Following many months of uncertainty in the financial services sector over the UK’s approach to sustainable finance disclosures and labels, we finally saw some long-awaited clarity in the government’s Greening Finance: A Roadmap to Sustainable Investing, published in the run up to COP26.
The Sustainability Disclosure Requirements’ (SDR) regime, briefly trailed in the Chancellor’s Mansion House speech in July, was unveiled in this Roadmap. While initially interpreted as the UK’s direct response to the EU’s SFDR, it has become clear in recent weeks SDR will encompass far more than this, with the implications yet to be fully appreciated across the industry.
In terms of what we now know, SDR’s aim is to encompass the full breadth of sustainability disclosures for financial services and companies into a single, integrated framework. Specifically, it will include three key components:
- disclosures against the UK’s ‘green taxonomy’ with firms required to disclose the percentage of their capital spending and turnover relating to taxonomy-aligned activities;
- disclosures against the Task Force on Climate-related Financial Disclosures (TCFD);
- and subject to consultation, reporting under the international standards under development by the IFRS Foundation’s International Sustainability Standards Board (ISSB) launched during COP26.
From 2023, firms will also need to disclose on a mandatory basis their climate transition plans within SDR, and these will need to align with the UK’s 2050 net-zero objective.
The UK’s intention to wrap all sustainability disclosures into one coherent framework through SDR appears to learn from Europe’s experience where various requirements were implemented for industry that were not necessarily compatible with one another, nor well-sequenced for different parts of the economy (e.g. with the EU taxonomy’s requirements applying to investors ahead of investee companies).
Similarly to the ongoing roll-out of TCFD across the economy, the SDR regime will adopt a phased approach, covering financial services, companies, asset managers, asset owners, and investment products. For investment products, rules will require products to report on their sustainability impact, forming the basis of the new sustainable investment labelling system – an important complement to the SDR and another key lesson learnt from the EU, where the SFDR has become a de-facto labelling system.
Challenges
As our sector continues to come to terms with SDR’s potential impact in future, UKSIF sees a few core questions and challenges emerging.
First, there is the issue of how policymakers ensure SDR’s smooth implementation across the economy while major regulations such as TCFD continue to be rolled out. TCFD has yet to be finalised for some groups like asset managers, though final rules are expected by the FCA imminently. Rather than a question of ‘regulatory fatigue’ for firms, how the transition from TCFD reporting to reporting against the SDR framework in future will work without duplicative requirements emerging is a real question.
A second challenge is how SDR will relate to requirements coming down the track, such as the UK’s ‘green taxonomy’ and the ISSB’s standards. Should the UK’s green taxonomy, particularly all of the Technical Screening Criteria (TSC) not be finalised prior to SDR coming into force, then investors may not have a full picture to report their taxonomy-alignment against. The finalising of the taxonomy’s TSC will undoubtedly take some time, particularly with government only committing to basing the TSC for the climate change mitigation and adaptation objectives on those of the EU, with extensive consultation needed for the TSC of the remaining four objectives.
How SDR can be interoperable with SFDR is arguably one of the most important considerations. Some UK investors will have only recently completed their initial disclosures against SFDR, and there will be concerns on producing two very different sets of disclosures, despite SFDR and SDR aiming towards achieving the same outcomes. We are making the case to government and regulators for the SDR regime to be as consistent as possible with SFDR, given that many UK investors’ funds are subject to both UK and EU rules. A similar challenge exists in relation to how the EU’s SFDR labelling categories – commonly known as Articles 6, 8 and 9 – could be mapped onto SDR. We anticipate this becoming a key agenda item for the new Disclosure and Labels Advisory Group, which UKSIF sits on.
Clarity would be useful too on how ‘double materiality’ – which considers the impact of investment decisions on the environment and wider society – could be incorporated into SDR, which UKSIF continues to strongly support, and is only hinted at in the UK’s recent ‘Roadmap.
Biodiversity and natural capital are the final missing pieces we see in the SDR framework. We recently wrote a letter on behalf of the sector to the Chancellor, proposing a series of policy recommendations including outlining how nature should be treated under SDR. Consideration could be given to incorporate disclosures against the Task Force on Nature-related Financial Disclosures (TNFD) framework post its launch in 2023, following consultation with the sector.
Despite these not inconsiderable challenges, the SDR regime is a very positive signal of intent from government on the role it expects the financial services sector to play in addressing climate-related risks and disclosing sustainability information in much more granular detail, and we should all strongly welcome the direction of travel shown and the systemic impact this approach is designed to deliver.
