(Bloomberg) -- Asset managers outside the UK are about to find out whether they can continue to sell their ESG funds to British investors.

The UK is preparing to launch a consultation on the geographic scope of its new rules for funds claiming to target environmental, social and governance goals. The results may have major implications for the roughly 1,600 funds that are currently available on the UK market but domiciled in the European Union, according to lawyers advising the industry.

“Lots of the techniques that have allowed firms to call their product sustainable in Europe just won’t work in the UK,” said Phil Spyropoulos, a partner at Eversheds Sutherland whose clients include asset managers with ESG mandates. 

Britain is implementing its ESG fund regulations more than three years after the EU enforced its rulebook for sustainable investing. Asset managers that have thus far sold into both markets now face a regulatory schism. 

About 15% of the ESG funds available in the UK are currently registered as Article 8 or 9, which are ESG designations under the EU’s Sustainable Finance Disclosure Regulation, according to data compiled by Morningstar Direct. 

Under EU rules, Article 8 funds are supposed to “promote” ESG. But such products may not meet the ESG threshold outlined in the UK’s new framework, according to Hortense Bioy, global director of sustainability research at Morningstar. Nor is it certain that all funds registered as Article 9, which under EU rules require an asset manager to make ESG an outright “objective,” will automatically be treated as ESG in the UK, she said.

The UK’s consultation is due to start next quarter and coincides with a wide-reaching review of SFDR that may upend the EU’s existing ESG investing rules. What’s more, Europe’s markets watchdog has just imposed new requirements limiting what can be called an ESG fund. For asset managers, the upshot is a turbulent regulatory backdrop in the months to come.

The UK’s Sustainability Disclosure Requirements create four ESG fund categories, and funds domiciled in Britain will need to comply by December. The London-based Financial Conduct Authority has said it wants the new regime to create “a level playing field” with the EU.

The UK’s ESG fund rules will require portfolio managers to reference “a robust evidence-based standard,” Spyropoulos said. “That essentially means firms aren’t able to use relative measures — for example, they can’t state that a company is sustainable just because it is a leader in its industry.” 

The rules are part of a larger UK package of sustainability requirements that includes new anti-greenwashing measures due to take effect on May 31. Non-UK funds may be required to comply as early as next year if they intend to continue selling ESG products to British investors.

Under the new UK rules, firms will “need to avoid cherry-picking data and ensure transparency by considering the full life cycle of products in sustainability claims,” Lucy Blake, partner and ESG legal expert at Jenner & Block, said by email. “It’s not a one-time tick-box exercise either — continuous monitoring and updating of a product’s sustainability status is required to maintain compliance.” 

What’s more, firms “must also be cautious about relying on third-party information, as they are responsible for verifying and transparently sourcing all data,” she said. 

The UK Sustainable Investment and Finance Association (UKSIF), whose members include the asset management arms of HSBC Holdings Plc and JPMorgan Chase & Co., said they hope the consultation ultimately creates a more uniform regulatory framework for asset managers operating in both jurisdictions.

“Our members have consistently called for clarity in this area,” said Oscar Warwick Thompson, head of regulatory affairs at UKSIF. “Ensuring interoperability between geographies is a priority,” as is ensuring “a level playing field when regulating how UK and EU sustainable-labeled funds are marketed.” 

The Investment Association, which represents UK asset managers, said it has yet to take a position on whether EU funds should be subject to the SDR requirements, and is looking at the implications of the EU’s new fund naming rules as part of its review.

“It’s important that UK consumers have access to a range of funds with sustainable options, including overseas funds, and that consumers understand what they’re buying,” the trade group said.

Meanwhile, the rigor of Britain’s new rules is giving some UK-based asset managers pause as they consider whether to stamp their funds with one of the four labels, according to Morningstar’s Bioy. 

Initially, SDR was considered to be better suited to helping retail investors navigate ESG funds than the EU’s rules. Bioy says that’s no longer clear. 

Morningstar’s research indicates that “a big chunk” of asset managers won’t seek the UK’s ESG labels, she said. That’s in part as investment firms try to maintain as much flexibility as possible to avoid cutting themselves off from potential avenues for improving returns, especially as flow data indicates growing investor skepticism toward ESG as a strategy.

“Managers are taking a cautious approach to adjusting their existing ESG portfolios, bearing in mind that the more constrained a strategy is, the more active risk is taken and the less optimal financial results become,” Bioy said.

(Adds lawyer comment on anti-greenwashing rules, in 11th paragraph.)

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