Ten years ago I worked on the ground-breaking ‘Winners & Spinners’ project, where our team exposed how some UK funds badged themselves as ‘green’ or ‘sustainable’ but still poured money into oil, gas and coal companies. It’s taken a decade, but in July this year the UK’s main financial market regulator – the Financial Conduct Authority (FCA) – finally launched rules to stop investment firms from exaggerating the green credentials of their products in this way to retail customers.
The new regime is known as the Sustainability Disclosure Requirements (SDR) and it means all UK-based funds marketed as sustainable will have to be ‘fair, clear and not misleading’ about the impacts their investments have. Most controversial is the rule that investment firms must adopt one of four new impact labels for every fund they want to market as ‘sustainable’.
SDR is a welcome step forward for retail investors. But as we explore in this article the change has some teething problems, and the new rules might make things worse before they get better.
So, what are the new rules?
First, any UK-domiciled fund that claims to be sustainable needs to provide us all with a consumer-facing document to explain in detail how it is having a positive impact. For example WHEB Asset Management, which last month became only the second fund manager to adopt one of the new SDR labels, published this two-pager for its ‘FP WHEB Sustainability Fund’ to comply with the new rules.
As a rule, retail investors can trust that funds labeled as sustainable will now be required to have at least 70% of their assets genuinely aligned with sustainability criteria, reducing the chances of investing in funds that only pay lip service to sustainability.
Second, UK-domiciled funds that wish to market their fund as having a positive impact must choose to use one of four sustainability labels.
The four distinct product labels aim to distinguish between the different types of objectives and approaches that exist in the responsible investment market. For example, those funds that have a stated mission and metrics to create a positive environmental and/or social impact should carry the ‘sustainability impact’ label. While those funds that have only financial returns as a mission, and which might be willing to invest in companies doing environmental and/or social harms now but who aim to improve their sustainability over time, should carry the ‘sustainability improvers’ label.
The four labels, each one representing a specific investment objective and approach, are:
Invests mainly in solutions to sustainability problems, with an aim to achieve a positive impact for people/planet
Investment mainly in assets that focus on sustainability for people or the planet
Invests mainly in assets that may not be sustainable now, with an aim to improve their sustainability for people/planet over time
Invests in a mix of assets focusing on either sustainability problems, aiming to improve sustainability over time, or achieving a positive impact for people/planets
It is still early days for the new regime, but we’ve already had a few clients ask for explanations and cite confusion on the meaning of these labels (which we are always happy to provide).
This suggests that while the new rules are an undoubted step forward - as a sign of a more mature market for sustainable investing – the lack of clarity around each label is also a potential step back.
This is not unusual for any labelling regime. Animal welfare campaigners cite a lack of consumer understanding about the difference between food labels such as ‘Red Tractor’ or ‘RSPCA Assured’, deforestation campaigners about paper labels such as ‘FSC’ or ‘PEFC’, or green building professionals on labels such as ‘BREEAM’ and ‘LEED’. I could go on, the point being that the nature of sustainability is that it’s always going to be difficult to quantify in simple and absolute terms.
The technicalities are also a burden for the investment firms themselves. WHEB has described how the prospectus they put together to comply with the SDR regime, “Went through more than 20 versions… and grew from 3 to 15 pages”. This is clearly putting some investors off. For example, Stewart Investors, a well-known name in sustainable investing, has said it will drop the term sustainability from funds such as its ‘Asia Pacific Leaders Sustainability fund’, which is one of the biggest ESG strategies in the UK at £6.5bn of assets£6.5bn of assets.
This risks adding to, rather than addressing, confusion over responsible investment options for your typical retail investor.
The other important aspect to bear in mind is that SDR labels apply to only a small fraction of the market.
According to Morningstar Analytics, approximately 300 UK funds (open- and closed-end) are expected to adopt the new sustainability labels by the end of the year. This represents only about 8% of UK-domiciled funds and less than 3% of all UK funds. It likely won’t include the giant passive funds run by the likes of Vanguard and BlackRock which make up a large chunk of most peoples’ portfolios.
For retail investors, the new SDR rules will impact investment choices. Over time they should provide clearer, more reliable options when selecting sustainable funds, but in the short-term it risks causing extra confusion for those who want to align their investments with their values.
For over 10 years the problem of greenwashing in responsible investment has been steadily growing and the FCA is to be congratulated for drawing a line in the sand and fighting back on that. The new rules are far from perfect, but as a team with deep experience in sustainable investment we know that calculating the sustainability of a product is far from easy whether its food, forestry or investment funds.
If you’d like a discussion on who the winners and sinners are in your portfolio – then it’s something we at Harmonic are always happy to discuss.
If you have questions about the UK SDR or sustainable investing get in touch with the Harmonic Financial Planning (HFP) team. Schedule a Meeting here with John Ditchfield and Sarah Dutton:
We'd welcome an initial discussion, and a first appointment can be booked using the links below.
If you require advice based on specific circumstances, contact our professional advisors.