What will the final SDR rules mean for investors?

The Sustainability Disclosure Requirements (SDR) and investment labels regime is a long-awaited package of measures issued by the UK’s Financial Conduct Authority (FCA) for sustainable funds. 

After two years of extensive consultation the final paper is here, bringing a raft of changes including new sustainability labels as well as updated marketing rules and guidance. The new rules will affect how sustainable funds are built, how they are described to investors, and how they are sold to clients.  

We welcome the consultative approach the FCA has taken and think the final rules enhance transparency through improved disclosure and will ultimately bring more clarity for investors to help them differentiate between sustainable products and strategies. 

The initial scope of SDR starts with sustainable funds authorised in the UK. However, the FCA has committed to consulting on whether to apply the rules more broadly than that, for example to pension providers, or portfolio managers. 

A new anti-greenwashing rule is likely to come into force from 31 May 2024 for all UK regulated firms. Asset managers can use the sustainability labels from 31 July 2024 and need to ensure that all their naming and marketing is updated by 2 December 2024.  

Here, our policy and sustainability experts discuss in detail what’s in the package, what has changed since the first proposal and what the implications are for investment firms and their clients. 

What’s your first reaction to the final SDR paper and its fund labelling requirements? 

Andy Howard, Global Head of Sustainable Investments, said: 

Looking at the big picture, this is a positive package. You've got a very logical and clear framework for conveying information to consumers about the types of sustainable investments that they are buying and how they differ. As the industry goes through this, there will no doubt be questions about the details and precisely how it is implemented. We look likely to end up with a good balance between prescription and principle-based rules, which should allow consumers to differentiate between different products. 

One of the points of feedback to the first SDR consultation was around the difficulties with labelling multi-asset funds, where you might have investments in different types of sustainable funds. That is why in the final SDR we now have four sustainability-focused labels instead of the initial three: ‘Sustainability Focus’ for those funds who focus on assets or companies that are already environmentally or socially sustainable; ‘Sustainability Improvers’ which are focusing on companies with the potential to improve in the future; ‘Sustainability Impact’ with funds that have got a clear and measurable impact in relation to social or environmental objectives.

The fourth and new category, ‘Sustainability Mixed Goals’, allows a combination of the first three types within the portfolio. 

Who will approve the labels? Can you clarify the changes around the 70% threshold rule? 

Andy Howard said: The fund labelling is not an approval process - investment managers themselves will need to determine which funds they think should fall into the different labels. We think that providing such flexibility and avoiding prescription of labelling will encourage innovation within this space and the ability to create more choice for clients and for consumers, along with the transparency they need to make informed decisions.  

Another change from the initial consultation has been to the % minimum investment threshold. The initial requirement in the FCA’s consultation was that you had 70% of the assets within Sustainability Focus portfolios contributing to the sustainability objective. That threshold will now apply to all labels in a more explicit way. It's also important that all the holdings within those portfolios are not undermining or contradicting the sustainability objective. This means the other 30% of the portfolios can't be investments that are negatively impacting that objective.

What’s your view of the new rules, overall? What is your response to the anti-greenwashing rules? 

Richard Fox, Head of Public Policy, said: ‘This was a really difficult task for the FCA, but they have clearly listened to the industry feedback. As usual, the devil will be in the detail and we're very happy to work through that detail with clients.  

We welcome the regulator’s focus on greenwashing and whether some parts of the market are exaggerating their claims - consciously or unconsciously - or not paying enough attention.  

Formally, this package of rules will not directly apply to those working in pensions, discretionary fund managers, advisors, or people running model portfolios. But the direction of travel is clear - the FCA has suggested they want to extend the same principles across the market (subject to consultation).  

For those clients, I would still look out for the anti-greenwashing rule, and I would engage with the consultation on the guidance around that. The questions they should ask themselves are ‘How confident are we to use SDR as a soft benchmark? How confident are we in our claims?’ because that rule will bite before those firms get the detailed framework that we already have as an authorised fund manager.

