Travers Smith's Sustainability Insights: The UK's new sustainability disclosure regime

A regular briefing for the alternative asset management industry.

Glasgow's climate summit was both an important step forward and a missed opportunity to go further. One important step forward was undoubtedly COP26's unprecedented focus on the role of finance in tackling the climate emergency, which catalysed huge commitments from the private sector. The Glasgow Financial Alliance for Net Zero (GFANZ) now speaks for over USD130 trillion of capital that is committed to transforming the economy. 450 firms from 45 countries – including several leading alternative asset managers – are signed up to help deliver the estimated USD100 trillion of finance needed for net zero over the next three decades.

Glasgow's focus on finance was strategic: enlisting the support of the private sector is seen as critical if governmental pledges are to be achieved. And while voluntary action is applauded, regulators, especially in Europe, are determined to use their rulebooks to ensure the asset management community is playing its part. In the EU, the first wave of asset manager regulation is already in force or in active development – and is not without its challenges. But it is only in recent months that the sustainability disclosure rules that will apply to UK-regulated alternative asset managers have started to emerge.

Some asset managers would argue that the benefits of harmonisation across Europe outweigh the opportunities created by divergence, but the British government only partially agrees. The EU Green Taxonomy, for example, has been endorsed and, with some adjustment, will be used by UK firms. But in other areas, UK regulators do not feel beholden to EU approaches. There is a recognition that the EU rules have not entirely hit their mark – at least not yet – and there is a willingness to learn lessons. Indeed, the UK has a close eye on emerging international standards and is tending to prefer those.

...UK-regulated alternative asset managers with over £5 billion under management need to get ready to publish TCFD-compliant climate change reports in the coming years – and for some firms that will be a significant additional level of public reporting...

The adoption of mandatory climate-related reporting for companies, asset owners and asset managers is a case in point – the UK has opted for a reporting framework created by the Task Force on Climate-Related Financial Disclosures (TCFD), a body established in 2015 by the Financial Stability Board, whose recommendations have gathered endorsements from organisations across the world. This reporting framework is designed to provide decision-useful, forward-looking information on how financial risks and opportunities are being addressed by companies and other organisations. Reports have to cover the strategy and governance of climate-related business issues, as well as quantitative disclosure of specific metrics and targets. UK-regulated alternative asset managers with over £5 billion under management (and various other financial market participants) need to get ready to publish these reports in the coming years. For some firms that will be a significant additional level of public reporting, even though many recognise the benefits and are, in fact, already actively engaged – as this week's BVCA report demonstrates. (See our detailed briefing on TCFD reporting requirements for asset managers.)

And this month the UK's regulator unveiled tentative proposals for a disclosure regime that will extend beyond climate-related issues, to include other "sustainability risks, opportunities and impacts". These "Sustainability Disclosure Requirements" (SDR) will use the TCFD framework (with its four core themes) and are intended to apply both at firm-wide and at product (or fund) level. Two distinct layers of disclosure are envisaged; the first, with basic information aimed at consumers, which could bear some resemblance to the EU SFDR's template disclosures; the second, including more granular information, would be targeted at sophisticated and institutional investors.

Unlike the EU SFDR, the UK envisages a separate labelling regime. As we have argued elsewhere, one issue with the way the EU has designed its rules is that disclosure obligations vary according to the way the fund is marketed, and that has created a de facto labelling system which could actually mislead rather than inform investors. The UK proposals may be able to avoid that muddle by starting with a clear objective to have well-defined categories that provide meaningful information about what the product can (and cannot) do. At the moment, the regulator envisages five labels, three of which would be sub-categories of "sustainable" funds. Getting the labels right will be hard and comments are sought on the preliminary proposals issued this month. Industry engagement will be crucial.

No one should be in any doubt that European governments will use regulatory change to drive their policy agenda, and larger alternative asset managers who are not currently collecting climate-related data from their portfolio companies, or reporting other key ESG metrics to investors, will have to step up. But regulators and firms are at least heading in the same direction, as demonstrated (for example) by recent industry-driven efforts to agree sustainability metrics that GPs and LPs will find decision-useful.

Co-ordination between regulators – especially, in the short term, those in the EU and UK – is vital, even though the UK will not adopt the EU rules. But it is also important to aim for consistency between industry-led initiatives and regulatory changes. Otherwise, we will only add to the confusing and growing proliferation of standards, which is both inefficient and potentially counterproductive.

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