We are just weeks away from the Financial Conduct Authority’s (FCA) 2 December deadline for meeting the naming and marketing rules of the Sustainability Disclosure Requirements (SDR) regime.
The Investment Association (IA) has long supported the FCA’s aim to bring greater transparency and market confidence to sustainable investment products – but hurdles remain to ensuring the regime is a success, with many firms still facing uncertainty over whether fund documentation will be approved to get a label.
While the FCA offered temporary flexibility in some limited circumstances on the December deadline, we are only aware of a small number of funds that have had documentation approved for a label, with many still going through the regulator’s approval process.
Looking forward to the role SDR will play in the sustainable and responsible investment market, and indeed the wider market, there remains work to be done to ensure it delivers against its end goal of improving consumer transparency.
Unless consumers are able to effectively use labels and disclosures to navigate the full range of products and make informed decisions, we risk damaging the UK sustainable funds market. In turn, this could negatively impact the competitiveness of the UK investment management industry as a whole.
The labelled fund market so far – are we seeing enough uptake?
In the FCA Policy Statement from November 2023 outlining the final rules, the number of funds (UK domiciled) using sustainability-related terms was anticipated to be a minimum of around 630, and they assumed that 45%, circa 284, would use the investment labels. An survey of IA member firms earlier this year also estimated that two-fifths of in-scope firms intend to apply a sustainability label to at least one of their UK domiciled funds, with the majority doing so by the end of 2024.
However, as we edge closer to the end of the year and the December deadline for firms to comply with SDR naming and market rules, we are aware of only around 20 funds that have had approvals of fund documentation for a label.
We all agree that the implementation of the regime is novel (both for industry and the regulator), meaning we have seen more amendments to applications than is the norm. The IA wrote to the FCA on behalf of our members to make the case for extending the 2 December deadline for all in scope funds, given the length of time the FCA application process was taking. Whilst we are pleased that the regulator listened to industry and granted firms additional time to comply, the extension only applies in limited circumstances.
For firms with restricted terms in funds names, the FCA flexibility grants extra time to go through the authorisation process, avoiding a cliff-edge risk of inadvertent breaches of the rules and possible market disruption and confusion for both retail investors and financial advisers. However, given the extension didn’t cover all funds in scope, we are still seeing reports of firms deciding not to label funds in the short term until FCA expectations becomes clearer.
Whilst we have only seen a limited number of firms getting approvals to use the labels, we are hopeful the market share will continue to grow throughout 2025. In order for the labelling regime to be a success, a critical mass of labels is need and with significant AUM, across multiple providers.
Which labels are seeing the most success?
The type of label obtained depends upon the investment objective of the fund, and is also influenced by the types of assets invested in.
Our estimations earlier this year showed that the ‘Sustainability Focus’ label could be the most popular amongst firms, while the ‘Sustainability Impact’ label would be applied to the fewest number of funds.
This is because the largest category of sustainable funds in IA data are global equity funds often investing across multiple sustainability themes – many of which are not selecting companies with an impact objective in mind. Our member survey suggested that most global equity funds have sustainable investment objectives that align with the requirements of ‘Sustainability Focus’.
‘Impact’ funds are more likely to be investing in real or private assets such as real estate or infrastructure, where there is a clearer investor contribution. However, there are fewer funds of this type available to retail investors compared to funds investing in more mainstream asset classes like equities and bonds.
The FCA has recently provided best practice examples for pre-contractual disclosure requirements as part of the SDR labelling regime. These illustrative examples across Focus and Improver labels aim to showcase how applicants can meet the pre-contractual disclosure requirements, presumably in the hope that more of such funds will get a label.
We are continuing to work with members and the FCA to effectively address the significant challenges being reported to us in several areas.
What’s next for SDR?
Over the coming weeks and months, industry and the FCA needs to continue to work together to overcome challenges with SDR implementation.
The first phase – implementation up to the 2 April deadline for those funds that avail of the flexibility – needs to be a success for the overall regime to work. The ultimate test will be how funds, both labelled and unlabelled funds with sustainability characteristics, will be communicated to investors to allow them to make informed choices.
The IA conducted investor research in conjunction with the Wisdom Council, which showed that investors broadly welcome the concept of labels and wanted a clear, simple framework that would help them to navigate sustainable funds. Notably, the financial advisers interviewed felt that measurability, clear criteria and accountability were critical issues.
However, given that the first funds with labels are yet to enter the market it’s too early to say how the market will react to the new labelling landscape. Whilst the introduction of SDR labels is an important step forward, we need to see a meaningful number of funds labelled in each category and across providers for the regime to be able to become a success.
Consumers’ ability to navigate the non-labelled sustainable and responsible investment funds and to make informed choices aligned with their own sustainability preference is crucial for a well-functioning and successful market – otherwise, we face the risk of a dysfunctional sustainable funds universe. In turn, this could negatively impact the competitiveness of UK investment management industry as a leader in sustainable finance.
It’s important to remember that the current FCA rules on SDR and investment labels for the investment management sector is only one piece of the jigsaw. As outlined in the Government’s 2023 Green Finance Strategy, SDR is a disclosure framework across the whole economy – businesses, the financial sector and investment products. The success of the SDR regime for investment managers is also dependent on data flowing from the other pieces of that jigsaw.