What are the implications of the SDR for private assets? 

Anna O'Donoghue, Global Head of Product Development and Governance said: In the final rules the FCA has introduced flexibility around the 70% rule for private assets. For example, a new Long Term Asset Fund (LTAF) may be fully invested in cash at the point of launch and then steadily deploy those assets into appropriate investments. The way the rules were written in the consultation would have meant that a label could not be accessed until the point that those assets had been deployed up to the 70% mark. But now a sustainability focused LTAF can qualify for a label from day one based on its intention to invest at least 70% of assets in accordance with the sustainability objectives.  

What's the impact of the SDR on pensions? 

Richard Fox said: ‘The SDR rules don't formally apply to those working in pensions, but there are clear signals that the FCA wants to expand them to this space too. If you want to have a sustainable default option for your members, you can look at the new Sustainability Mixed Goals label for the kind of standards the FCA might set through any future consultation. They would probably be setting a 70% bar for the constituent elements to be labelled sustainable funds from your third-party providers. But this will all be consulted on as normal, so pensions colleagues will have a chance to input and shape the detail.

How are you going to quantify a particular label?  

Anna O’Donoghue, said: Each individual firm will determine what is appropriate in the context of the sustainability objectives of their products and demonstrate that they have attained those standards. The threshold of what that standard constitutes is for each individual firm to determine too. The FCA allows the option to leverage third party tooling to determine the standard, but equally to develop proprietary tools to define what that standard looks like. Every firm in scope – like us – will now be thinking through this in detail, and how to demonstrate that standard for each of the funds that we would hope to apply labels to.

Can you explain the concept of ‘unexpected investments’ in the context of the new rules?  

Richard Fox, said: In the original SDR proposals we had to identify whether our funds held any “unexpected investments”, and if they did, or might, to explain this to clients. This means – as the name suggests - an investment that a client didn’t expect to see in their portfolios. We thought it was quite a tricky standard because it is very subjective. In the consultation feedback, some people asked for that term to be strengthened by something more akin to the EU requirement that everything in a sustainable fund should “do no significant harm”.

The FCA listened to both those points and went a third way - they've dropped the idea of unexpected investments but nor have they introduced a formal "do no significant harm" test. 

Instead, we have to ensure as a manager that nothing in the fund conflicts with the sustainability objective we have set. We will need to work out how we determine that and how we set that standard, but the rules make sense to me and set a clear standard.

How will the SDR operate in conjunction with other European regulations, like the SFDR? 

Andy Howard said: ‘The different rules in UK and the EU might add some complexity for managers that are selling into different markets. The FCA has been very clear about interoperability - you're not going to get a single global standard on sustainability regulation, but you do want to have as much consistency and interoperability as possible.  

A piece of regulation is not a document that comes out and fixes everything. The EU itself is going through a process of reassessing whether there are parts of the SFDR regulation that should be revised or revisited. 

What’s your view on other global reporting initiatives? 

Andy Howard said: We have found that there is a tendency to talk about lack of sustainability data or disclosure as being an insurmountable hurdle to sustainability analysis. That's certainly not our view. 

There is a lot more sustainability-related information available than there was a few years ago. The data could certainly be more consistent and more precise, but data itself is not a hurdle.  

Still, what we've begun to see more recently are mandatory requirements. For example, in the EU, the Corporate Sustainability Reporting Directive (CSRD) will create more mandatory requirements, and we are seeing a similar move here in the UK with the International Sustainability Standards Board (ISSB) standards being introduced into reporting more disclosure on sustainability and climate change performance.  

All of this will help to bring more precision and more consistency to how different companies are assessed and how different assets are evaluated. But ultimately this won't drive everyone down the same route. There is a difference between disclosure and how that disclosure is interpreted and applied to assessments of individual companies or assets and then applied to portfolios. It should make for a more robust foundation without necessarily driving everyone into the same corner of the market.