Our thoughts on the FCA’s proposed Sustainable Disclosure Requirements (SDR)
Like so many of our peers, over the last couple of years we’ve been grappling with the implementation of the EU Sustainable Finance Disclosure Regulation (SFDR) as well as the introduction of different regulatory regimes across the globe, including in Taiwan, Hong Kong, Singapore, Australia, the US, and now the UK.
In October 2022 the UK Financial Conduct Authority (FCA) published its much anticipated consultation on proposed Sustainability Disclosure Requirements, investment labels and restrictions on the use of sustainability-related terms in product naming and marketing.
The intention of the FCA (and all the regulatory authorities) is close to our heart: to provide greater clarity to consumers about how ‘sustainable’ financial products really are. Without greater clarity, there is a risk that greenwashing becomes the next biggest mis-selling scandal, which could slow the flow of capital needed to make economies more sustainable at a time when that flow needs to improve.
We have formally responded to the FCA consultation which closed in January 2023 via our parent company, First Sentier Investors. We’ve also shared our views through our involvement with organisations such as The Big Exchange, the first UK based investment platform to actively rate funds for their positive impact. We thought it might be worthwhile to summarise our views here.
Where do we fit?
The FCA are proposing three non-hierarchical sustainable investment labels based on how a product contributes to sustainability outcomes.
Sustainable Impact
- assets (often in underserved markets) that achieve a positive, measurable contribution to sustainable outcomes.
Sustainable Focus
- assets that are environmentally and/or socially sustainable according to a credible standard.
Sustainable Improvers
- assets that may not be sustainable now but aim to improve their sustainability over time.
The requirements are stringent and more clarity will be beneficial. At Stewart Investors we invest in companies that we believe are well placed to contribute to, and benefit from, sustainable development. At this stage, we believe our approach sits best in the Sustainable Focus category, although we have some suggestions for how the category could be framed:
- The 70% threshold should be raised to a minimum of 90% of qualifying assets. At 70% the unsuspecting consumer could find themselves exposed to a significant number of companies they wouldn’t (and shouldn’t) expect to hold in a sustainable fund, which the proposed regulation is trying to avoid.
- The requirement to have independent assessments of any in-house and proprietary systems and methods that managers use to define sustainable investments should be clarified and qualified. Not all independent assessments will be useful, especially if they rely entirely on off-the-shelf ESG scores. In our view, some ESG data can be useful, but an over reliance on simplistic, mechanistic ESG scores won’t necessarily always help to reorient capital towards more sustainable companies. We think it’s important to recognise that many companies, particularly in emerging markets, have yet to develop the sort of data reporting capabilities that many well-endowed companies in developed markets have been able to invest in and develop. Engaging providers of independent assessments will require a substantial cost and time commitment that currently isn’t fully factored into the cost-benefit analysis.
The Sustainable Impact category in its current form may be challenging for many of the existing ‘impact’ labelled equity funds that focus on the enterprise contribution of listed companies, i.e. the contribution companies make to sustainable outcomes. The FCA is focusing first on the investor contribution and the concept of additionality, which typically requires investment in primary or private capital – not a traditional hunting ground for retail investors.
The Sustainable Improvers label requires asset managers to specify a causal link between individual company engagement or stewardship activity and changes in company behaviour. Further clarity on the timescale for reporting on stewardship outcomes would be helpful, along with a recognition that stewardship outcomes often require a long-term, partnership-oriented approach with companies. Furthermore, positive stewardship outcomes are sometimes the result of collaborative industry efforts and/or efforts undertaken outside the investment industry. These realities make it difficult to quantify the individual contribution of each investor.
Health warnings for the consumer
In contrast to the EU SFDR, a strength of the proposed regulation is that the FCA has stated their intention to be non-hierarchical. Their intention is to differentiate, rather than rank, approaches, in order to help consumers make more informed choices. However, not all market participants will appreciate this intention, and it may even be widely misconstrued.
The use of the labels will be voluntary, but any products that don’t qualify will face restrictions in terms of how they can be marketed and named. While this is a step in the right direction, is the proposed regulation ambitious enough? The onus is on sustainable funds to disclose what they invest in. But if we want investors to make informed decisions and allocate more capital to sustainable investments, shouldn’t all funds disclose what exposure they have to companies whose business models, products and source of profit are not sustainable?
A similar approach to the compulsory food labelling traffic light system we have in the UK, which at a glance tells the consumer if what they are buying is ‘healthy’ or ‘unhealthy’, may not be realistic, but what we can do is ensure that fund sustainability-related reporting doesn’t get buried deep in a 500-page annual report. Information needs to be accessible to consumers. We’ve spent a great deal of time improving our own transparency. Our Portfolio Explorer – an interactive tool which provides the investment and sustainability case for every company in which we invest in – provides useful information on the contribution that each company makes to climate solutions, human development and the Sustainable Development Goals, plus key risks and engagement topics.
Another plea for international collaboration
We appreciate that the FCA has worked hard to achieve some alignment with the European Commission SFDR regulation, but there are some issues that still need to be resolved.
The UK SDR will not initially cover overseas products that are marketed in the UK. This remains under review and the FCA has indicated that it plans to issue a further consultation on overseas funds. Like many managers with both UK and EU funds, we now have to plan how we can meet the requirements of two different and detailed sustainability disclosure regimes under both SFDR and SDR.
We would welcome a further update from the FCA as to when they intend to consult on the plans for the Overseas Fund Regime, the regulation that governs investment funds domiciled overseas and how they are marketed to UK retail investors, and we would encourage closer international collaboration and integration of regulatory initiatives. Without this, there is likely to be a confusing proliferation of regimes, rules, definitions and acronyms.
What next?
Following its consultation, the FCA intends to publish the final rules and guidance in a Policy Statement by the end of the first half of 2023. The anti-greenwashing requirements will become effective immediately. The labels, consumer-facing and pre-contractual disclosures, and marketing rules, will become effective 12 months later. The timeline will be a challenge, but we look forward to rising to this challenge. We want to continue playing our part to improve the ability of investors and consumers to make more informed investment decisions.
Investment terms
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