Interoperability in focus after final UK SDR rules released

Industry delivers a positive verdict, but challenges remain for interoperability, and implementation deadlines may be shorter than expected.

Market participants have welcomed the final release of the UK’s fund-labelling regime and sustainability disclosure requirements (SDR), but warned that interoperability reamins a key consideration.

In response to industry feedback, the Financial Conduct Authority (FCA) made a series of changes to its proposals, with the most significant being the addition of a fourth “mixed strategy” label to cover funds that did not meet the requirements for a single label.

Several investors said the UK regulator had gone beyond their expectations in taking market concerns on board and dealing with issues raised in consultation.

Ashley Hamilton Claxton, head of responsible investment at Royal London Asset Management, said the FCA had done a good job in navigating the complexities and responding to feedback.

“The regulation strikes a good balance between protecting end investors and applying the practical realities of how the market for sustainable investing operates today,” she said.

Other UK-based investors also welcomed the final release. Joseph Pinto, CEO of asset manager M&G, said the standards will improve market confidence, and that the FCA had achieved balance between consumer protection and leaving space for product innovation within the asset management industry.

Similarly, Seb Beloe, partner and head of research at WHEB Asset Management, said the addition of a fourth label had been “less expected but no less welcome”. The rules will close “fund-labelling loopholes that have left current reporting requirements open to manipulation and abuse by fund management companies”, he said.

Hilkka Komulainen, head of responsible investing at Aegon UK, also welcomed the SDR as a significant step towards addressing greenwashing and enhancing transparency, but argued that more guidance is needed on the implications for pensions and discretionary fund managers, which will be indirectly affected by the new regulations.

While the mixed strategy label is welcome, diversified portfolios may face challenges with their own labelling, as they are reliant on the labelling and disclosures of underlying funds, she warned.

Assorted associations

UK investment industry groups also delivered positive verdicts. Their key concerns focused on interoperability with other jurisdictions, as the EU is in the process of consulting on reforming SFDR into a labelling regime. Australia is also in the early stages of planning a labelling system.

Leo Donnachie, senior policy manager for sustainable finance at the IIGCC, said it was “vital” to keep in mind the need for interoperability with other regimes and welcomed the FCA’s commitment to engage on this.

This was also welcomed by Galina Dimitrova, director of investment and capital markets at the Investment Association.

James Alexander, CEO of UKSIF, called on the FCA to “closely engage” with other regulators in order to positively shape their approaches to disclosures and fund labels, and promote international harmonisation.

Meanwhile Margarita Pirovska, the PRI’s head of policy, said policy alignment across jurisdictions is an “operational imperative”.

Greenwashing and names

The FCA also kicked off a consultation this week on detailed guidance on its greenwashing rule.

The rule requires references to the sustainability characteristics of a product or service to be consistent with actual characteristics, as well as fair, clear and not misleading. The FCA is consulting on the guidance – which will apply to all FCA-authorised firms – until late January.

Benjamin Maconick, a managing associate in the financial services team at Linklaters, said that, while a lot of attention had been paid to SDR, the greenwashing guidance is “probably more exacting than people would perhaps think from looking at the general rule, particularly the part around sustainability claims being complete”.

“This greenwashing guidance applies to absolutely everything. Where firms that are subject to the SDR regime are fairly familiar with sustainability disclosure regimes, some of the firms subject to the more general anti-greenwashing rule might not have gone through their sustainability claims with quite the same fine-toothed comb before.”

Jessica Reed, a financial services partner at Farrer & Co, said she was encouraged to see the FCA listen to market feedback on the SDR and improve its rules on using ESG phrases in fund names outside of the labelling system.

The initial proposal had been to ban this entirely, but this was relaxed in the final version.

Reed told Responsible Investor that there will be a “significant” compliance burden for putting labels into place, highlighting an FCA estimate that the average ongoing compliance cost for an asset manager would be £217,000.

“Firms will have to design rigorous procedures to ensure that each labelled fund stays within the qualifying criteria and, importantly, must also develop KPIs to show whether a fund’s sustainability objective is being met,” she said. “All of this will likely incur significant compliance costs.”

A few questions

While the response to the rules was overwhelmingly positive, a few questions and complaints remain.

The IIGCC’s Donnachie said that more clarity was needed on the timeline for corporate reporting, given the data needs of investors. He added that the concept of stewardship in the rules should also have included macro stewardship.

Phil Spyropoulos, a partner in the financial services team at Eversheds Sutherland, said the window for implementation of the labelling system was “fairly short”. Funds can start using the labels from July 2024, which he said was sooner than the 12 months investors had been expecting.

This was echoed by Phuong Gomard, head of the sustainable finance practice at Mazars, who warned that the deadline “may pose challenges, emphasising the need for firms to proactively embed the rules without delay to navigate any potential obstacles as soon as possible”.

Raza Naeem, a partner at Linklaters, said the introduction of 70 percent compliance thresholds for all the label types was “very interesting and will likely be challenging for many products to meet, and perhaps get drowned out a bit in the rhetoric of all the other helpful things the FCA has done”.

He also noted that the regime will eventually be extended to overseas funds.

“Overseas funds are left with a big question mark. It seems clear that the regime will be extended to overseas funds, it’s just a matter of when and how.”