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Regulators around the world recognise the powerful role that the investment industry can play in addressing some of the major environmental and societal issues we face. And they are creating rules and standards that aim to support a meaningful shift toward sustainable finance. In this article, we’re exploring the UK’s upcoming Sustainability Disclosure Requirement (SDR) and what it means for asset managers.
Within decades, scientists warn the climate crisis will spiral out of control. But if we can move to a low-carbon economy, there is a glimmer of hope. In the words of Mark Carney, “Finance will be critical to accelerating and smoothing this transition”[1]. A whopping $6.9 trillion of targeted sustainable investment is needed each year for us to meet our climate goals[2]. The UK’s pensions funds – worth an estimated £2.5 trillion – could certainly make a dent.
Regulators around the world recognise the essential role of the investment industry. And they’re developing ways to support sustainable finance. In this article, we’re exploring the UK’s upcoming Sustainability Disclosure Requirement (SDR) and what it means for asset managers.
Borne out of the UK Government’s wider Green Finance Roadmap, the SDR is one of several key pieces of legislation designed to help us transition to a low-carbon and sustainable future. As with the EU’s Sustainable Finance Disclosure Regulation (SFDR), the UK’s regulatory body –the Financial Conduct Authority (FCA) – is keen to implement its own disclosure requirements across investment services.
The idea is simple: Asset and wealth managers should be transparent and not misleading about the credentials of their investment products. By doing this, retail customers can feel reassured that their investments match their values and expectations.
But in practice, it’s complicated. The UK’s SDR was first brought up in 2021 and has already gone through a second round of industry feedback. What needs to be included and to what extent will have serious implications for investment firms. Not only will finding the required information take up significant resources, but the compliance risk increases too.
The potential impact of the SDR is far-reaching.
Asset managers will be required to substantiate ESG claims they make in a way that is comparable between products and is accessible to clients and consumers. They will also need to disclose whether and how they take ESG-related matters in their governance arrangements, and in their investment policies and strategies.
Asset managers will need to ensure that the sustainability data that underpins their analysis is reliable, which means conducting additional due diligence on the Environmental, social, and governance (ESG) data they use from third-party providers. They will also need to be careful about the language they use in their fund communications to ensure it is “clear, fair and not misleading”.
As the regulation takes shape, it looks like firms will only be able to use ESG labels on their investment products when sustainability is the principal objective. The emphasis will be on intentionality and primary channels. Three categories of labelling will apply to investment products:
These categories are somewhat comparable to Articles 6, 8 and 9 in the EU’s SFDR. At the time of writing, they appear to be a little stronger, but may become softened following the consultation process. While there was broad support for the spirit of the regulation, many respondents highlighted practical issues with its implementation. For example, the head of the Investment Association, Chris Cummings, criticised the strictness of labels, as if they were to go ahead in their current form, between 60 and 70% of all retail investment products would be excluded [3]. In response to such feedback, the FCA indicated that it may ease the rules.
To qualify for any of the three available SDR labels, a financial product must:
- have a sustainability objective
- define how its investment policy and strategy support the objective
- list its relevant KPIs
- outline its relevant use of resources and governance
- articulate its view of investor stewardship, and
- disclose any “unexpected investments” that consumers are likely to view as inconsistent with its sustainability objective.
Some experts, such as James Purcell and Simon Smiles [4], compare these labels to the nutrition stickers on our food. The idea is that retail customers should be able to quickly understand how sustainable their investment is, without needing a degree in finance. This could offer benefits beyond ESG, as it could also enhance better stewardship, trust, and transparency.
The SDR requirements will reverberate throughout the industry. They will affect all FCA-regulated firms and the work of other actors along the value chain, including trade bodies and consumer groups. The SDR will impact the largest asset managers first, with smaller firms following.
Implementing the changes will require some work from almost every area of the firm. Compliance, marketing, operations, analysts, and investment managers will probably all need to adjust.
You can find out more about how ESG impacts asset managers in our 2023 white paper.
Retail customers will likely benefit the most. Bringing new levels of transparency to pension holders and investors gives them control and reassurance. It is hoped that this landmark legislation can help to rebuild trust in the industry, something which has suffered since 2008.
Another benefit is that genuinely sustainable firms - rather than those who have big marketing budgets to greenwash- could finally see more investment. If ESG funds direct money towards businesses that are designed to create lasting value whilst being good stewards of the environment and society, they will have a better chance of thriving.
At the time of writing, the FCA has been reviewing feedback for the SDR and investment labels consultation. The regulator is considering the 240 written responses. One of the thorniest issues is around disclosures for multi-asset and blended strategies. It’s difficult to put one label on these funds. The FCA aims to publish its Policy Statement in on 30 June 2023.
As of that date, the FCA will have a new explicit rule upon which to challenge firms and bring enforcement action where it considers them to be greenwashing their products or services.
The rest of the rules for labeling, disclosures, naming and marketing will apply a year later, from 30th of June 2024.
Firms should now be considering how to demonstrate compliance with the anti-greenwashing rule ahead of the 30 June 2023 deadline. The key challenge will be to assess if references in client communications are “consistent with the sustainability profile of the product or service” and are “proportionate and not exaggerated”.
You can read more on the FCA website.
The timelines and exact requirements continue to evolve. But it seems clear that over the next 12-24 months, asset managers offering ESG products will need to prepare. Almost every area of ESG - including training, labelling, marketing, pre-contractual disclosures, and customer-facing disclosures – will probably be affected.
Companies should start working on the following:
However, we believe that avoiding greenwashing and meeting the spirit of the SDR goes deeper than how information is communicated. It's about real ESG integration, effective stewardship throughout the investment process and a genuine understanding of the beneficiaries' values and expectations.
Consistent and successful compliance with industry best practice is possible and can be simple, quick, and effective. Impactive is a custom-built platform that provides all the tools for managing ESG activities within investment organisations. This includes engagement management, ESG data and research aggregation, regulatory reporting and team workflow management. Most importantly, Impactive enables seamless interaction between those responsible for implementing regulations - like SDR - across their firm.
SDR will challenge the way asset managers conduct business. Impactive is on hand to ensure firms have the tools they need at their disposal, to meet regulatory requirements as and when they appear.
Click here to request a 7 day trial.
[1]Source: UKCOP
[2]Source: OECD
[3]Source: FT
[4]Source: Sustainable Investing in Practice (book)
[5]Source: FCA
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