With the implementation date for firms to start using the labels laid out in the FCA’s Sustainable Disclosure Requirements (SDR) only three weeks away, Morningstar Sustainalytics provides an early perspective of what the sustainability-labelled funds market may look like, and SDRs impact on the investment industry, assessing opportunities and challenges.
“There was initially a lot of enthusiasm about sustainability labels in the UK, partly in opposition to the inadequacy of the EU SFDR regime. But that enthusiasm has waned in the past six months as asset managers realize that a) the criteria to get a label are more stringent than expected, and b) the demand for labelled products, at least at the beginning, won’t be as high as initially thought. For these two reasons, many asset managers have decided to take a wait-and-see approach.
An additional factor dampening managers’ enthusiasm for labels is that many funds marketed in the UK aren’t even in scope. We can therefore expect the number of labelled products to be smaller than the universe of unlabeled funds with sustainability disclosures.” – Hortense Bioy, Head of Sustainable Investing Research, Morningstar Sustainalytics
Some challenges we have identified are around selecting KPIs; labelling funds of funds; SDR in context of other regulations; and label eligibility.
Key takeaways include:
- We observe mixed reactions among asset managers to the SDR labelling regime. We expect the universe of unlabeled funds with sustainability disclosures to be larger than the universe of labelled funds, which would be an unexpected outcome and unintended consequence of the regulation. The result, however, would be in line with the FCA’s unique goal to combat greenwashing and improve transparency, contrasting with SFDR’s broader objective to channel capital towards sustainable activities.
- ‘Sustainability Focus’ and ‘Sustainability Mixed Goals’ labels are more likely to be adopted by fund managers than the ‘Sustainability Impact’ label, due to challenges faced in evidencing theory of change.
- The introduction of the ‘Impact’ label challenges criticisms that impact can only be achieved through private markets, refuting skepticism that listed equities can deliver additionality as it involves buying into what is already available as opposed to private markets which support the financing of new opportunities.
- The introduction of SDR has received positive feedback from both asset managers and asset owners.
- Asset managers are facing challenges. One being the selection of KPIs to evidence that a product meets its sustainability objectives. Managers lack clarity about qualifying KPIs and have requested further guidance from the FCA. Additionally, managers are concerned about interoperability with the SFDR, which is still under review. Implementing a consistent approach that aligns with regulatory requirements across multiple jurisdictions is not straight forward and potentially costly.
- Challenges also remain around how to apply a label for funds of funds, with further questions around achieving this for off-shore products that are out of the scope of SDR – particularly impacting redistributors.
- For asset managers, aligning to different regulatory frameworks will be challenging and costly. Economies of scale will be lost if there becomes a need to offer different types of strategies to satisfy local jurisdictions.
