entities invested in. This provides clients with an understanding of new holdings on a regular basis.

In addition, for larger entity-level disclosure firms, some context on the proportion of in-scope relative to out-of-scope products (or proportion of AUM invested in labelled and non-labelled funds) would also be useful for consumers.

This would provide an important ‘sign-post’ for investors who would prefer to have their money managed by firms who devote a high proportion of their time and resources to investing sustainably and are thus perhaps more culturally aligned with the objective of the proposals.

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? 104 CP22/20 Annex 3 Financial Conduct Authority Sustainability Disclosure Requirements (SDR) and investment labels

Yes, provided that differences in timing of the evolution of the ISSB standards does not unduly impact the SDR proposals.

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?

Broadly, yes.

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?

Yes, but we would be happy to use a template should industry develop one. Indeed, if the Consumer Disclosures are to form a standalone document, as proposed, the Consultation Paper draws parallels with KIIDs/PRIIPS, both of which are very structured in form and content, so some clear guidance may be necessary in future.

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.

Yes, the proposals for items in the "Pre-Contractual" disclosures seem relevant, including the split between summary consumer facing and more detailed reports although both "Stewardship approach" and "Unexpected investments" would likely warrant some level of inclusion in the ongoing detailed product reporting as well as the pre-contractual documentation.

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.

Yes, although it will be demanding for smaller investment firms with fewer resources available for developing reports. As noted above, we would add that it would be useful, and perhaps expected, to see details of "unexpected holdings" in this detailed, product-specific report in addition to the "pre-contractual" report.

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?

"On demand" reports for portfolio-based solutions from 2025 seems appropriate, provided that issue-specific data on individual holdings within a portfolio is available.

It may be beneficial to use cohorts of similar portfolios (e,g. balanced medium risk portfolios, etc), similar to some performance comparison reporting, in order to provide timely reporting, provided the data presented is clear, fair and not misleading under existing rules.

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.

The phased introduction seems sensible. A further, entity-level disclosure outlining the amount/proportion of AUM managed according to sustainability labels relative to the same entity's overall AUM may aid consumer understanding of a firm’s approach. See previous response to Q11.

There will no doubt be overlap here with disclosures made in the PRI submission and we would encourage the FCA to look at ways of reducing the reporting burden e.g. by utilising the existing PRI reporting framework where possible, such as by highlighting PRI sections or questions where answers can be replicated.

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?

Yes, we broadly agree provided that timelines do not materially change.

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

Yes, we agree with the proposed general ‘anti‑greenwashing’ rule. We would appreciate some specific guidance on naming and marketing during the interim period after the introduction of the anti-greenwashing rule, but before the fund labelling scheme begins.

During this time, we assume that as long as materials are clear, fair and not mis-leading and not breaching the anti-greenwash rule, that fund managers awaiting the launch of the labelling scheme can continue to name and market their (existing) products as sustainable. We would welcome specific guidance from the FCA on this.

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?

Yes. A clear link between product labelling and use of related terms is very desirable. We agree with prohibiting the use of some terms in the absence of a sustainable label. In our view it is important to give protected status to the term ‘sustainable’. If wider use of the term is allowed – i.e. beyond the labelled funds – then it would risk undermining the effectiveness of the labelling scheme as a whole.

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

Yes, the proposals are sensible and the 90% threshold for use of labels/terms is suitably high.

Q23: Are there additional approaches to marketing not covered by our proposals that could lead to greenwashing if unaddressed? 105 CP22/20 Annex 3 Financial Conduct Authority Sustainability Disclosure Requirements (SDR) and investment labels.
Branding and imagery can be used to imply that a fund has sustainable attributes.

Stewardship is both valid and desirable in promoting ESG concerns with management and achieving good outcomes for clients, however, is difficult to evidence alignment with a sustainability goal. So some consideration of how engagement itself is tracked (voting activity/company meetings etc) would be useful.

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

No answer.

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?

Our view is that there should be as much consistency as possible with the existing proposals, and that Occupational Money Purchases should be included. We would welcome a labelling scheme for simple pension products where a default investment could be labelled clearly - it seems easier to implement this at strategy level rather than via the overarching product.

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?

Yes, it sounds reasonable.

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?

Excluding pensions entirely seems to be a poor outcome for investors, especially due to the volume of non-advised scheme members in the UK. However, whether the same level of granularity should be imposed on very simple entry level products is perhaps debatable.

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?

There could be difficulties within packaged products as consumers do not have the same level of detailed information about insured funds typically. Overall, our view is that Chapter 5 disclosures should be available for pensions.

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?

No answer.

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

No answer.

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.

This should apply to investment bonds too for consistency. They are also likely to become more relevant as the capital gains and dividend income allowances reduce.