The FCA is planning new ‘sustainable’ fund labels, but is it a regulatory imposition or an opportunity for asset managers and advisers?


Sustainable investing has risen to the top the agenda for policymakers, regulators and most asset managers in recent years. Indeed, things are accelerating.

European policymakers and regulators have led the way globally, which means many UK-based fund managers, depending on their regulatory status, are already considering where they fit into the European taxonomy – a broad range of definitions, labels and requirements.

Yet the UK, after what you might call a pause for thought due to Brexit is now creating its own regulatory regime.

November brought a discussion paper from the FCA proposing a domestic range of fund labels and climate disclosures at both fund and ‘entity’ level.

The UK’s planned regime is similar to the EU’s and sits alongside a wider range of planned requirements across most of the UK’s financial sector and indeed most major sectors of the economy.

IFAs told to expect new rules

Yet until recently one very important group appeared to have been left out – UK IFAs.

That is set to change. While we don’t have details, the Treasury and FCA, amid a flurry of other initiatives published in the run up to the global climate change conference COP26 in Glasgow, confirmed that advisers will be required to talk to clients about sustainability as part of the suitability process.

That should bring advisers into closer alignment with their European peers where new adviser requirements have been finalised and come into force next year.

There is a sense the UK wants to do things a little differently as it seeks to make green and sustainable investing and related financial expertise a competitive advantage. We know fund managers would like to see something similar for the UK, if it can’t be the same. We’ll see how that debate pans out.

For Space, any initiative involving labelling is of great interest. Anything you have to include as information disclosed to both intermediaries and to the end consumer/investor has a bearing on our work. Indeed, we always need to understand what it means for our clients. We also like to ask how it can be turned to our clients’ competitive advantage as well.

Therefore, we thought we would share a few of our initial thoughts. We are going to leave the CO2 disclosure requirements for now at least partly because, in our view, they are going to become universal.

First, briefly, for those who haven’t read the paper, it establishes three broad categories – the first is those funds which will fall outside the overall sustainable landscape. There is a category of responsible investments which may be roughly equivalent to what has been referred to an ESG integration. While stressing that we are still at the discussion stage, it could encompass a lot of funds, as many asset managers apply elements of ESG to their full fund ranges.

Then sustainable describes a more thorough approach with three sub-categories – sustainable aligned, sustainable transitioning and sustainable impact.

(The best summary in the discussion paper comes on pages 17 and 18, Box 3, for those who don’t want to read the whole paper.)

Our thoughts

1) More than compliance – it can inform your marketing
We sense that this is not just a matter of including something like a wealth warning. Even if an asset manager was minded to simply do the minimum to comply, rivals will be considering how to make it integral to their marketing. Recent fund statistics suggest sustainable funds have been gathering a lot of assets, so we do think there will be something of a contest to use the labels and approaches to best effect. But it will require fund firms to continue to ask themselves some fundamental questions about their investing approaches and how to communicate them to advisers and investors.

2) The labels are a departure – to a degree
Any review of fund marketing, and indeed debates in the trade websites have seen ESG (environmental, social, governance) in vogue as a description. ESG will certainly not disappear and is mentioned in the FCA press release, but driven by these regulations, it may now be time for other terms to have their time in the sun. It is a substantial shake up. For example, till now the terms responsible and sustainable have arguably been used interchangeably but now may be attached to a specific approach. (We are at a discussion stage, so the paper asks whether using this dividing line is appropriate or not.) Likewise, some of the sub-categories in sustainable are new or at least applied in a new way.

3) Three kinds of sustainable make for a comms challenge
Explaining the differences between all three sustainable sub-groups will be a challenge. We don’t want to overstate the complications – sustainable-aligned means broadly holding shares and bonds which are already low carbon and thus aligned to the global climate targets.
Sustainable transitioning means investment in firms that are serious about the transition with an emphasis on asset managers actively encouraging them – a view that likely comes as a boost to passive fund management with its emphasis on engagement. Sustainable impact involves assets that are actively helping to drive the change. However, our initial view is that this is a lot to get across whether to help IFAs or for direct investors though at the same time, we would relish the creative challenge.

4) Don’t take adviser attitudes for granted
Our next point is about what you might describe as sealing the deal with advisers. It is partly because many advisers view the discussion about sustainability as the latest marketing wheeze rather than a major economic change. However, wherever you stand on this in terms of concern for climate change, we think brands have to be mindful of adviser scepticism about how relevant this will prove be for mainstream portfolios in particular.
We know asset managers have done a lot of work on their messaging, but labelling requirements and new advice rules will change the terms of the debate. It is important to bear in mind there will be several camps among advisers – specialists or least advisers with sustainable services, mainstream accepters and many who will be resistant. There are strong arguments in favour based around performance, risk management and indeed because regulations are reaching across the whole economy. Yet we think fund managers need to remain in persuasion- mode regardless of what they may see as the obvious changes on the horizon.

5) FCA research among consumers could well see things change
The FCA suggests it will be conducting consumer testing as these reforms progress. Hopefully, it will be published as it would give the sector some valuable market insights. It could also inform further research among investors and advisers. We suspect the consumer research could reveal a relatively low level of understanding among investors which could influence the final outcome.

6) One big omission
The paper talks about fund labelling but of course advised and indeed many direct investors have portfolios. Will an investor get a mix of responsible, sustainable, and other funds. Will an overall portfolio be labelled on the same basis as an individual fund? How exactly do we disclose or communicate this combination to clients? For now, we can only speculate, but it feels as if it will be important.

7) The greenwashing risk
The discussion paper says that one aim of the reform is to combat greenwashing by building investor trust. It comes in the wake of sceptical coverage from national newspapers regarding the holdings held by ESG funds – usually querying holdings in oil companies and the like.

Indeed, the regulator also raised the matter in the summer with a letter to asset management chief executives suggesting that the claims made by some ESG or sustainable funds did not bear scrutiny.
This suggests there is still work to be done.

We see some challenges around the sub-category of sustainable transitioning.

It may involve a decision on whether a big energy company is committed to change as opposed to the relatively easily understood metrics such as the carbon footprint. However even CO2 emissions can be measured in three ways – scope 1 the firm’s emissions, scope 2 including indirect emissions from heating its buildings for example and scope 3 the emissions across the whole value chains including the use of the products.

The paper does set out a blueprint for more clarity – which should bring reassurance along the full chain of fund distribution including platforms, advisers and investors but it is essential that there are no misapprehensions. As we say we wonder about the current level of knowledge across the market and the thorny issue of how we demonstrate good intentions.

These are our thoughts for now and they will develop over time, but we would also be very interested to hear you views.

Views welcome from all our clients.


28 August 2020

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