On 25 January 2023, the Financial Conduct Authority (FCA) closed the latest round of consultation on its proposed Sustainable Disclosure Requirements (SDR) and investment labels.
The SDR proposals are intended to combat greenwashing across multiple asset classes and to improve the level and clarity of sustainability information that investors receive. Whilst the labels are primarily intended to be used for products marketed to retail investors, managers also have the option to use these sustainable investment labels for products being marketed to institutional investors.
The outcome of the consultation and the FCA proceeding with its proposals is expected in the summer. So how could real estate institutional fund managers prepare to use this new label system?
Some may argue that the SDR label system is a regulatory burden that they would rather avoid, and that managers that also operate in the European Economic Area are already having to give much attention and resources in meeting the EU’s Sustainable Finance Disclosure Regulation (SFDR) requirements.
More broadly, however, there are good arguments for UK managers to opt to use the labels voluntarily, the most compelling of these being that SDR provides credible labels for funds looking to market themselves as having sustainability objectives.
We anticipate that SDR will provide a welcome step forward to create a clearer situation around labelling than has evolved under SFDR. Whilst the European Securities and Markets Authority (ESMA), the EU supervisory authority that focuses on SFDR, has clarified that SFDR is a disclosure framework and not a labelling system, the market has latched onto SFDR Article 8 and 9 and looked to use them as product labels.
SDR key provisions: in addition to product labels
Managers will be required to make certain accompanying disclosures. Where sustainability-related features are integral to an investment policy and strategy, but the manager chooses not to use a label or is unable to do so because the product does not satisfy the criteria, the manager will need to ensure those features are communicated in a proportionate way to the sustainability profile of the product, in line with the FCA’s naming and marketing rules. In practice, this may often mean that the manager will not be able to use ESG-related terms in the relevant name and marketing.
On the contrary, the FCA has started from the premise of creating a labelling regime and has put forward under SDR three fund labels that describe a fund’s intentionality regarding sustainability. The three proposed labels are:
- Sustainable focus – for funds that aim to invest in assets that a reasonable investor would regard as environmentally and/or socially sustainable;
- Sustainable improvers – for funds with an objective to improve the environmental and/or social sustainability of assets over time;
- Sustainable impact – where the funds are investing in solutions to environmental or social problems to achieve positive real-world impact.
Importantly for real estate fund managers, the proposed sustainable-improvers label offers a transition dynamic: an opportunity to attract capital in order to accelerate net-zero goals. The label will be attractive for funds that wish to invest in assets that are stranded or currently unsustainable, but where there is an objective to improve sustainability performance over time.
Usefully, because the FCA proposes that there be no hierarchy between the three SDR labels, a sustainable-improver fund focused on retrofitting existing building stock is intended to carry the same sustainability credentials as the focus and impact labels.
It may also be the case that institutional investors, whether in the UK or elsewhere, recognise the merits of the SDR labels for their own fund commitments. The FCA indicates that it has “developed a set of threshold criteria that all firms must meet, as well as some implementation guidance”. It says: “The criteria are objective, rigorous and aim to ‘raise the bar’. At the same time, they provide flexibility to accommodate different sustainability objectives for continued evolution and innovation in the market within clear guardrails”.
This approach from the FCA lends itself to institutional investors adopting SDR labels criteria as benchmarks for assessing sustainable products.
Those adopting SDR could be at the forefront of a growing move towards clear sustainability labelling globally as other regulators also take action. The US is proposing an amendment to the ‘names rule’ to expand its scope to apply to any fund name with terms that suggest, for example, investment decisions incorporating one or more ESG factors. In the EU, ESMA is consulting on “guidelines on funds’ names using ESG or sustainability related terms”. ESMA’s objective is to provide fresh and firm direction on labelling following the SFDR situation where the market made its own interpretation.
A significant point of context is that, according to the World Economic Forum, buildings account for nearly 40% of global greenhouse gas emissions, 50% of the world’s energy consumption and 40% of raw material use. Our real estate sector must prepare for the ESG regulatory paradigm where anti-greenwashing measures and sustainability labels are here to stay. UK managers: get ahead of the curve, and be aware of the opportunities presented by SDR product labels.
