UK SDR Fund Universe too Narrow
More sustainability-labelled funds needed to invigorate the UK market, as interoperability with EU remains a priority.
Labelling rules for UK-domiciled sustainable funds have introduced more transparency and rigour, but there is still work to be done to ensure a wide spectrum of choice for investors.
Finalised in November 2023, the Financial Conduct Authority’s (FCA) Sustainability Disclosure Requirements (SDR) were intended to improve transparency, bolster reporting and limit greenwashing related to sustainability-focused investment products.
As part of the SDR package, the FCA introduced four sustainability-focused labels – ‘focus’, ‘improvers’, ‘impact’ and ‘mixed goals’. To use one of the labels, fund managers need to demonstrate that at least 70% of the fund’s assets support the chosen strategy.
In February, the FCA announced that over 100 funds had passed through its review process.
Data and research provider Morningstar Sustainalytics has since identified 80 open- and closed-end funds with an SDR label – representing £34.5 billion (US$45.95 billion) of AUM – and 325 non-labelled funds providing sustainability disclosures.
“SDR has brought clarity and transparency to the UK fund market. It has forced asset managers to clarify their sustainable funds’ objectives and the metrics they use to measure sustainability,” Hortense Bioy, Head of Sustainable Investing Research at Morningstar Sustainalytics, told ESG Investor.
“However, the labelling review process by the FCA, combined with the regulator’s high standards, have discouraged some asset managers from opting for more labels, resulting in a limited choice for investors.”
The FCA previously acknowledged that the application process for the SDR labels has been slow and complicated, offering asset managers temporary flexibility to comply until the beginning of this month.
Sustainability focus is the dominant label, according to Morningstar Sustainalytics’ paper, representing 56% of all labelled funds. This is followed by impact (26%), improvers (13%) and mixed goals (5%).
Limited choice
The introduction of the SDR labelling regime has led to a concentrated market in terms of strategy and exposure type.
Morningstar Sustainalytics said that all labelled funds are actively managed, with large global large cap equity strategies and fixed income funds representing 31% and 4% of total assets, respectively.
The most popular themes targeted by SDR-labelled funds are emissions reduction, water and renewable energy, its report said.
“So far, the funds gaining SDR labels are mainly climate-focused,” said Oscar Warwick Thompson, Head of Policy and Regulatory Affairs at the UK Sustainable Investment and Finance Association (UKSIF).
“Social-focused funds should also have a place in the UK’s sustainability-labelled funds market. Recognising that sustainability goes beyond climate change alone is very important, and there is more work to do to ensure this is reflected in SDR.”
Investors will find a wider variety of strategies with sustainability characteristics among unlabelled funds, according to Morningstar Sustainalytics.
Around half of unlabelled funds have ESG-related terms in their names, including 55 funds (17%) that use the term ‘ESG’. Thirty funds (9%) with the world ‘responsible’, 16 products (5%) employing ‘ethical’, and 20 using a climate-related term (6%), the report said.
BlackRock, which has notably walked back its climate ambition in recent months, is the largest provider of non-labelled funds with sustainability characteristics, with 66 products totalling £150 billion in assets, Morningstar Sustainalytics said.
Label adoption is likely to continue this year, but Morningstar Sustainalytics does not expect the SDR universe to exceed 200 funds.
Warwick Thompson called for more detailed guidance in relation to the mixed goals and improvers labels – both of which have seen lower adoption rates – as well as clarity on the FCA’s finalised approach towards portfolio management services and the treatment of overseas domiciled funds under SDR, both of which are currently excluded from SDR’s scope.
Interoperability across Europe
There are also concerns that the UK’s SDR regime does not fully align with fund name rules introduced in EU member states by the European Securities and Markets Authority (ESMA).
ESMA requires funds to invest at least 80% of their assets in line with sustainability-related terms in their name – such as ‘ESG’ or ‘transition’. The rules have applied to new funds since 21 November 2024 and will be introduced for existing funds on 21 May of this year.
The rules aim to serve as an interim anti-greenwashing measure ahead of a more expansive and far-reaching review of the Sustainable Finance Disclosure Regulation (SFDR) later this year.
Since ESMA’s fund name rules were introduced, the number of funds with sustainability-related names has fallen by 20%, according to MSCI.
Europe has just recorded a quarter of net outflows from sustainable open-end and exchange traded funds, according to Morningstar. Within the first three months of 2025, 64 European sustainable funds were closed – 49 liquidated and 15 merged – which the paper noted “reflects a maturation of the sustainable fund market”.
Against this backdrop, the UK’s SDR and ESMA’s fund names guidance have also prompted widespread rebranding across Europe, with Morningstar estimating that 335 funds across Europe with ESG-related terms in their names rebranded in Q1 2025 – with 216 changing from one ESG-related term to another, while 116 dropped their ESG terms altogether. Three added ESG terms.
“More will need to be done to enhance interoperability for fund naming rules by the FCA and ESMA which are not currently well aligned,” said Warwick Thompson.
“This consistency will be important for our members operating in both jurisdictions, and importantly for retail clients to minimise confusion in fund disclosures.”
Tensions between the two sets of rules are likely to be “exacerbated” by the EU’s ongoing regulatory simplification agenda, he warned.
Within the upcoming SFDR review, the European Commission will consider whether its existing Article 8 and 9 disclosure categories should be formally recognised as labels, or whether it should introduce new labels altogether.
“When reviewing SFDR, the EU should learn from the first phase of SDR implementation and ultimately commit to a fund labelling system drawing on the SDR framework,” said Warwick Thompson.
However, Bioy from Morningstar Sustainalytics challenged the need for an EU labelling system that aligns with the UK’s SDR.
“While useful for consumers in theory, the proposed product categories [for SFDR] – sustainable, transition, ESG – would be very challenging to implement in practice, potentially even more challenging than the SDR labels with many unintended consequences, such as limited choice of strategies and stifled innovation,” she said.
“Also, it would add a layer of complexity and compliance that no one wants at this juncture, considering the ongoing omnibus work.”
The European market would benefit from simplified Article 8 and 9 disclosure rules paired with ESMA’s fund names guidance, she suggested.
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