A regular briefing for the alternative asset management industry.
At the end of last year, we previewed likely changes to EU sustainability regulation in 2025. There are several imminent changes – and significant uncertainty about the future of the headline regulations: the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD). The latter is top of the To Do list for many ESG professionals this year; understanding what is required – and by whom, and when – should certainly be a priority, even while calls for a delay to implementation are mounting. (Our recent ICYMI recap of 2024 may help those who need to get up to speed.)
But the UK is taking a different approach, choosing a less prescriptive path. And although the (still relatively new) government in the UK has similar policy objectives to those of the EU – and, indeed, appears to want to move further and faster than its Conservative predecessor – several regulatory initiatives are still under review, or on a go-slow.
It is true, of course, that some important changes have already been made. Larger UK companies and asset managers are required to report on their climate-related risks and opportunities using the TCFD framework, and many private capital firms and their portfolio companies issued their first mandatory TCFD reports last year. Another regulation, the Energy Savings Opportunity Scheme (ESOS), has been updated to require many companies to publish an Action Plan by March 2025. Among other things, this must explain what the company intends to do to reduce energy consumption, and when it intends to do it.
However, the UK currently has no equivalent to the considerably more demanding and wide-ranging corporate disclosure requirements of the CSRD; instead, it will adopt the less prescriptive International Sustainability Standards that were finalised by the ISSB in 2023. At the end of last year, the advisory group appointed to advise the government on ISSB-adoption reported, recommending adoption with only minor modifications. It is now expected that the UK will require mandatory reporting using these standards by listed companies, following a consultation that the FCA will launch in 2025 – although for the first two years, the reports will focus on climate-related issues. But it is not yet known whether large private companies will be required to follow suit. Even if they are, it seems highly likely that the thresholds will be higher in the UK than in the EU, narrowing the number of companies in scope.
The EU's Corporate Sustainability Due Diligence Directive (CS3D) will (eventually) require many large companies (including many based in the US, UK and elsewhere) to adopt transition plans aligned with the Paris Agreement's goal to limit global warming to no more than 1.5C (bolstering the CSRD's requirement to disclose a plan if you have one). The UK also has a plan to mandate transition plans: before the 2024 election, the Labour party committed to require "UK-regulated financial institutions – including banks, asset managers, pension funds, and insurance – and FTSE 100 companies to develop and implement credible transition plans that align with the 1.5 degrees centigrade goal of the Paris Agreement".
A consultation on that commitment is imminent, but (in line with the recommendations of the influential Transition Finance Market Review) the government is likely to proceed with some caution: companies have warned that they cannot produce high-quality, credible plans without more granular sector-specific emissions pathways, clarity on what it means to me "aligned" with the 1.5C ambition of the Paris Agreement (especially as that goal now seems unlikely to be achieved), and comfort on legal and regulatory risks from misstatement or omission in forward-looking statements.
The UK's caution on new disclosure frameworks is also reflected in its approach to a Taxonomy. The EU's Taxonomy, which all companies in scope of the CSRD will soon need to report against, is notoriously complex. Previously, the UK said it would follow the EU's lead and implement a UK-version of the EU Taxonomy, with suitable adaptations for the UK market. But now, after significant work on the UK Taxonomy was completed by a government-appointed expert group, the government is re-consulting on the principle – and seems decidedly lukewarm. The government is seeking views on whether to proceed with this project, or whether to focus on more impactful interventions. Many market participants are likely to suggest the latter.
Meanwhile, while several countries have developed due diligence regimes, requiring companies to identify and act upon adverse environmental and/or human rights impacts in their own operations and their value chain – the EU's CS3D being the most well-known and wide ranging – the UK has not (yet) committed to anything similar. Perhaps the most obvious vehicle for such a requirement is the expected upgrade of the UK's 2015 Modern Slavery Act, but the government's recent response to a parliamentary report calling for more ambition is, at best, non-committal.
As far as the finance sector is concerned, the FCA has finalised and launched its labelling and disclosure rulebook. This has required compliance with a new anti-greenwashing rule from 31 May 2024 and (for unlabelled products with retail investors) a naming and marketing rule from 2 December. The former is accompanied by detailed guidance, which has prompted many firms to review their marketing materials, and the latter regulates the use of certain ESG-related words in fund names and marketing materials. In addition, firms who comply with detailed rules can now use sustainability labels for their financial products, although take up has so far been slow (especially in private markets).
Other aspects of the FCA rules are coming into effect in stages, including new entity-level disclosures which will bite for firms with between £5 billion and £50 billion of assets under management in December 2026, and a year earlier for the largest firms.
Bearing in mind that the EU-equivalent (although quite different) regime – the SFDR – has been in effect since March 2021, the UK is some way behind. Its rules are also more limited in scope, mostly focused on the retail market, and not yet applicable to firms engaged in portfolio management, nor to non-UK managers, or even non-UK funds. Both of those developments are planned, but both have been deferred – with timelines currently unclear.
The UK is also following behind the EU in the way that it regulates ESG ratings providers. The EU's rules are final and will apply from July 2026. The UK is finalising its primary legislation, but the regulator will then need to consult on the details, meaning that the regime is unlikely to come into effect until around 2028. Again, the rules will diverge from their EU equivalent in important respects, and many firms will have to comply with both rulebooks.
"… the UK government has been approaching its task with more caution, moving more slowly, and with some apparent scepticism about the value of disclosures – or, at least, a keener eye on the balance of benefits and burdens."
