Clifford Chance

This article explores the UK Financial Conduct Authority's new Sustainability Disclosure Requirements and investment labels regime, highlighting associated fraud risks and compliance measures for in-scope firms.

On 31 July 2024, the UK Financial Conduct Authority (FCA) introduced an investment labels regime for products with sustainability objectives, marking a significant milestone in the FCA's Sustainability Disclosure Requirements regime (SDR). With an estimated $18.4 trillion of ESG-oriented assets managed globally, in-scope firms that opt to use one of these new labels must conduct thorough risk assessments to comply with regulatory requirements and avoid serious corporate fraud risks.

New Investment Label Regime

The new regime introduces four voluntary sustainability labels to help consumers navigate investment products: Sustainability Impact, Sustainability Mixed Goals, Sustainability Focus, and Sustainability Improvers. In-scope firms will be able to opt to use these labels in respect of in-scope products, if those products meet the relevant criteria. For a detailed summary of each label, refer to the previous Clifford Chance blog here.

Criteria for Use of the Labels

The FCA has outlined both general and specific criteria that must be satisfied in order to use one of the sustainability labels. Generally, a product using a sustainability label must have an explicit sustainability objective related to the label. At least 70% of the gross value of the product's assets must align with the product's sustainability objective unless it is designed to build its initial portfolio over time, such as in the case of a Long Term Asset Fund (LTAF).

Assets must be selected based on "a robust, evidence-based standard", and those not aligning with the product's sustainability objectives must not conflict with them. Key performance indicators (KPIs) demonstrating the product's progress towards meeting its sustainability objective are also required.

The emphasis on demonstrating robust standards for sustainable investment labels poses risks for firms. In addition to breach of the new investment label regime, firms may also risk breach of the FCA's anti-greenwashing rule (under which sustainability-related claims made by in-scope firms must be fair, clear and not misleading and consistent with the sustainability profile of the relevant product).

Corporate Crime Risks

In serious cases, firms may also risk engaging the new corporate offence of failure to prevent fraud, expected to enter force in early 2025, and criminal responsibility under the extended 'identification principle' reforms introduced by the Economic Crime and Corporate Transparency Act 2023 (ECCTA), effective from 26 December 2023.

Focusing on the identification principle that is currently in force, under the ECCTA, instead of relying on the “directing mind and will” of a company for corporate criminal liability, the focus is on whether a “senior manager” committed a defined economic crime, including fraud and making misleading statements under section 89 of the Financial Services Act 2012 (FSA). The definition of “senior manager” is drawn from the Corporate Manslaughter and Corporate Homicide Act 2007 (CMCHA), covering individuals who play a significant role in:

• Making decisions about how the whole or a substantial part of the company or partnership’s activities are managed or organised; or
• Managing or organising the whole or a substantial part of those activities.

The notes to the CMCHA clarify that this includes those in direct management and strategic or regulatory compliance roles. The UK government's Impact Assessment for the ECCTA emphasises the importance of the senior manager’s roles and responsibilities within the organisation, rather than their job title, with a focus on whether the senior manager is acting within the actual or apparent scope of their authority.

This test differs significantly from the Senior Managers and Certification Regime, potentially encompassing more individuals responsible for setting sustainability objectives. Managers, including Chief Sustainability Officers, within in-scope firms focused on approving investment labels are therefore particularly at risk.

A successful prosecution under the ECCTA may result in an unlimited fine. In-scope firms should carefully consider which parts of the business, positions, and individuals may fall within the ‘senior manager’ definition as part of their wider SDR risk assessments. Clear segregation of duties, education of risks, and robust monitoring processes are essential to mitigate potential corporate criminal liability.

Risk Assessments

ESG risk assessments should be tailored to the new investment labels regime. While any corporate crime prosecution under the identification principle would require evidence that a senior manager committed fraud, presenting a high evidential hurdle including proof of dishonest intent on the part of the individual concerned in fraud cases (or at least evidence of knowledge, recklessness in FSA cases), an appropriate baseline for the robustness of sustainability labels should be established. This includes:

• Considering standards produced by the Sustainability Accounting Standards Board (SASB) when assessing topics clients associate with sustainability requirements, as suggested by the FCA.
• Selecting assets using a systematic methodology based on authoritative industry practices or proprietary methods for determining sustainability characteristics and their ability to contribute to positive environmental or social outcomes.
• Implementing escalation plans for poorly performing sustainability products against relevant objectives or KPIs.
• Ensuring governance and resources demonstrate adequate knowledge of the assets and high diligence in selecting data or information used to inform investment decisions.

Future

In April 2024, the FCA published Consultation Paper (CP24/8) on extending the SDR and investment labels regime to "portfolio managers", broadly defined to include firms that manage investments or that provide investment advice or management of investments on a recurring or ongoing basis in a private equity or private markets context. With around 400 firms providing portfolio management services in the UK, the risk of ESG-based corporate criminal offending is set to increase. Given the trend of tightening ESG standards and prosecutorial appetite to tackle greenwashing, in-scope firms should assess the new SDR investment labels regime for corporate criminal risks from the outset and implement appropriate compliance mechanisms.