In response to the recently released (and highly anticipated) Sustainability Disclosure Requirements consultation paper issued by the UK’s Financial Conduct Authority, Joe Dharampal-Hornby, a policy and public affairs manager at the Impact Investing Institute, assesses how the requirements, as well as the FCA’s proposed investment labels, will impact the UK’s sustainable investing sector, and how they stack up against the EU’s SFDR.
Do you see an advantage for the proposed investment labelling approach of the UK’s Financial Conduct Authority over that of the EU’s SFDR? How do the article 6, 8 and 9 categorisations compare with the Sustainable Impact, Sustainable Focus and Sustainable Improvers labels?
The Financial Conduct Authority’s proposed investment labels present another opportunity for UK leadership in impact investing and sustainable finance more broadly.
However, although the FCA’s proposals are a significant step toward meeting the vital objective of enhancing consumer trust in sustainability products, the design of the Sustainable Impact label must be amended to align with and accommodate the direction of travel of the global impact investing market.
The FCA’s commitment to developing world-leading standards is commendable, as is its recognition of the benefits of interoperability with international equivalents, particularly articles 8 and 9 of the EU’s Sustainable Finance Disclosure Regulation, and ultimately the International Sustainability Standards Boards (ISSB) framework at global level.
It should be noted that this is a difficult balancing act, and although we applaud the FCA’s efforts so far, we identify three main challenges:
- First, the proposed three-label approach diverges substantially from the existing EU framework and will likely require market participants active in both jurisdictions to develop a parallel compliance framework to that in place for the SFDR.
- Secondly, divergence of key terminology definitions risks causing confusion and undermining market confidence – for example, many ‘impact’ funds in the EU wouldn’t qualify as ‘impact’ in the UK.
- Thirdly, the SFDR itself has created significant confusion in the EU, particularly around article 9 qualifications, so identifying clear alignment with the SFDR at this stage is very difficult. We hope that the FCA re-engages with market participants and EU policymakers to further explore and clarify interoperability, and to consider providing worked examples of how mapping to the SFDR would work in practice.
Ultimately, we expect that the UK’s development of a world-leading framework for sustainable investment labels could provide helpful guidance as other jurisdictions develop similar frameworks.
What issues might result in best-in-class products failing to be eligible under the proposals?
The proposed Sustainable Impact label’s requirement for ‘additionality’, its description of enterprise and investor contribution towards impact, and its focus on private markets (which risks excluding public markets) can all lead to the exclusion of best-in-class impact investments.
We recommend that the framework of the Sustainable Impact label allow for more expansive criteria with regard to demonstrating impact – thereby allowing a full range of asset types and strategies that can deliver impact – first, by recognising that assets in both private and public markets have the capacity to provide “sustainability solutions to environmental and/or social problems”. Making it easier for public market assets to be eligible facilitates the inclusion of funds that are typically more accessible and attractive to retail investors.
Secondly, by recognising that investor contribution can be achieved through capital allocation and/or investor stewardship. We recommend that these are not presented in a hierarchy (‘primary channel’ vs ‘secondary channel’ for sustainability outcomes) but alongside each other.
What is the theory of change concept incorporated in the Sustainable Impact label?
A theory of change is a well-established mechanism for articulating a problem affecting people or the planet, the solution to that problem, and how the investor intends to contribute toward that solution.
We strongly endorse the FCA’s requirement for Sustainable Impact products to have a theory of change and recommend that the FCA provides a fuller explanation of its role and structure. In other words: how as a mechanism does it set the investment objectives and strategy, and how does it govern the process for determining asset selection, investor contribution, KPI selection for measurement and reporting, and mitigation/escalation strategies for those occasions when intended outcomes are not achieved?
This amendment would provide a robust and highly differentiated framework for the Sustainable Impact label which, we believe, would require sufficient supporting documentation to make FCA supervision effective. It requires the investor to have a clearly defined framework both for selecting assets based on their expected positive impact in the real world and for recording how investors seek to contribute toward enhancing that impact and mitigating negative consequences.
How can the FCA’s labelling system contribute to channelling more institutional and retail capital into sustainable investment products and strategies?
The proposals come at a crucial point, given the need to protect the integrity of sustainable and impact investing at a time of huge growth and, in many areas, unfortunate dilution, compromise and controversy. Tackling greenwashing and empowering consumers to make informed choices are mutually reinforcing endeavours.
The Impact Investing Institute’s consultation response is framed by the belief it is critically important that the Sustainability Disclosure Requirements and investment labels strike a balance between codifying existing best practice, raising the bar for sustainable investing across the financial sector, and leaving space for continuing innovation.
The regime should promote transparency and accountability, protect consumers, and sit within a wider policy and regulatory environment that incorporates investee enterprise reporting and the full value chain of those providing financial services, including distributors of financial products.
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Joe Dharampal-Hornby oversees the Impact Investing Institute’s policy engagement across all programmes, liaising with government officials, members of parliament and other policymakers. He also leads its social metrics project, building on the Green+ Gilt programme, which advised the government on the issuance of £16bn worth of green gilts. Joe previously worked at Imperial College London, the Labour Party, and in the UK Parliament, and is currently also a Lambeth councillor.