UK’s ‘Edinburgh Reforms’ set stage for further divergence on sustainability regulation

Recent announcements by UK regulators and the government suggest that upcoming reforms are likely to result in a competitive landscape for sustainable finance regulation.

The ‘Edinburgh Reforms’ for UK financial services, announced earlier this month by chancellor Jeremy Hunt, were strongly motivated by the idea of “seiz[ing] on Brexit freedoms” and aim to detach the UK from EU-retained law on financial services, including environmental, social and governance and sustainability policymaking.

They confirm the government’s intention to publish an updated green finance strategy in early 2023 and to consult on bringing ESG rating providers within the regulatory orbit of the Financial Conduct Authority.

The government has also since confirmed that it will delay the publication of the UK’s green taxonomy (originally expected by the end of 2023) and will instead outline details within the green finance strategy.

Wendy Saunders, legal director and head of financial services regulatory at law firm Lewis Silkin, said: “The UK government is rapidly seeking to move away from EU regulation and to set its own path. This typically involves a more flexible and less prescriptive approach across a wide range of areas of financial services regulation, including that relating to ESG.”

Labels vs articles

The most prominent example of divergence so far, is the FCA’s proposals on sustainability disclosure requirements and investment labels. The UK regulator’s suggested investment product labels (sustainable focus, sustainable improvers and sustainable impact) constitute a different approach to Articles 6, 8 and 9 under the EU Sustainable Finance Disclosure Regulation, in force since March 2021.

According to the EU regulation, Article 6 funds do not need to embed sustainability factors, whereas Article 8 funds promote environmental and social factors, among other objectives. Article 9 funds are the strictest category, their main objective being sustainable investment, without causing significant harm to other environmental or social objectives as defined by the EU Taxonomy for sustainable activities.

A French impact investor, who wished to remain anonymous, noted that the UK labelling regime is seen as smart and practical, and hopes it would influence existing EU regulation.

However, a Brussels-based climate regulation expert said: “Although they don’t specifically state it, there is a competition between EU and UK regulators in the direction of travel related to sustainable finance legislation.”

Meg Brown, chief product and marketing officer at Impax Asset Management Group, said it is in everyone’s interest to avoid a competition between regulators on sustainability disclosures, as this would risk causing confusion for fund analysts and potential damage to underlying clients. “We are keen to see interoperability between UK, EU and US labelling and classification systems, as we expect these regimes to set the standard for the rest of the world,” she added.

The proposals for a UK consumer-focused labelling regime have generally been well received by the market.

Meanwhile, EU asset managers are facing stricter requirements under EU Regulatory Technical Standards, supplementary to SFDR, due to come into force from January 2023. Recent EU guidance has implied that Article 9 funds should be as close to being 100 per cent sustainable as possible, and in recent months, some large asset managers have downgraded  Article 9 funds due to concerns over this increased regulatory scrutiny.

Saunders at Lewis Silkin says one of the big challenges to satisfying increased regulatory requirements is the lack of data in the market.

Tackling greenwashing

The number of Article 9 funds advertised across EU markets has dropped significantly this year, with their future in limbo as asset managers also brace for a wave of specific anti-greenwashing rules.

The FCA’s labelling regime, first published in October, included suggestions for anti-greenwashing rules, by introducing restrictions on the use of terms such as ‘ESG’, ‘green’ or ‘sustainable’ in names and marketing of products that don’t qualify for the proposed sustainable investment labels.

Three weeks later, the European supervisory authorities launched a call for evidence on greenwashing and on November 18, the European Securities and Markets Authority opened a consultation for the use of sustainability-related terms in funds’ names.

“Ensuring consistency between a fund’s name, investment objective, process and reporting is a very effective way of reducing greenwashing, as well as scrutinising green or sustainable claims by fund boards,” according to Brown at Impax. She added that both the UK and EU regimes (as well as US proposals) are seeking to tackle these areas, albeit they have each started in different places along the value chain.

Fund managers should brace for tougher rules to combat greenwashing, though jurisdictional alignment on sustainable finance frameworks are not yet on the horizon.

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