It is now over six months since the Financial Conduct Authority (FCA) published its final rules on sustainability disclosure requirements (SDR) and investment labels and just over one month before firms can start using the sustainability labels on their fund marketing materials. The regulator’s aim with SDR has always been clear – improve trust and transparency in the market for sustainable investment products and prevent greenwashing by ensuring financial products marketed as sustainable can provide clear evidence to back up these claims.
In practice, what will this mean for retail investors navigating the new sustainability fund universe? There is a risk of confusion as investors will see funds fall largely into four buckets:
- funds with a sustainability label;
- funds without a label but with certain sustainability characteristics;
- funds with no label and no sustainability characteristics; and
- overseas funds marketed in the UK that currently won’t be allowed to apply the SDR regime, even though they may be as sustainable as funds with a label.
While it may be too early to determine which bucket products will fall into, responses to a recent survey of Investment Association (IA) members, who between them account for an estimated 80% of total FUM in UK domiciled Responsible and Sustainable funds, have provided key insights into how the industry is implementing SDR.
Investment Association member firm responses have indicated there could be over 200 labelled funds by the end of this year. Once the market has established itself and managers can be more confident funds are meeting the criteria, we could expect to see further movement into labels next year – particularly from index trackers and fund-of-funds.
See also: Pimfa members call for one-year delay to SDR reporting for portfolio management
Funds that will have a sustainability label
The FCA has set a high bar for a fund to receive a label – it must have a clear, specific and measurable sustainability objective, with at least 70% of the product’s assets invested in line with that objective.
While only 14% of firms plan to use labels from the go-live date at the end of July, two-fifths of firms within the scope of the regime intend to label at least one of their funds by the end of this year.
According to the IA’s survey, the Sustainability Focus label (funds that have an objective to maintain a high standard of sustainability in the profile of the assets) could account for almost half of all labelled funds. Sustainability Impact (a fund or product with an explicit objective to achieve a positive, measurable contribution to sustainable outcomes) could be applied to the fewest number of funds, accounting for just over a tenth of labelled funds.
Labelled funds are likely to sit across multiple asset classes, but equity assets will account for the majority, by both number of funds and funds under management.
Funds that won’t have a label but that have certain sustainability characteristics
IA figures show 70% of firms in scope will have funds that won’t get a label but have certain sustainability characteristics. These could include funds with a positive tilt, best-in-class funds that find companies that are sector leaders in meeting certain ESG criteria but may not have a specific, measurable sustainability objective, or funds screening out specific stocks such as tobacco or oil that would struggle to hit the required 70% threshold of assets invested according to a sustainability objective.
To avoid confusing investors, under the new naming and marketing rules, firms will be required to remove the words ‘sustainability’, ‘sustainable’ or ‘impact’ in the name of funds without a label by 2 December 2024.
IA analysis shows the majority of firms will not be changing the names of their funds to comply with these new rules – just over a 10th will be changing the name of at least one of their funds. This indicates the majority of current funds with those words in the fund name will be aiming to get a label.
It is worth remembering the labelling regime is voluntary, so just because a fund may not decide to use a label, it does not mean it doesn’t have strong sustainability characteristics.
Overseas funds being marketed into the UK
The UK retail fund space is global in nature. Two thirds of our survey respondents have both UK and offshore domiciled funds. Of the 4,700 funds available to UK retail investors, 2,100 funds are domiciled overseas and, for now, those overseas funds being marketed into the UK will not be allowed to use the labelling regime.
This means there will be sustainability funds that could meet the high bar set by the FCA for getting a label which will not be able to apply one. With the UK and EU currently moving in different directions, it will be crucial that UK regulatory divergence doesn’t work against a competitive and dynamic product market or create disadvantage for investors.
Whilst we now have a clearer picture of how the investment management industry is getting on with the implementation of SDR, the impact of the new rules on the actual shape of the funds market remains uncertain.
However, one thing is clear: investment managers remain committed to delivering the best possible outcomes for their clients and our industry embraces the vital role we play in supporting financial advisers, wealth managers, investment platforms and investors themselves in understanding our newly reshaped sustainable funds universe.
The IA has recently published its implementation guidance for firms complying with SDR – find out more here.
