SDR consultation feedback

The SDR (Sustainability Disclosure Requirements) consultation paper was, in my view, a big step in the right direction for the FCA and for financial services in general.

I can’t claim to be unbiased.  I have been discussing what I believe needs to happen in sustainable investment with the FCA since long before the paper was published – and firmly believe it is crucial investors take both sustainability and their responsibilities to retail investors seriously.

As a member of the FCA’s Disclosure and Labels Advisory Group (DLAG) I have also seen first hand the efforts the FCA team is making to identify feedback trends and find sensible solutions. They have been doing this throughout the consultation period and will continue to do so for some time – whilst they digest the 200+ consultation responses they have received.  My hope is that once feedback is digested some important improvements will be made.

I do not however believe the consultation paper is perfect.  It was a ‘consultation’ for a reason.

Our response was 33 pages long.  It combines both giving credit where it is due and offering suggestions where I believe more work is needed.  You can download it here, but you may find the following summary more digestible.

• Realities of retail.  A core focus of the paper is to address greenwash – and it is firmly focused on the retail market, but there are aspects I would like to see the final SDR focus on more clearly in order to give individual retail investors a better experience.    The main points I ‘fed back’ were:
  • • Focus more explicitly and directly on ‘client preferences’ .  Legitimise primarily focusing on what clients who care about sustainability actually want by encouraging investment institutions to move away from industry metrics and complex objectives if they so wish.   Specifically that means ensuring wider ‘lifestyle’ decisions can be sensibly and easily matched with fund strategies without the need for unnecessary complexity.
    • Don’t ignore ‘ethics’ .  I appreciate not everyone wants to focus on ethical issues (although many can easily be reclassified as ‘social issues’), and most ethical issues are not existential threats, but they should not be ignored. The term ‘ethical’ remains popular in retail and ignoring it could be confusing.  If additional ethical issues are considered, clients should be able to expect them to be dealt with with the same professionalism as any other issue (eg proper pre sale disclosures).
    • Make better use of screening – particularly exclusions.  I doubt any of us would want this area to be only about exclusions – but exclusions are a useful tool that brings much needed clarity for clients (who are typically focuses on where a fund will or will not invest – which leads to greenwash criticisms when there are ‘surprises’).
    • Make sure clients understand the complexity of investing in eg 40-70 or more companies – on an ongoing basis.  They need to know ‘things happen ‘and ‘things change’.  The paper could do more to manage expectations explaining that KPIs may not be static, shifting regulation may mean fund policies have to change of certain holdings may no longer be desirable etc.   Managers need to explain how they deal with change and what do they do when things go wrong.

• Real world challenges.  I would like to see the SDR consistently convey the message that the FCA understands the seriousness of the sustainability risks we face. Not improving sustainability standards is infinitely more risky that any steps that may be taken to manage it.  Areas that I believe could be made clearer include:
  • • Performance caveats – we need to update messaging so that proposed text along the lines of ‘…any performance implications’ are not interpreted as implying there may be downside risks associated with considering sustainability.
    • Using unscreened assets to ‘reduce risk‘ risk needs careful management. I understand why managers do what they do, but stepping back – it makes little sense to use ‘unscreened’ assets to help de-risk sustainable funds longer term. Ideally assets should aim to be either be demonstrably in line with fund objectives – or the closest they can be.   Having significant elements of funds in unscreened assets – is not what clients have generally signed up to, and won’t help accelerate progress.  We need sustainable fund managers to exert pressure wherever possible to help create investible sustainable alternatives that can help reduce risk in both regards.
    • We need to be more open about holdings  No business is perfect, all ‘assets’ could be improved – which is in part why fund manager opinions’ will always vary.  This means assets may be held in funds for different reasons, and funds with different labels will have holdings in common. So although there are many areas of agreement clients and intermediaries should not necessarily expect consistency of decision making.   Explaining stock selection decisions is therefore important for clients,  in particular stock selection processes, decision making and any claims about ‘real world outcomes’.   Broadly speaking (and there certainly are exceptions), this is what I call that a healthy, diverse market, but it is also why disclosure and transparent methodologies matters so much.
    • Recognise positive and negative screens are often effectively two sides of the same coin. (How strategies are explained shifts over time.)
    • Make it clear that ‘things change’ (and need to change a great deal more in future).  The process of seeking continual improvement is far from over and situations will continue to shift, sometimes dramatically.   Some of the framing in the CP (eg protected terms and methodologies) is ‘very now’ – but will almost certainly change over time.  Regulation needs to cope with continual evolution and welcoming of innovative initiatives.

