The UK’s Financial regulator has outlined its classification system for its Sustainable Disclosure Requirements (SDR) as it continues to diverge from EU regulation on sustainable investing.

In a discussion paper published by the Financial Conduct Authority (FCA) to coincide with COP26, the regulator set plans for five new categories for environmental, social and governance (ESG) funds.

This is different from SFDR’s three categories, where funds are classified either; Article 6, no sustainable lens; Article 8, funds that promote ESG characteristics or Article 9, funds that have a sustainable investment objective.

Under the FCA’s proposals, funds would be categorised as not promoted as sustainable or ‘responsible’, which may have some sustainable investments.

Three further categories, ‘transitioning’, ‘aligned’ and ‘impact’ make up the rest of the classification system.

Source: FCA

The regulator added how these would align with the SFDR provisions: “We recognise that many UK firms are subject to SFDR in respect of their EU business and have already invested in systems and processes to classify products according to SFDR provisions.

“We therefore consider it important to explore how products already classified under SFDR can map against the UK framework.”

Funds not promoting sustainable investments would be aligned with Article 6, while ‘responsible’ and ‘transitioning’ funds would fall under Article 8.

Funds that are ‘aligned’ would be Article 9 under SFDR, as would ‘impact’ funds making up a smaller subset of the category.

The new categories come after Chancellor Rishi Sunak set out new requirements for asset managers to outline how they incorporate sustainability into their investment strategy in a bid to weed out greenwashing from the financial system.

At COP26, Sunak said the UK will become the world’s first net-zero aligned financial centre in a bid to “rewire the entire global financial system”.

Commenting on the new proposals, Galina Dimitrova, director for investments and capital markets at the Investment Association, said: “We welcome today's announcement from the FCA on the launch of their discussion paper looking at SDR and investment labels, as part of their new ESG strategy.

“The considerations in this discussion paper reflect the evolution of the fund market and the expectations investors have for greater transparency and consistent, trusted standards.”

Emma Wall, head of investment analysis and research at Hargreaves Lansdown, added: “It is fantastic to see the regulator giving responsible investing the attention it deserves.

“We welcome the particular focus on transparency, which we know investors are calling for, as well as the wider commitment to supporting the transition to a greener, cleaner economy.”