SDR in Practice: What the FCA’s Good and Poor Practice Review Reveals About Sustainable Investment Governance

Summary

The regulatory conversation around sustainable investing has evolved significantly over the past two years. What began as a policy discussion around ESG transparency has moved into the supervisory phase. The Financial Conduct Authority’s (FCA) recent review of good and poor practice under the Sustainability Disclosure Requirements (SDR) provides one of the first practical insights into how the FCA expect firms to operationalise sustainability claims.

The key message is that sustainable investing has got to move beyond disclosure and demonstrate real governance, evidence, and operational discipline.

This newsletter explores:

• The global ESG investing climate and regulatory direction.
• What the UK SDR regime aimed to achieve and what has changed since go-live.
• Key findings from the FCA’s review of good and poor practice.
• Practical next steps for asset managers and allocators conducting due diligence.

 

The Global ESG Investment Climate: Diverging Narratives, Converging Regulation

The last 18 months have seen a notable shift in the global sustainable finance landscape.

The early ESG boom of 2019–2022 was characterised by rapid asset growth, product proliferation and relatively limited regulatory oversight with the exception of some early ‘example’ enforcement (think DWS). That phase has now transitioned into a period of regulatory consolidation and scrutiny.

Several structural trends define the current environment.

 

1. Europe remains the largest sustainable investment market

Europe continues to dominate sustainable fund markets, accounting for the majority of global sustainable assets and roughly half of EU fund assets being classified under sustainability categories. This reflects the strength of the EU’s sustainable finance framework, including:

• SFDR,
• EU Taxonomy,
• and corporate Sustainability Reporting Directive (CSRD).

 

However, regulators have increasingly acknowledged that SFDR has effectively become a labelling regime rather than a disclosure framework, creating confusion for investors and firms alike.

 

2. The UK is pursuing a more consumer-focused regime

The UK’s approach has deliberately diverged from the EU by focusing on consumer clarity rather than complex disclosure templates. The FCA introduced SDR to address three core issues:

• investor confusion around sustainability claims,
• inconsistent product disclosures,
• growing concerns about greenwashing.

 

Research cited by the FCA suggested 70% of investors believe many sustainable investments may not be genuinely sustainable, highlighting the trust deficit regulators are attempting to address.

 

3. The United States has experienced ESG politicisation

In contrast, the US has seen a political backlash against ESG investing. While the SEC continues to develop disclosure rules, the market narrative has become increasingly polarised.

The result is a fragmented global regulatory landscape, where the EU and UK are strengthening frameworks while the US moves more cautiously.

Despite these differences, regulators across jurisdictions increasingly share one priority: substantiated sustainability claims supported by evidence and governance.

 

SDR: What the UK Regime Was Designed to Achieve

The FCA’s Sustainability Disclosure Requirements (SDR) regime was introduced through Policy Statement PS23/16 in November 2023. The framework aims to improve transparency and investor trust through a package of measures including:

• An anti-greenwashing rule applying to all authorised firms.
• A labelling regime for sustainable investment products.
• Consumer-facing disclosures.
• Detailed product-level and entity-level disclosures.
• Naming and marketing rules governing sustainability terminology

 

Four investment labels were introduced:

1. Sustainability Focus
2. Sustainability Improvers
3. Sustainability Impact
4. Sustainability Mixed Goals

 

The regime became operational through staged implementation:

• Anti-greenwashing rule: May 2024
• Use of labels permitted: July 2024
• Naming and marketing rules: December 2024 onward

 

Unlike SFDR, the UK regime emphasises intentionality and outcomes. Labelled products must pursue a defined sustainability objective and demonstrate credible evidence supporting that objective.

 

Early Compliance Challenges Across the Industry

Even before the FCA’s good-practice review, several implementation challenges had emerged.

 

1. Defining credible sustainability standards

Many firms struggled to demonstrate that their internal ESG frameworks met the “robust, evidence-based standard” required by SDR. The regulator has been clear that sustainability claims must be defensible and supported by verifiable data, rather than marketing narratives.

 

2. Translating ESG strategy into measurable objectives

A recurring difficulty has been translating broad sustainability themes into:

• specific sustainability objectives
• measurable KPIs
• clear theories of change

 

3. Operationalising stewardship and engagement

For funds labelled as Sustainability Improvers, firms must demonstrate credible pathways for improvement. This requires clear escalation processes where investee companies fail to progress toward sustainability targets.

 

4. Aligning investment teams, ESG specialists and disclosure functions

In many firms the investment process, stewardship activities, and disclosure drafting remain siloed, creating inconsistencies between marketing claims and investment strategy. These issues are precisely what the FCA’s review sought to examine.

 

FCA Review: What Good Practice Looks Like

The FCA reviewed applications and disclosures submitted through the fund authorisation process and identified several common features of strong disclosures.

1. Clear and specific sustainability objectives

Good disclosures define sustainability objectives that are:

• clear,
• specific,
• measurable,
• and aligned with the assets being invested in.

