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SDR – no pain, no gain?

19 November 2024

The stage is set for a rapid increase in the number of funds using sustainable investment labels.

By Seb Beloe,

WHEB Asset Management

Currently, only a handful of funds are authorised to use one of the four sustainable investment labels, which were recently introduced along with the Financial Conduct Authority’s (FCA) sustainability disclosure requirements (SDR). We are happy to be one of them.

Perhaps counterintuitively, we are very keen to see other funds use these labels. The FCA’s ambition is for the labels to be a valuable designation that the market actively uses as part of fund selection. To achieve this, we need tens if not hundreds of funds to be using the labels and covering all asset classes, regions and styles of investing.



Keeping the faith

At the many conferences we have spoken at, there is clearly real frustration with the FCA. It took us five months before the FCA allowed us to start using the label.

We went through 20 iterations of the prospectus and had three in-person Zoom calls along with three rounds of written feed-back with the FCA. Annex 1 of the prospectus grew from one to 15 pages.

But despite frustration with the process, there is still generally solid support for the SDR itself. From our conversations one-on-one with clients and at various conferences, it’s clear that the fund management industry generally likes the labels.

After all, the labels’ purpose is to weed out greenwashing and create a clear and trusted identity for investors wanting to invest in truly sustainable investment funds.

There is also support for the four categories: ‘sustainability impact’, ‘sustainability focus’, ‘sustainability improvers’ and ‘sustainability mixed goals’. The labels represent existing practices, are distinct but complementary, and should help financial advisers and investors find products that better suit their needs.

And while the process has been difficult, the basis for a principles-based regime is also understood to be sound. The early pain that the industry is experiencing should bear dividends in having a regulatory regime that is flexible and able to evolve as the industry develops.

Much better to have this regime than a more prescriptive approach that is perhaps clearer, but rapidly becomes irrelevant, or worse, a barrier to innovation.


So where are we?

We know of at least 10 funds have made the necessary changes to their prospectuses that allow them to use one or other of the sustainability labels. There are also a huge number of applications in the pipeline.

Anecdotally, our own SDR webinar attracted hundreds of participants, of which approximately one third were other fund managers.  Rumours of the premature death of SDR are, to misquote Mark Twain, ‘grossly exaggerated’.

Nonetheless, the FCA has itself acknowledged that the authorisation process has taken longer than anticipated. ‘Temporary flexibility’ on the new rules, extending the deadline for some funds to adhere from 2 December 2024 to 2 April 2025, have now been agreed.

If the FCA is right, the next few months will see a rapid acceleration in the number of funds announcing their use of the labels. Otherwise, our own achievement will represent something of a pyrrhic victory.

 

What’s next

The critical next step is publication of the FCA’s final policy statement on ‘Extending the SDR regime to portfolio management’. This is expected in the second quarter of 2025. The regime is expected to mirror the SDR requirements for fund managers in terms of the structure of the labels, as well as disclosure and reporting requirements.

One practical challenge is the extent to which model portfolio service (MPS) providers are required to ‘look through’ the funds they own and into their underlying holdings. This has implications for the level of due diligence that needs to be conducted, as well as for the reporting of key performance indicators (KPIs).

The SDR process for fund managers has clearly been onerous. We think it is right that standards are high, but there remains a danger that the additional resources this requires make the process unattractive for some providers. This balance also has to be struck in how the regime applies to portfolio managers.

We believe we are past ‘peak pain’ for fund managers. We hope that some lessons have been learnt both by the FCA and by the industry that will ensure the process is altogether quicker and less painful for portfolio managers.

Seb Beloe is a partner and head of research at WHEB Asset Management. The views expressed above should not be taken as investment advice.

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