Countdown to Compliance: Navigating the New UK SDR Regulations

Understanding the SDR Landscape

The UK Financial Conduct Authority (FCA) has outlined a comprehensive framework under the SDR aimed at increasing transparency and curbing misleading claims about the sustainability credentials of financial products. The overarching goal is to ensure that products marketed as sustainable genuinely meet these claims, supported by robust, evidence-based criteria.

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Key Aspects of the SDR:

1. Anti-Greenwashing Rule: This rule, which applies to all FCA-authorised firms, mandates that any environmental or social claims must align accurately with the characteristics of the product or service, ensuring fairness and clarity.
2. Sustainability Labels: Starting from July 31, 2024, firms can opt to use one of four sustainability labels, provided they meet specific criteria that align with their investment objectives and strategies. These labels are designed to help consumers navigate the sustainable investment landscape more effectively.
3. Naming and Marketing Regulations: Effective from December 2, 2024, these rules stipulate how sustainability-related terms can be used in product names and marketing materials, aiming to prevent misleading information.

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Timeline for Implementation

• 31st May 2024 – Anti-greenwashing rule and guidance comes into force
• 31st July 2024 – Firms can begin to use labels with accompanying disclosures
• 2nd December 2024 – Naming and marketing rules come into force with accompanying disclosures
• 2nd December 2025 – Ongoing product-level and entity-level disclosures for firms with AUM > £50bn
• 2nd December 2026 – Entity-level disclosure rules extended to firms with AUM >£5bn

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Impact on Investors

Private equity firms, particularly those with significant assets under management, must prepare to integrate these regulations into their operational and communication strategies. This involves:

• Due Diligence and Compliance: Ensuring all portfolio companies and potential investments align with the new sustainability standards and disclosure requirements.
• Strategic Communication: Updating marketing materials and product communications to comply with the anti-greenwashing rules and new labeling requirements.
• Investment Strategy Alignment: Adjusting investment strategies to not only focus on financial returns but also consider the sustainability impact, aligning with one or more of the specified sustainability labels.

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The fund labels

These labels provide a framework for defining and communicating the sustainability characteristics of investment products. Here's an overview of each label, along with the key criteria required for their application:

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1. Sustainability Impact Label

This label is designated for products that aim to achieve a predefined, positive, measurable impact on environmental or social outcomes.

Key Criteria:

• Sustainability Objective: The product must have an explicit goal that aligns with achieving significant positive impacts.
• Measurement and Reporting: There must be a robust method for measuring the impact, both in terms of the investment activities and the outcomes.
• Theory of Change: Investors must outline a clear strategy on how the investment will lead to the desired impact, detailing the anticipated changes and mechanisms.

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2. Sustainability Focus Label

Products under this label invest in assets that are inherently sustainable, based on established, evidence-backed standards.

Key Criteria:

• Explicit Sustainability Objective: The objective must be integrated into the investment strategy and be specific, clear, and measurable.
• High Proportion of Sustainable Investments: At least 70% of the product's assets must be selected based on their sustainability credentials, which should be verifiable through independent assessments.
• Alignment with Standards: The sustainability claims must align with recognized industry standards or authoritative bodies.

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3. Sustainability Improvers Label

This label applies to investment products that focus on assets with the potential to improve in sustainability over time.

Key Criteria:

• Improvement Potential: Assets included under this label should show potential for significant sustainability improvements, supported by clear evidence and time-bound targets.
• Investment Horizon and Targets: The improvement objectives should align with the investment's time horizon, with specific milestones set for asset performance.
• Ongoing Monitoring and Reporting: Regular reporting and reassessment of the assets' improvement trajectories are required to maintain the label.

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4. Sustainability Mixed Goals Label

This label is used for products that invest according to a combination of the objectives outlined in the other three labels.

Key Criteria:

• Combination of Objectives: At least 70% of the portfolio must meet the sustainability criteria set out for the other labels, blending various sustainability approaches.
• Disclosure and Transparency: Detailed disclosures must be made regarding the proportion of investments adhering to each label's standards.
• Regular Review: The product's adherence to the mixed objectives must be reviewed at least annually to ensure ongoing compliance with the set standards.

Disclosures should include information on the investment policy, strategy, and specific sustainability-related KPIs. For private equity investors, understanding these labels and integrating their criteria into investment and operational strategies will be crucial in not only aligning with the new regulatory environment, but also enhancing investor trust, and capitalizing on the growing demand for sustainable investment.

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Conclusion

Investors must take proactive steps to understand and integrate these changes. The next two months provide a critical window for firms to adjust their strategies and operations to align with the new requirements by trailing out the new fund labels.

The landscape of investment is set to continually prioritize transparency, sustainability, and long-term impact alongside traditional financial metrics.

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