UK and EU Sustainability Disclosure Should Be Simplified Without Weakening Transparency

UK and EU Sustainability Disclosure Should Be Simplified Without Weakening Transparency Enforcing the clarity and credibility of sustainability claims in the investment fund industry is by now a key tenet of capital market regulation in Europe. This issue has also become a flashpoint in the debate over disclosure simplification and competitiveness in the European Union and United Kingdom. The EU’s 2021 Sustainable Finance Disclosure Regulation (SFDR), the first of its kind, largely failed to live up to expectations and is now undergoing a fundamental reform. In comparison, the design of the post-Brexit Sustainability Disclosure Requirements (SDR, adopted in 2024) in the United Kingdom was more market oriented from the start. Yet, because the criteria for individual fund categories were relatively demanding, the SDR requirements elicited much more limited industry interest in the use of sustainability labels than was the case for SFDR. A key test for regulators will be whether ongoing reforms in the United Kingdom and EU preserve credible climate-risk information while reducing reporting that investors use infrequently, if at all. Both regimes need simplification, but simplification must not become a retreat from transparency. Regulators should remove complex reporting that investors rarely use while preserving a mandatory core of clear, decision-useful climate-risk information. Greater flexibility should come with supervisory scrutiny of firms’ materiality assessments. UK and EU standards should remain sufficiently compatible to support their closely connected investment markets. The goal should be disclosure that costs less and works better, not a lighter regime that allows material climate risks to disappear from investors’ view. UK Ambition and Experience In a just concluded consultation, the UK’s Financial Conduct Authority (FCA) proposed to abandon a separate requirement that fund managers produce annual climate disclosure reports for each fund. Until now, UK asset managers and other regulated investors produced such reports based on a format defined by the Task Force on Climate-Related Financial Disclosures (TCFD), which set out data, targets, strategy, and governance for the management of climate risks. This requirement, which has applied since 2021 alongside the later SDR, was designed to give investors more information, incentivize climate risk management by fund managers, and improve information quality in the investment market. Investor feedback now suggests there was little interest in these reports. According to the FCA, the reports were too technical and insufficiently aligned with investor needs. Asset managers pointed to alternative tools to manage climate risks internally. Asset owners, such as pension funds, seem to require more-tailored climate risk information rather than standardized reports. In the view of the investment industry, disclosure rules appear to be an unnecessary add-on to the SDR and detract from the UK competitiveness in the asset management sector. The FCA sensibly took stock of the TCFD rule after five years. Should the proposed change be adopted, climate reports for individual funds would be more demand-driven and tailored to investor needs (although the existing disclosure requirement would remain for fund managers themselves). The FCA acknowledges the need for information provision to institutional firms that have their own reporting obligations. Yet under the new proposal, the scope of reports would be slimmed down, their frequency would be reduced, and previously binding rules would become more flexible guidance. Reports themselves would become optional in certain cases. In communication with retail investors, the disclosure of a fund’s climate risk exposures would be at the discretion of the fund manager, driven by its own assessments of financial materiality. The Case for Simplification Targeted simplification makes sense where it improves investor outcomes and reduces a reporting burden that yields little benefit in financial market outcomes. It appears that retail investors have not engaged with product reports, which proved to be overly complex. Where standardized reports attract limited investor use, a narrower mandatory core combined with more demand-driven disclosure may deliver more decision-useful information at lower cost. For retail clients, the communication should be plain, short, and give a sense of product risk and return, allowing a reasonable investor to form a view as to how climate risk matters for a product. Fund managers will in any case continue to meet the disclosure requirements of institutional investors, which have their own reporting obligations. Upon request, they may need to spell out the full scope of greenhouse gas emissions for their portfolio, though this information falls well short of the more forward-looking TCFD framework. That said, the proposed optionality and discretion are a step back from what used to be firm FCA standards for climate risk management. For the new reporting framework to be effective, disclosures should be scrutinized by the supervisor, including where a firm decides that climate risks are not material. This approach would reduce the risk that flexibility obscures climate risks, as well as the risk that processes for climate risk management are under-resourced. Compatible Standards for Interconnected Markets The FCA justifies its simplification drive with its secondary mandate for the competitiveness of the United Kingdom as a global financial center. In this effort, it should be cautious about a further divergence from EU standards. Notwithstanding the disruption from Brexit, the UK investment industry (with £12 trillion equivalent in assets under management at year-end-2024) continues to play an outsized role within the EU market. Linkages have been sustained in the form of delegated asset management, cross-border marketing of funds, and the use of common market infrastructure. The EU’s SFDR and the SDR have already established quite different fund categories and disclosure regimes for the EU and United Kingdom, respectively. With the proposed deletion of the FCA’s TCFD product-reporting requirement, the United Kingdom is abandoning a general, standardized fund-level climate disclosure requirement that finds no equivalent in the original SFDR, nor in its likely future version. Yet, the overall discipline for managing climate and other sustainability risks is much stronger for EU-based fund managers than for their UK counterparts. The newly revised EU rules for alternative investment fund managers (the Alternative Investment Fund Managers Directive, or AIFMD) are very specific on sustainability risks. For instance, EU rules set standards for how these risks need to be reflected in the investment process or in the fund manager’s governance and resourcing. SFDR establishes transparency not just on sustainability risks to the portfolio but also on what investments do to the environment and broader economy (the so-called principal adverse impact reporting). The upshot is that EU regulators treat sustainability as a risk driver that requires specific internal governance and controls, whereas these are captured in a more general and light-touch framework in the United Kingdom. To sustain the current linkages between the UK and EU fund management sectors, regulators in the two jurisdictions should establish compatible standards and climate risk analysis, and disclosure should be fully credible in both markets. The Rationale for Climate Disclosures Remains Valid Climate and other sustainability risk disclosures are important from a market-integrity perspective. They make an important and complex driver of portfolio risks more transparent to investors and provide firms with the tools and data to establish sensible governance and resources. Policymakers gave their strong backing when rules for the corporate and financial sector were first conceived (see, for instance, the position of the Bank of England at the time). This policy has borne fruit as data availability has vastly improved and European fund managers have made some progress in integrating climate and other sustainability factors into their risk management. Recent years have underlined an unexpectedly rapid onset of climate-related damages in Europe, making the initial motivation for good disclosures doubly relevant. Climate risks already impact certain portfolios and fund managers and, according to regulators’ warnings, are set to spread further. In addition to the direct impact of the physical effects of climate change, asset value following an abrupt transition to a less carbon-intensive economy, or portfolio companies deploying fossil fuel-based technologies, could be exposed to liability risks. The purpose of good disclosure is to provide investors with all relevant information so that they can anticipate such an impact. A more flexible framework may improve market discipline if it forces firms to explain material climate risk where it truly matters. But any change in requirements should not be allowed to usher in a weakening of transparency.