Passing the ‘peak pain’ of SDR and what this means for clients

September’s back-to-school feel was particularly pronounced this year as delegates gathered at the traditional post summer conference season. Returning from their holidays, participants were keen to hear about the progress (or lack thereof) – with the FCA’s Sustainability Disclosure Requirements (SDR). At the time of writing, the FP WHEB Sustainability Impact fund is still the only listed equity fund to feature the Sustainability Impact logo. This status has meant that WHEB has been in particularly high demand as a presenter at these conferences.

Perhaps counterintuitively, we are very keen to see other funds use these labels. It is for this reason that WHEB organised a webinar in late September where we shared our insights from the fund’s authorisation process. Currently only a handful of funds are authorised to use one of the four sustainability labels. The FCA’s ambition is for the labels to be a valuable designation that the market actively uses as part of fund selection. To achieve this, we need tens if not hundreds of funds to be using the labels and covering all asset classes, regions and styles of investing.

Keeping the faith

At the many conferences that we have spoken at there is clearly real frustration with the FCA. It took WHEB five months to finally agree the changes with the FCA that allowed us to start using the label. We went through twenty iterations of the prospectus and had three in-person Zoom calls and three rounds of written feed-back with the FCA. Annex 1 of the prospectus (which is the main focus of the changes) grew from 1 to fifteen pages. And we were the first listed equity fund over the finish line¹!

But despite this frustration with the process, there is still generally solid support for the SDR itself. The fund management industry generally likes the labels. There is also support for the four categories: ‘sustainability impact’, ‘sustainability focus’, ‘sustainability improvers’ and ‘sustainability mixed goals’. The labels represent existing practices, are distinct but complementary, and should help clients find products that better suit their – or their clients’ – needs.

And while the process has been difficult, the basis for a principles-based regime is also understood to be sound. The early pain that the industry is experiencing, should bear dividends in having a regulatory regime that is flexible and able to evolve as the industry develops. Much better to have this, than a prescriptive approach that is clear, but rapidly becomes irrelevant, or worse, a barrier to innovation.

So where are we?

According to comments by FCA representatives at recent conferences there are now ten funds that have made the necessary changes to their prospectuses that allow them to use one or other of the sustainability labels. There are also, again according to the FCA, a “huge” number of applications in the pipeline. More anecdotally, our own SDR webinar attracted over three hundred registrations of which approximately one third were other fund managers. Rumours of the premature death of SDR are, to misquote Mark Twain, ‘grossly exaggerated’.

Nonetheless the FCA has itself acknowledged that the authorisation process has taken longer than anticipated. “Temporary flexibility” on the new rules, extending the deadline for funds to adhere from 2 December 2024 to 2 April 2025, have now been agreed. Clearly the next few months will need to see a rapid acceleration in the number of funds announcing their use of the labels. Otherwise WHEB’s own achievement will represent something of a pyrrhic victory.

What’s next

The critical next step is publication of the FCA’s final policy statement on ‘Extending the SDR regime to Portfolio Management’. This is expected in the second quarter of 2025. The regime is expected to mirror the SDR requirements for fund managers in terms of the structure of the labels as well as disclosure and reporting requirements.

One practical challenge is the extent to which model portfolio service (MPS) providers are required to ‘look through’ the funds they own and into their underlying holdings. This has implications for the level of due diligence that needs to be conducted as well as for reporting of key performance indicators (KPIs).

The SDR process for fund managers has clearly been onerous. We think it is right that standards are high, but there remains a danger that the additional resources that this requires make this unattractive for some providers. This balance has also to be struck in how the regime applies to portfolio managers. We believe we are past ‘peak pain’ for fund managers. We hope that some lessons have been learnt both by the FCA and by the industry that will ensure the process is altogether quicker and less painful for portfolio managers.

¹ Only one other fund, a real estate investment fund, beat us to it (https://tiny.cc/finqzz).