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In light of the FCA’s discussion paper on Sustainability Disclosure Requirements (SDR), financial advisers need to be ready for new rules, writes Prema Sohun, Technical Marketing Manager for VitalityInvest.

One of the main reasons why financial advisers can no longer ignore Environmental, Social and Governance (ESG) funds is that regulation is undoubtedly on the horizon.

This was confirmed in November, when the Financial Conduct Authority (FCA) signalled its intent to make sustainability issues a pre-requisite fixture of client conversations, as outlined in its discussion paper1 on SDR and investment labels.

Following suit with Europe, which brought Sustainable Finance Disclosure Regulation (SFDR) into play in early 2021, it’s clear that financial advisers will need to understand their client’s sustainability preferences, as well as how chosen ESG funds are constructed - sooner rather than later.

The story so far…

According to Jag-Preet Chandi, Head of Legal for VitalityInvest, the beginnings of regulation in this space can be traced back to when the UN adopted its Sustainable Development Goals (SDGs) in 2015. “Since then, the focus on sustainable investing has intensified, particularly within the asset management industry,” she explains in an episode of Vitality’s ESG Explored video series for advisers.

In March 2018, the European Commission released an Action Plan for Financial Sustainable Growth, however this was not carried across to the UK prior to its exit from the EU.

"It’s clear that financial advisers will need to understand their client’s sustainability preferences, as well as how chosen ESG funds are constructed - sooner rather than later."

Offering clarification around the duties of institutional investors and asset managers through amendments to MiFID II and the Insurance Distribution Directive (IDD), it saw sustainability incorporated into suitability assessments for financial instruments alongside increased transparency for sustainability benchmarks. “Basically, what this means is that financial advisers have to clarify their clients’ ESG preferences, predominantly through the use of questionnaires,” adds Chandi.

While there are currently no rules as prescriptive as those that exist in Europe, UK financial advisers already do need to consider how to reflect their client’s ESG preferences should they express an interest or preference in sustainable investing.

COBS 92, for instance, requires firms to take ‘reasonable steps’ to ensure suitability and to obtain the ‘necessary information’ regarding investment objectives, both of which could include ESG considerations. The FCA’s recent discussion paper, announced during COP26, stated that these requirements will go even further.

Acknowledging plans to develop proposals with government in due course, the regulator said in November: “Building on existing rules, a key aim will be to confirm that [advisers] should take sustainability matters into account in their investment advice and understand investors’ preferences on sustainability to ensure their advice is suitable³.”

So, what’s next?

In the discussion paper, the regulator laid out its intention to classify sustainable investments into five categories4, with changes focusing on disclosures around investment products across asset managers and owners, as well as financial advisers.

Transparent labelling and clear criteria will no doubt aid and assist in the delivery of information needed to guide investors, making advice conversations easier when it comes to client segmentation, while helping to clear up any greenwashing concerns that might persist.

It’s reassuring, therefore, that getting sustainability right is high on the regulator’s agenda. Alongside the discussion paper, the FCA also unveiled its ESG strategy and priorities not long after the government laid outs its UK roadmap for SDR5. “If the financial sector is going to help support the transition to a more sustainable future, market participants and financial firms need high quality information, a well-functioning ecosystem and clear standards,” the FCA stated in November.

Why does this matter?

There are already clear expectations placed on authorised fund managers around the design, delivery and disclosures related to ESG or sustainable investment funds, as laid out in a letter outlining its guiding principles (July 2021)⁶. “This highlights a need for clear and accurate ongoing disclosures to consumers in a way that meets regulatory requirements,” according to VitalityInvest Head of Legal, Chandi.

With this in mind and further regulation coming down the pipeline, it would therefore be prudent, she believes, for UK firms and financial advisers to start thinking about the implications of this on their businesses going forward.

“Intermediaries will ultimately benefit from more transparency and increased trust being built by the regulator in this segment of the market,” concludes Chandi. “Firms will increasingly be expected to put clients at the heart of their business by offering products which are fit for purpose and represent fair value. This will help ensure advisers meet the needs of their clients, as interest in ESG inevitably continues to go grow.”

In Vitality’s ESG Explored series, they tackle the big questions on financial advisers’ minds when it comes to integrating ESG funds into the advice process.

To find out more, visit https://adviser.vitality.co.uk/insights/esg-guide-financial-advisers/