Rebecca Kowalski, founder of Overstory Finance and specialist paraplanner, provides her ten takeaways from the FCA Sustainable Disclosure Requirements (SDR) paper, with specific reference to financial planning processes.
The FCA’s long awaited rules on sustainable fund labels, disclosures and marketing rules, was published on 28 November last year, at 212 pages long. That’s without including much on the subject we in the financial planning community were most keen to read – best practice for advice firms.
The length of the document reflects the long journey that the regulations have been on. The FCA first issued proposals for Sustainable fund labels in November 2021 and was taken aback by the number of responses it received to its consultation. Some of the proposals were popular, others less so. Of the 240 respondents, it is unlikely that any of them liked and disliked all of the same things.
The policy paper explains not just the final rules are but also how the FCA has adapted them in response to stakeholder views. Keeping all the people happy all of the time is never an easy task and it seems the final rules have been shaped, but not entirely shaken up, by the large number of passionate people who have had a say in their development.
I have summarised below my ten key takes from the paper, considered from the view point of the financial adviser/paraplanner and clients.
1. The objective is key.
It’s important to keep in focus that the legislation is designed to help the consumer to navigate this potentially complex area of finance, as well as to support the channelling of capital to a UK and global transition to Net Zero. It has put additional expectations on fund managers relating to transparency, fund structure and clarity and this should support adviser understanding too. Consumers are not the only people who can find sustainable investment choices complex.
2. Principles and Prescription
The regulations aim to set the right balance between compulsion and flexibility. While there are some fixed requirements – such as a minimum of 70% in relevant sustainable assets to achieve a label – there is still a lot of room for fund manager manoeuvre.
The definition of sustainability is not locked in for example, nor are the KPIs by which progress towards the sustainability objective is measured. While some might wish for more defined rules, the FCA’s decision not to codify everything is reflective of the evolving nature of the sustainable finance ecosystem. The government and other bodies are currently consulting on a UK Green Taxonomy which will define the official line on what is sustainable. Regulations that require businesses to report comprehensively on their sustainability impacts are on the horizon, but not yet in place. At this point in 2024, it’s still not possible to complete a perfect jigsaw showing a green future, as we don’t yet have all the pieces. We can however assemble the ones we have.
3. Four labels but 57 varieties?
The flexibility within the legislation will allow fund managers to apply their own style and strategy to sustainable fund design. This means that fund researchers and selectors at adviser firms need to understand the differences between interpretations of the Focus, Improvers, Impact and Mixed Goals labels. There remains plenty of need for a detailed scrutiny and comparison of options.
4. Raising the bar
Standards required by SDR are a minimum. It is to be hoped that competitive forces will come into play and generate progress and advancement in sustainable investment design. If all labelled funds must have at least 70% in aligned assets, then some may aim for 80% to differentiate. If Impact fund managers see that all labelled funds now have to set sustainable objectives and report progress towards them, they may seek additional ways of making their strategies seem more dedicated to the impact cause.
As consumers receive more clarity on the difference between sustainable investment strategies, they may develop more defined and sophisticated views.
Advisers and paraplanners should be watching out for product and investment preference development with interest.
5. The subjectivity of Sustainability
If there were a consultation on what is sustainable and what isn’t, it would no doubt receive even more than 240 differing responses. While some clients may not have firm views on a subject that requires a certain amount of knowledge and interest, others will feel strongly about whether, for example, nuclear power or burning biomass or AI applications make the S grade.
This will always be an area where there are multiple views, changing views and possibly some need for compromise. We need to think about how to incorporate this into propositions, product selection and exploring client preferences.
This gives advisers the option of stepping in to that watchperson role; perhaps a means of improving overall consumer trust levels in the finance industry.
6. Keeping the faith
The FCA carried out consumer research in association with the labels, which is insightful. It revealed that the public like the idea that the regulator (who they consider to be reliable and on their side) is going to vet and monitor the label system, so that investment managers cannot “play fast and loose” with the labels.
However, the flexibility within the system and other demands on FCA resource mean that oversight is unlikely to meet consumer preferences. This gives advisers the option of stepping in to that watchperson role; perhaps a means of improving overall consumer trust levels in the finance industry.
I would suggest that the adviser contribution to helping clients navigate sustainable finance adds a lot of value to the price paid for advice.
7. Doing our Duty
The FCA has done a great job of adhering to Consumer Duty principles with SDR regulation and adviser firms should consider how it affects Product and Services, Customer Understanding and Price and Value outcomes.
We should all have reviewed and refreshed our Product Governance procedures before CD Day last July and should review them again to consider how the fund labels might affect our current client segments and investment propositions. It’s convenient that the labels come into effect around the same time that our Consumer Duty first birthday review needs to be completed,July 2024.
The SDR requirement for simple client-facing documents are a gift to help us with Consumer Understanding and I would suggest that the adviser contribution to helping clients navigate sustainable finance adds a lot of value to the price paid for advice.
8. Understanding the Customer
Consumer research suggests that many potential investors will not fully understand what concepts like “sustainability”, “net zero” and “environmentally friendly” will mean. They want clear, simple information in manageable doses. They want this to be in terms they are familiar with, and that tells them practically what they need to do. The labels could form a helpful part of a process that incorporates this need at all stages, from deciding your firm’s investment proposition, processes and messaging to individual conversations, recommendations to clients and annual reviews. Disclosure requirements mean that labelled funds must provide clear updates about progress towards sustainability objectives, which I can see providing rich material for annual review reports and meetings.
If you haven’t yet done so, now could be a good time to create that client friendly sustainable finance advice journey. Do you give your clients that clarity about what they need to do and why?
The part of the SDR regulations that advisers really NEED to consider is the anti-greenwashiing rule, due to take effect from 31 May.
9. Spotlight on Greenwash
The part of the SDR regulations that advisers really NEED to consider is the anti-greenwashiing rule, due to take effect from 31 May. This is something that advisers, not just investment managers, have to comply with. Greenwashing is a problem that is rife across many sectors, with energy producers, airlines, banks, fashion retailers and many others facing fines and reputational damage.
I am sure that there is plenty of IFA material out there – on websites, in brochures and suitability letters that wouldn’t meet the clear, fair and not misleading requirements. Particular care needs to be taken with the use of the words “impact, sustainable and sustainability” in the description of products and services, but any other terms that could imply good outcomes for people and planet also need to be used with care. I believe that in the vast majority of cases, this is unintentional. I have asked the FCA in its current consultation on the matter to encourage or provide more learning and some initial leniency for smaller firms.
10. How much difference will the labels make?
At present, this is in the hands of the investment managers, although the baton will be passed to advisers later on. Will managers adopt a label and which one? How soon will they ready themselves for the additional requirements and go “label live.” Recent research from Morningstar indicates that around 300 UK funds will opt for a label by the end of 2024, about 3% of all funds available for sale in the U.K. “Sustainability Focus” will likely be the dominant label, followed by “Sustainability Mixed Goals,” then “Sustainability Improvers,” and “Sustainability Impact.” This contrasts to the FCA consumer research, which suggested that the “Impact” label was the one that consumers were initially most drawn to.
There is an element of wait and see until the labels become available for use from July onwards but I would encourage advisers to consider the implications of SDR if carrying out any reviews or forward planning on proposition development, staff training, marketing and communications.
Referenced research/surveys
Financial Lives 2022: Key findings from the FCA’s Financial Lives May 2022 survey
U.K. Sustainability Disclosure Requirements: An early analysis | Morningstar
The Language of Sustainability | Trajectory (trajectorypartnership.com)
