SDR for Portfolio Managers: lessons learned from the journey so far
It is now almost ten months since the first Policy Statement on the FCA’s new Sustainability Disclosure Requirements (SDR) & investment labels was published. For those firms most impacted, it has been a period of significant amount of effort, lessons learned and, as most people dealing with the labelling process would agree, frustration.
During this time, we have published a series of blogs summarising the requirements of the regime, from a general overview, to a more detailed breakdown on how to interpret the anti-greenwashing rule. In this latest blog, in anticipation of the final SDR rules for portfolio management to land as a post-summer holiday treat, we are switching our focus for the wealth market.
Below, we provide a reminder on what already applies to wealth managers, an update on the practicalities of SDR implementation based on what we have learnt from working with clients in the asset management sector, and finally some thoughts on what comes next.
Where are we now?
What already applies to wealth managers?
The anti-greenwashing rule (‘AGR’)
The AGR and finalised guidance took effect for all regulated firms on 31st May this year. In a nutshell, it requires any sustainability references made by a regulated firm to be…
Correct and capable of being substantiated;
Clear and presented in a way that can be understood;
Complete, not omitting or hiding any relevant information; and
Fair and meaningful in relation to comparisons to other products.
If you haven’t done so already, we’d recommend a deep dive through marketing materials and website content in particular, as well as updating guidance for financial promotions to ensure you don’t fall foul of the AGR.
Requirements for distributors
All distributors of sustainability products are required to ensure product-level information is made available to consumers, specifically:
Where you distribute a sustainability product with a label to a retail client, you must display the label in a prominent place on your website (or communicate it using any other channels you may typically use); and provide access to the consumer-facing disclosure (‘CFD’) for the sustainability product.
Where you distribute a sustainability product without a label to a retail client, but the product which uses sustainability-related terminology in its name or marketing materials, you will still need to provide access to the product’s CFD.
Given asset managers have only been able to apply labels to their funds since 31st July and that application windows are narrow (with FCA engagement ongoing for a lot of firms seeking labels), we’d recommend engaging with any fund providers you use. You can do this to confirm whether they plan to label or to figure out if any funds you use will be caught by the naming and marketing rules. This will help ensure you have the potential scope of any distributor disclosures clearly identified and monitored.
Lessons to be learned from implementing SDR so far…
While the asset management sector has been grappling with the challenges of applying for a label, most market research signals that the opt-in to the labelling regime would be fairly limited in 2024, as the various players observe how peers are approaching SDR implementation.
For those who have opted to apply for a label already, we’ve seen a few challenges crop up that we think useful for wealth managers to consider if they do choose to label products or services.
The evidence-based standard
The FCA has provided firms with flexibility in determining their process to identify which assets they consider sustainable, so long as it meets their requirements (i.e., robust, evidence-based, and absolute). However, we are aware of challenges firms have faced in relation to convincing the FCA of the robustness of their selected standard where this is based on internally derived approaches – with particular focus on how the firm has determined their chosen approach is an absolute measure of sustainability and what evidence they have based that on. When determining your sustainability standard, we recommend explicitly documenting these specifics to support in any FCA engagement.
The independent assessment
As a key part of the labelling requirements, firms must have an independent assessment of their chosen sustainability standard carried out to ensure it is fit for purpose. This may be done by a third party or internally, so long as the person or function carrying out the assessment is adequately skilled and sufficiently independent of the investment process.
A number of firms we have engaged with have struggled to identify who that relevant body would be internally - where there is sufficient expertise to demonstrate appropriate challenge of the standard and sustainability concepts but are not conflicted through exposure to involvement in supporting investment teams (e.g. internal ESG teams who work with investment managers to establish ESG / sustainability processes or support on engagements or reporting etc.). Where this is the case, having the initial test of the standard carried out by an external party may be more appropriate, giving firms time to establish new governance forums to oversee SDR compliance or recruit or upskill existing staff to perform this role in the future.
Referencing external sources
The Regulator has made clear that using the United Nations Sustainable Development Goals (‘SDGs’) as a broad investment approach or primary reporting tool for your KPIs is not sufficient to meet the SDR labelling requirements due to the extremely broad nature of the SDGs.
Since the key difference between ESG and sustainable investments lies between non-financial risk management and achieving sustainable outcomes, the latter likely requires forward-looking data to take a more prominent role. International standards such as the EU and (eventually) UK Taxonomies, as well as KPIs from frameworks such as ISSB or GRI may serve as more constructive references.
Consistency in approach
We’ve seen the FCA challenge firms on the strength of the connection between the stated sustainability objective, the KPIs used to report on achievement of that objective, and how any stewardship activities carried out support the meeting of the objective. Wealth managers seeking labels must ensure that the objective clearly aligns with the definition of sustainability which the portfolio manager outlines. Also, any KPIs selected to demonstrate performance against the objective should be relevant and specific to the objective (and that they would allow a customer to see where the sustainability objective has not been met, as well as where it has been met and how). And finally, stewardship activities should be evidencing and supporting this, noting the FCA does acknowledge the different challenges wealth managers face regarding stewardship activity.
Overlapping regulatory requirements
Due to the Regulator’s continued focus, we can’t fail to mention the links between SDR and the Consumer Duty. When implementing SDR we highly recommend reflecting on the four Consumer Duty outcomes for all aspects. We may focus particularly on consumer understanding, where there likely needs to be an internal training programme to uplift adviser knowledge and understanding on the sustainable product landscape and potential changing customer preferences. Nevertheless, other areas such as how you have considered price and value when developing any new sustainability-focused offerings will form part of key interlinkages between the two rules.
In a nutshell, the FCA is eager for labelled products and services to be watertight, clear and precise, and most importantly, be easy for retail customers to understand and trust.
What next?
Whilst we wait for the FCA to respond to the Consultation feedback, noting the proximity to the first deadlines noted in the draft rules, we wouldn’t be surprised to see at least a six-month extension on the naming and marketing implementation.
Having said that, given the material aspects of the regime are unlikely to change, we’d still recommend getting started, even if those extra few months are granted.
Hopefully, we won’t have too long to wait before the publication of the portfolio management Policy Statement providing clarity on timelines, but in the interim, here are five key questions we believe you should begin to ask yourself ahead of kicking off your SDR implementation:
Are you comfortable that you are already compliant with the anti-greenwashing rule and aware of the status of any products you distribute and may need to publish or make available sustainability-related information on?
Have you performed an initial gap analysis against the proposed SDR rules to identify where any significant work will be required?
Have you assessed your existing products and services to determine whether any will be eligible for a label or caught by the naming and marketing rules?
Is there a requirement to carry out internal education sessions across all levels to ensure those involved in governance activities are equipped to adequately oversee SDR compliance and client-facing advisers are equipped to tease out and translate customer preferences regarding sustainability into suitable products and services?
Do you have sufficient resource with sustainability skills and experience to support implementation, including specific activities such as the independent assessment of any sustainability standard?
If you would like to discuss anything covered above, or SDR more generally, please do reach out to me - ramon@avyse.co.uk
We’ll also be hosting a roundtable specifically for Wealth Managers in November so keep your eyes peeled for more information on that!
