UK SDR Impact Stretches Beyond Retail Investors
UKSIF confirms interest from institutional investors in how labels will add credibility to funds’ sustainability credentials.
The UK’s Sustainability Disclosure Requirements (SDR) package may have been designed with retail investors in mind, but it also has implications for the institutional market to consider.
Finalised in November last year, the Financial Conduct Authority’s (FCA) UK SDR rules were intended to improve transparency, bolster reporting and limit greenwashing related to sustainability-focused investment products through the introduction of labels and guidance.
SDR applies to UK firms managing investment funds, UK firms distributing investment products to UK-domiciled retail investors, and FCA-authorised firms making sustainability claims in their marketing.
“But there will be a knock-on impact for institutional investors via the disclosures they receive from their fund managers who use these labels, and who are caught by the anti-greenwashing rule,” Oscar Warwick Thompson, Head of Policy and Regulatory Affairs at the UK Sustainable Investment and Finance Association (UKSIF), told ESG Investor.
“Asset owners will also need to think about how they plan to interact with the labels,” he said. “While the SDR regime is really geared towards enhancing retail investor understanding, we have heard that there is some interest from the institutional market in how these labels will help to demonstrate a fund’s sustainability credentials and characteristics to their own beneficiaries.”
Earlier this month, AEW – the real estate arm of Natixis Investment Managers – became the first asset manager to receive necessary approvals from the FCA to apply an SDR label to one of its UK-domiciled funds. The fund is only open to institutional investors.
Investor rules
In effect since the end of May, the anti-greenwashing rule requires entities to ensure all communications made to clients about the sustainability characteristics of their products and services are fair, clear and not misleading.
This requirement follows similar efforts in other jurisdictions, such as the EU and Australia.
Warwick Thompson argued it is still very early days to judge the full impact the anti-greenwashing rule has had on the market, with firms likely still focused on compliance.
“One issue that remains outstanding is the treatment of legacy disclosures,” he said. “From the day the anti-greenwashing guidance rule came into effect, firms have had to comply – but what about before that? The FCA may need to some more work there.”
As part of the SDR package, the FCA introduced four sustainability-focused labels – ‘focus’, ‘improvers’, ‘impact’ and ‘mixed goals’ – which can be applied to funds from the end of this month.
To use one of the labels, fund managers need to demonstrate that at least 70% of the fund’s assets support the chosen strategy. They must also provide consumer-facing disclosures – to both retail and professional clients – at the entity- and product-level, adhering to corresponding naming and marketing rules.
Taking the temperature
Ahead of the SDR labels’ implementation date, research and data provider Morningstar Sustainalytics this week published a survey assessing market readiness.
“There was initially a lot of enthusiasm about sustainability labels in the UK – partly in opposition to the inadequacy of the EU’s Sustainable Finance Disclosure Regulation regime,” said Hortense Bioy, Head of Sustainable Investing Research at Morningstar Sustainalytics. “But that enthusiasm has waned in the past six months as asset managers realise that a) the criteria to get a label are more stringent than expected, and b) the demand for labelled products won’t be as high as expected.”
As a result, many asset managers have decided to take a wait-and-see approach, Bioy added.
Many funds marketed in the UK currently aren’t in scope, meaning the universe of SDR-labelled funds will probably be smaller than that of unlabelled funds, according to Morningstar Sustainalytics.
The analysis revealed mixed feelings among asset managers about the upcoming regime, and that the ‘focus’ and ‘mixed goals’ labels are likely to be more popular than the ‘impact’ one – due to the challenges of demonstrating the ‘theory of change’ associated with the latter.
Morningstar had previously projected that around 300 UK open- and closed-end funds would opt for an SDR label by the end of this year – a number that is representative of 8% of UK-domiciled funds.
In May, UKSIF and consultancy PwC evidenced some of the challenges that firms would likely face in implementing the new rules.
These included fund-labelling interoperability across different jurisdictions, uncertainty over qualifying criteria and standards for labelling categories, product governance, and tight timelines for compliance with the anti-greenwashing rule.
They also outlined a series of recommendations, including establishing a firm-wide product classification framework to manage SDR complexity and international fragmentation, stepping up engagement with distributors to ensure they are comfortable with SDR labels and criteria, and developing an internal taxonomy of terms to identify potential greenwashing risk.
Long-term horizon
It will likely take time to assess the extent of the SDR labels and greenwashing guidance’s impact on the institutional market.
In the medium term, the FCA plans to extend the SDR’s remit to pension funds, having recognised that greenwashing-related risks are also pertinent to these products.
“We are expecting a consultation in the coming months that will outline how pension funds will be called into the scope of the SDR regime,” said Warwick Thompson. “This will require insights from the Department for Work and Pensions, The Pensions Regulator and the FCA, which will probably take some time, but we do expect it to be eventually rolled out.”
Guidance for overseas funds is also expected later this year.
More broadly, Warwick Thompson noted that there are still several other items on the agenda which need to pass to underpin the UK’s sustainable finance landscape.
“We need to see the other puzzle pieces beginning to fit together in the UK – such as the Green Taxonomy, mandatory transition plans, and the adoption of the International Sustainability Standards Board standards,” he said. “These tools can also provide lots of useful different data points and metrics for institutional investors.”
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