Does the Financial Conduct Authority’s (FCA) Sustainability Disclosure Requirements (SDR) initiative represent a critical step in addressing the challenge of greenwashing and improving trust in sustainable investment markets? Or is it a damp squib?
At its core, the SDR aims to ensure that financial products marketed as sustainable genuinely meet their claims, fostering transparency and protecting consumers. However, the journey toward implementation has been fraught with challenges for fund managers, with industry consultation repeatedly highlighting concerns about the assumptions underpinning the FCA’s approach and the practical realities of compliance.
Greenwashing, the act of misrepresenting an investment’s sustainability credentials, is the primary concern driving SDR’s development. In CP22/20, the FCA’s consultation paper that preceded the SDR, the word “trust” appears 13 times in the opening summary, reflecting the regulator’s belief that trust in sustainable investment is at risk. A survey cited in the policy statement suggests that 70% of retail investors believe many sustainable investment claims are exaggerated or misleading.
The characterisation of the UK fund management industry as defaulting to greenwashing was, I believe, an overly combative opening gambit. The law defines misrepresentation at three levels — innocent, negligent, or fraudulent — and the FCA’s narrative risks conflating these distinctions. While there have been instances of fund groups misrepresenting their sustainability credentials, I suspect these were not intentional greenwashing. Evolving definitions of sustainability, varying consumer expectations and multi-regional compliance touchpoints can make it challenging for firms to align their practices and value propositions. Furthermore, the media and fund gatekeepers have become much more vigilant concerning identifying greenwashing and calling it out.
The SDR places significant demands on fund managers, all of which are navigating a rapidly evolving regulatory landscape. The new anti-greenwashing rule, labelling requirements and disclosures require substantial operational changes and interpretive judgement. For some, the apparent cost burdens and lack of clear benchmarks for compliance have led to hesitation. We have seen firms opting to defer labelling decisions until the regulatory environment stabilises or claim “out of scope” status. This does not help build a buoyant and robust gene pool of sustainable funds for investors to choose from.
Despite these challenges, the SDR has not prompted an industry retreat from responsible investing. Fund groups have moved promptly to align with anti-greenwashing regulations with some avoiding premature commitments to labelling. However, it has been uplifting to see more labelled funds working through the FCA’s pipeline in recent weeks demonstrating that obtaining a label is indeed possible. These pioneers will (and rightly so) enjoy reputational benefits as the SDR regime gains traction.
While the SDR framework may be challenging to submit to, it also represents an opportunity for firms to refine and display their responsible investment credentials. Willing submission to the labelling process sends an extraordinarily strong signal to fund gatekeepers. However, it is wrong to assume that all that came before SDR was bad and it has been difficult to witness some of the original ethical funds disenfranchised from this initiative.
The introduction of sustainability labels presents a double-edged sword for fund managers. On one hand, other investment factors held constant, these labels will undoubtedly offer a competitive edge in attracting fund flows, improving access to fund buyers’ lists and CIPs. On the other hand, the average retail investor may not give as much weight to sustainability labels. Their investment decisions are often influenced by factors such as performance, fees and risk, rather than the intricacies of a fund’s sustainability framework.
Nevertheless, labels play a crucial role in enabling advisers and portfolio managers to align products with their clients’ preferences, providing a standardised tool for navigating the increasingly complex landscape of sustainable investments.
Early adopters of SDR-compliant labels are likely to enjoy reputational advantages, positioning themselves as leaders in responsible investing. These firms will not only attract conscientious investors but also set a standard for others to follow. However, the journey to achieving a label is far from straightforward. The FCA’s emphasis on clear, evidence-based standards demands rigorous due diligence, which may deter less well-resourced firms from seeking labelling in the near term. It would be a shame if one of the unintended consequences of SDR was crushing fund innovation.
At Square Mile Research, we have consulted with over 50 fund groups with respect to the SDR. Many have voiced frustration with a lack of guidance about what was expected, and it is a shame to see some fund groups walk away in frustration. However, our industry has made significant strides in embracing sustainability, and we should give fund groups credit for that rather than casting the industry in a uniformly negative light. It is encouraging now to see more funds coming through the FCA’s approval pipeline in recent weeks.
As we begin to see early successes with labels, I feel SDR will avoid damp squib status potentially becoming a cornerstone of sustainable finance in the UK. However, it needs to evolve with industry feedback and practical realities. Trust is the foundation of the SDR, and building that trust requires ongoing collaboration between the regulator, fund managers, advisers and their clients.
