How the EU and UK regulatory approaches to sustainability differ

Regulators in the European Union and the United Kingdom have introduced regulations to address growing concerns that sustainable investment products may not be as green as they claim.

The EU framework set out in the Sustainable Financial Disclosure Regulation (SFDR) has been in place for much longer than the UK’s Sustainable Disclosure Regime (SDR), which includes a new anti-greenwashing provision that will come into force soon.

In essence, the two regimes are different. The EU’s SFDR is a disclosure framework, while the UK’s SDR is a labeling system. When the European Commission consulted on SFDR last year, it said the legislation acted as an art fund labeling scheme. 8 and art. 9. (Article 6 funds must clearly identify themselves as unsustainable).

Comparison of the importance of greenwashing

The UK’s new anti-greenwashing laws, which came into force on May 31, have raised questions among market participants given their broad scope. It requires all sustainability claims to be “fair, clear and not misleading.” While this principle is limited to financial advancements, it is much broader because sustainability claims can occur in a variety of ways, including the claims that institutions make about themselves.

The accompanying consultation on guidance from the UK Financial Conduct Authority (FCA) outlines what companies need to do to comply with the anti-greenwashing principle, such as ensuring that references to sustainability are correct and can be substantiated . This will pose a challenge for companies as it will require them to build an evidence base to support the claims made in all forms of communication, including presentations to stakeholders.

Another challenge is that communication must be complete and should not omit important information. Given the applicability of the principles to all companies, each will need to be prepared to ensure completeness across a wide range of interactions by tailoring communications to specific customer needs.

From an EU perspective, countering greenwashing is an integral part of financial services policy. Outside the financial sector, the two most recent and visible initiatives are the proposed Green Claims Directive and the proposed Green Money Laundering Directive.

In the financial sector, not only does SFDR exist, but the European Securities and Markets Authority (ESMA) has also proposed guidelines for fund names that use terms related to environmental, social and governance (ESG) or sustainability. Compared to the British system, there is no special regulation against greenwashing in the EU financial sector.

Variations on the Sustainable Development Goal

Another significant difference is the sustainable development goal. Under the UK SDR, all products carrying the label must have a sustainability objective, which is a clear statement of the intention to invest “to directly or indirectly improve or achieve positive environmental and/or social outcomes”. Such goals must be clear, specific and measurable.

On the other hand, the EU’s SFDR directive defines three categories of financial products, each with different transparency obligations, but they do not have a sustainability scope.

Market participants have a responsibility to objectively assess the characteristics of their financial products, such as ESG and sustainability, to apply appropriate transparency obligations for their category. However, the European Commission consultation asked whether labels are preferred and it will be interesting to see if there is any realignment with SDR.

How the Sustainable Asset Thresholds and Taxonomy Alignment differ

Another important difference concerns the sustainable asset thresholds. In the UK, the SDR states that for each label at least 70% of assets must be invested to a sound, evidence-based standard that provides an absolute measure of environmental and/or social sustainability.

Article 9 of the EU SFDR establishes a sustainability threshold for the so-called dark green funds, but there is no specific link to an evidence-based standard. Instead, these funds must justify the portion of their investments that are not consistent with their sustainability characteristics. They are not limited to a set minimum percentage of their portfolio aligned with these characteristics.

There are also differences in taxonomy alignment. The UK wants to develop its own ecological taxonomy, although there have been delays. The EU has its own ecological taxonomy to help businesses and investors identify environmentally sustainable economic activities, but no social sustainability taxonomy.

The UK remains a strong supporter of the International Sustainability Standards Board (ISSB), which released its first standards in June 2023. The FCA has stated that it will consider updating product-level disclosure requirements once the UK Green Taxonomy comes into force and may issue entity’s disclosure requirements at a level consistent with future ISSB standards.

In addition, the FCA said it would consult on updating the regulations of its Task Force on Climate-related Financial Disclosures (TCFD) for listed companies to address ISSB standards. (The 45th edition of the Primary Markets Bulletin sets out the FCA’s proposed approach to implementing the standards. The ISSB standards are based on the TCFD framework, which has been consolidated within the International Financial Reporting Standards Foundation.)

Instead, the EU developed European Sustainability Reporting Standards (ESRS), although it struggled to ensure compatibility between them and ISSB standards. In a Q&A issued last summer, the Commission said: “The EU goes further than any other major jurisdiction to date in integrating ISSB standards into its own legal framework.”

Looking to the future

It will be interesting to see how the EU SFDR regime evolves in the light of the Commission’s consultation. Some Member States have already faced calls to create labels. For example, the Netherlands Financial Markets Authority recommended the creation of three new sustainable products: transitional products, sustainable products AND sustainable products.

Developments in the United States, for example at the U.S. Securities and Exchange Commission and in the state of California, will also have a key impact.

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This article was written by Simon Lovegrove, Global Head of Financial Services Knowledge, Innovation and Product at Norton Rose Fulbright; and Haney Saadah, managing director of risk consulting for Europe, Middle East and Asia at Norton Rose. They are both based in London.