• Labels. Basically I think the labels are great.  They are flexible enough to stand the test of time, will help deal with greenwash (by helping to ‘manage expectations’) and help shine a light on the different ways investors can add value – ie encouraging / driving change, supporting good companies, driving real world impact.   However they are not perfect (imho). My feedback included:
  • • Sustainable Focus.  The idea is right – the label is for people who want to invest in sustainable companies I am not sure the FCA has completely ‘nailed’ how this group works.  I am particularly uncomfortable with the 70% limit.  I can’t image a rule that says 30% of a fund does not have to be in line with the fund purpose will go down very well … however I do understand the problem they are looking to solve – risk – so we need to find a way to deal with that.
      • Investors need to be able to manage risk, so I’m thinking along the lines of creating a safe space that allows investment managers to hold demonstrably neutral assets for risk management purposes (cash etc).  The proviso would be that managers should select the most sustainable options within their chosen asset group – and encourage innovation and higher standards amongst issuers in that group if no sustainable option is available (otherwise the greater exposure there is to such assets the further entrenched we are in maintaining the – highly risk – status quo).
    • Sustainable Improver. My view remains that this works well.   Having a specific label that puts the spotlight on encouraging improvement is incredibly useful. There is much investors can and should do to encourage real world change and this will help make that clear. My primary concern is that some managers seem concerned that assets may have to be sold if a company achieves its sustainability objectives.  My hope is that the FCA will decide that no company should ever be sold from a sustainability fund for being ‘too sustainable’!  And let’s be honest – there is always room for improvement. (I believe the ‘progress towards objectives’ concept is going to prove problematic for that – and other – reasons. Its not that simple.)
    • Sustainable Impact.  This label has proven difficult.  The real world outcomes, ‘theory of change’ message etc is an absolute delighted, but getting the balance right between what secondary / listed market investors can claim (and therefore present to clients), plus entity (fund manager) level contributions – and ‘additionality’ (things that would not have happened without the investment being made) all need work – which is exactly what the FCA team is doing. We want everyone to be acutely aware that where we invest has an impact on the world, no matter how or where or how we invest.  And we want clients to be able to find funds that focus on ‘solutions companies’, hence the benefit of an ‘impact’ label.  Metrics should remain a key feature of this label… but I suspect there will be further clarification here in due course.

• Encouraging alignment across the labels. Where possible I believe it would be helpful to intermediaries and clients if the same (high level) requirements can be applied to all the of the labels.    Areas where I think greater alignment of metrics etc could work include:
  • • Proportion of assets aligned to objective. If some labels and products (eg portfolios) have a minimum proportion of assets that must align to fund objectives it would be preferable if the same concept applied to all labels. (The percentage may not be the same, but the idea could be employed consistently.)
    • Independent verification – if required for one label (the paper proposes Sustainable Focus) it should apply to all.
    • Make it clear across all labels that no fund should ever sell an asset because it is ‘too sustainable’.

• Anti Greenwash rule, Naming and Marketing – I am entirely supportive of the need for an anti greenwash rule and certainly do not want fund names to mislead clients.  But I am not confident that the marketing proposals will work and suspect they could prove counterproductive.   Specifically, I’d prefer the marketing rules to be more principles based and less prescriptive so that they stand the test of time better and are not ‘gamed’.

• Distributors. There are a few issues here and the FCA has received feedback that they will no doubt be working on.
  • • Issues include – the 90% limit for portfolios and labelling.  I’d like to see both relaxed a little, but with care.
      • Regarding the 90% – I appreciate many portfolios have more than 10% of their assets ‘unscreened’ – for risk mitigation purposes. ‘Comply or explain’ could be a fair description of what I think might work here.  Unscreened holdings should be explained – along with  ‘surprise holdings’ (as identified in the paper – a great addition).
    • There may be practical issues for platforms regarding links, what can and can not be shown etc. (A topic for another day perhaps!)
    • Advisers – all intermediaries should be expected to be able to discuss this area with clients by now.  More ‘granular’ work will be carried out after the SDR goes live – this summer.

• Encouraging alignment across products, metrics and jurisdictions. 
  • • Broadly – I do not much like there being lots of different sets of rules in this area – I don’t think anyone does.  But it would be nonsense to adopt rules we do not agree with, and I like what the FCA is doing, so I am hoping common ground will be found over time.  The easiest and most sensible areas of work to support are probably what might loosely be called ‘jurisdiction neutral’ international initiatives – projects such as TCFD and  ISSB.  They  are designed to address international issues through international collaboration (setting a baseline for everyone to work from). Bluntly no single country can solve internationals issues alone – so we need to collaborate.   However some of these projects are pretty new and will evolve over time – and new initiatives are bound to appear.  So the door must be kept firmly fixed open to future improvements and innovation.
    • I would also like to see pension funds, life funds and international funds encouraged to use our labels as soon as possible, to avoid client confusion and help intermediaries.  I would also like platforms and others to be able to reference labels such as SFDR, with care of course – but generally, we should not be hiding such information. None of this is straight forward though.

• Be honest but confident. Sustainable investment enjoys the benefits of more data now than has ever previously been available, but it is not perfect.   Measuring the all important real world contribution investment via secondary markets can deliver is particularly hard, but that does not mean it should be ignored.  We know share values matter to companies – as does the ‘supply and demand’ dynamic in other secondary markets such as bonds, property and alternatives.  So in brief, we need to acknowledge criticism but recognise that critics can not have it both ways. We need to strive to be more effective whilst recognising the benefits the area can bring. And we need to be straight about the fact change is constant. (as mentioned above).  And make it clear that ‘assets’ will be doing good and bad things – often at the same time.  So funds, commentators and rules should try not to imply holdings (or ‘the sustainable fund market’) are/is straightforward or a homogenous mass.  We need to convey dynamism and complexity carefully to clients, preferably with our humble hats on.  If we do not convey the concept of inherent imperfections and constant change alongside working to meet clients needs – and helping to deliver real world benefits – we can expect greenwash allegations to persist…  I remain confident however. It can be done – and we are heading the right direction.