 

For example, an objective might focus on contributing to climate change mitigation through investments in companies advancing energy transition technologies. In contrast, vague objectives such as “contributing to planet and people” were highlighted as poor practice.

 

2. Transparent discussion of negative outcomes

Strong disclosures acknowledge potential trade-offs and unintended impacts.

For instance, investments in clean energy infrastructure may still carry biodiversity or land-use impacts, which should be transparently discussed. Ignoring such trade-offs was viewed as a key indicator of weak governance.

 

3. Evidence-based sustainability standards

For Focus and Improvers funds, at least 70% of assets must align with the sustainability objective, assessed against a robust and consistently applied standard.

Good practice examples included:

• clear scoring frameworks,
• documented sustainability thresholds,
• and references to recognised external standards

 

Poor practice included vague references to ESG frameworks without supporting evidence.

 

4. Meaningful KPIs

KPIs should measure progress toward sustainability outcomes rather than simply governance inputs. Examples of credible KPIs include:

• carbon emissions reductions
• water efficiency improvements
• renewable energy generation capacity

 

By contrast, generic metrics such as governance quality scores were considered insufficient if they do not directly measure environmental or social outcomes.

 

5. Consistency between holdings and disclosures

Disclosures must be consistent with the actual portfolio.

The FCA highlighted cases where firms claimed sustainability exposure without demonstrating how underlying holdings supported those claims.

 

Common Examples of Poor Practice

The FCA also identified recurring weaknesses across disclosures.

Vague sustainability objectives
Objectives framed around broad themes without measurable outcomes.

Unsubstantiated sustainability claims
Claims that portfolio companies derive revenue from sustainable activities without supporting data.

Lack of escalation processes
Engagement strategies without defined timeframes or consequences if companies fail to improve.

KPI misalignment
Metrics that do not relate directly to the stated sustainability objective.

Portfolio inconsistencies
Holdings that conflict with the sustainability strategy without adequate explanation.

These weaknesses suggest that some firms are still approaching sustainability disclosures primarily as marketing documents rather than governance frameworks.

 

What Asset Managers Should Do Now

The FCA’s review suggests that regulators are increasingly focused on evidence, governance and demonstrable outcomes, rather than narrative sustainability disclosures.

For firms operating across the UK and EU, this also presents a practical opportunity. Many of the operational expectations emerging from the SDR review, particularly around governance, evidence standards and measurable outcomes, overlap with the direction of travel under the proposed SFDR 2.0 reforms.

Where firms are preparing for both regimes, it may be more efficient to conduct a single cross-framework review, assessing how sustainability objectives, evidence standards and disclosures operate across the organisation.

Asset managers may therefore wish to consider the following actions.

 

Strengthen sustainability governance

Ensure sustainability objectives are embedded into core investment processes and decision-making frameworks, including:

• investment decision processes
• stewardship and engagement strategies
• risk management and oversight structures

 

These elements are increasingly central to both SDR expectations and the anticipated evolution of EU sustainable finance rules.

 

Validate sustainability frameworks

Internal ESG scoring models and sustainability assessment methodologies should be demonstrably robust, documented and applied consistently across portfolios. Where firms operate across jurisdictions, this can also support alignment between SDR labelling criteria and potential future EU product categorisations.

 

Confirm that disclosures align with investment reality

Marketing, ESG and portfolio teams should work closely together to ensure that sustainability disclosures accurately reflect the underlying investment strategy.

In particular:

• portfolio holdings should clearly support the stated sustainability objective
• disclosures should reflect the actual investment process and decision framework

 

This alignment will be increasingly important under both SDR and SFDR reforms, as regulators scrutinise whether sustainability claims are supported by portfolio construction.

 

Test escalation frameworks

For strategies focused on sustainability improvement, firms should ensure that stewardship and engagement frameworks include clear escalation pathways where investee companies fail to make progress. This includes defining engagement timelines, monitoring milestones and identifying when divestment or other escalation measures may be appropriate.

For firms reviewing their sustainability governance in light of the FCA’s SDR thematic review, incorporating these elements as part of a combined SDR and SFDR readiness assessment may provide both regulatory clarity and operational efficiency.

 

Final Thoughts

The SDR regime reflects a broader shift in sustainable finance. ESG is moving away from marketing narratives toward regulated product frameworks supported by evidence and governance. The FCA’s thematic review reinforces that sustainability claims must be:

• specific,
• measurable,
• evidence-based,
• and embedded within the investment process

 

For allocators, this also provides a useful lens for due diligence. Investors are likely to not only expect the demonstration of sufficient pre-contractual disclosures, but also the outcomes from the last 18 months including:

• proof that the sustainability objective truly aligned to the investment strategy
• testing of ESG assessment methodologies
• outcomes of sustainability KPIs
• validated and credible stewardship and escalation processes

 

For firms that approach sustainability as a governance discipline rather than a marketing exercise, SDR provides an opportunity to strengthen both credibility and investor trust.