The Financial Conduct Authority’s incoming ESG rules, which include green labels for UK funds, risk outshining the European Union’s sustainable disclosure framework, a leading ESG expert has said.
Speaking at a media roundtable on 18 October, Hortense Bioy, global director of sustainability research at Morningstar, praised the regulator for “going in the right direction” with its Sustainability Disclosure Requirements, which are more granular and product-focused than the EU’s Sustainable Finance Disclosure Regulation.
“I think the SDR label framework has the potential to be a step-up from SFDR Article 8 and Article 9,” Bioy told Financial News.
With the final SDR rules slated to be rolled out some time in 2023, two years after phase one of SFDR came into effect, the City watchdog has the added benefit of hindsight, Bioy added.
“The FCA has had a chance to learn a few lessons from the SFDR’s chaotic start,” Bioy said. “The UK regulator has learned that the market want labels, so that’s what they’re going to provide.”
Europe’s SFDR requires asset managers to disclose sustainability risks in their investment products. Those that ‘promote’ sustainability factors have to be classed as Article 8, and products that have sustainable investment objectives are required to be classed as Article 9.
But critics complain the rules are too broad and difficult to interpret and inadvertently open up asset managers to greenwashing claims.
Victoria Hasler, head of research at EQ Investors, said with the details of the proposed SDR rules yet to be announced, it is difficult to have a firm opinion on their future. However, she said the FCA’s intended aims – to promote transparency, build trust, and enhance the tools available to investors and support the net zero transition – are “laudable”.
“We understand that SDR plans to go a step further than SFDR and introduce fund labels. These would seem to be aimed at retail investors, with the broad aim of avoiding greenwashing,” she said. “At a high level we find it difficult to see how these could be viewed as anything other than positive for retail investors. The information will need to be clear, understandable, and comparable, but assuming these conditions are met, such a label could improve confidence in the industry.”
READ Investors pull €47bn from ‘light green’ funds, but managers claim it’s an ESG ‘red herring’
Bioy said the FCA’s SDR framework “provides more clarity about the spectrum of green”.
When the FCA launched its initial consultation a year ago, it floated five potential labels that products would be required to display to reflect their sustainability characteristics, including ‘transitioning’, ‘aligned’ and ‘impact’.
The ‘transitioning’ label is particularly noteworthy, said Bioy, as it is “an explicit acknowledgement that there is currently a limited pool of green investments and that capital flows need to be facilitated towards companies that may not be sustainable today but are on the right path to become sustainable in the future”.
While the FCA’s proposals to have fund labels to help retail investors have a better understanding of what they’re buying is a positive, Troy Mortimer, a director for ESG and responsible investment at Alpha FMC, thinks this is easier said than done.
“In many cases retail investors still view ESG strategies as ethical investing,” he said. “Clearly, financial advisers and wealth managers play key roles in ensuring retail investors understand any fund label or product classification, and they will need to ensure they fully understand the labels/classifications themselves. This may prove to be more difficult than expected.”
SDR has been designed to be in line with SFDR, as well as proposed SEC regulations, to avoid over-burdening asset managers with additional paperwork and regulatory hurdles, and to avoid confusion among consumers.
READ FCA crackdown on greenwashing: ‘A matter of when, not if’
But asset managers have grown increasingly anxious their Article 8 or Article 9 badged funds could be de-classified under the UK’s incoming ESG regime. Bioy said the level of granularity with SDR could mean some funds marketed as ‘sustainable’ are less green.
“When they [investors] look at an Article 8 fund, for example, they might realise under the SDR framework, it’s not a sustainable fund because it didn’t make it to the first level,” she said. “This is probably going to create a divide in the Article 8 category in particular.”
Hasler thinks funds are unlikely to be “de-classified,” but she admitted there could be confusion if the two regimes have different standards.
“Under this scenario one could envisage a situation where, for example, an onshore fund is classified as the equivalent of Article 8, whilst the offshore fulfils Article 9 requirements,” she said. “Given that the nomenclature is likely to be different between the two regimes, this may not be as confusing as it sounds, but could certainly lead to questions if one regime is seen as more lenient than the other.”
“Having said that, the devil is always in the details and it remains to be seen how easily the SDR label system will be implemented,” Bioy said.
Sign up for your Sustainable Finance newsletter here, brought to you by ESG writer Kristen McGachey
To contact the author of this story with feedback or news, email Kristen McGachey
