The Sustainability Disclosure Requirements (SDR) framework is designed to enhance transparency in sustainable investing by introducing these standardised labels for investment products:

• Sustainability Impact

• Sustainability Focus

• Sustainability Improvers

• Sustainability Mixed Goals

In doing so, the intention is to eliminate greenwashing and restore trust in financial services. It will mean that funds purporting to have sustainable characteristics actually have to do so. Despite these benefits, its introduction at the end of July 2024 may present financial advisers with a number of challenges.

To meet those challenges head-on, advisers will need to employ a range of tools and strategies - doing so will allow them to make the most of the opportunities the new regulation offers. Recently, sustainability specialists from across the industry including Legal and General IM’s Amelia Tan, Miranda Beacham from Aegon Asset Management and Katherine Dockreay from Schroders all joined Square Mile’s Richard Romer-Lee to explore what exactly those strategies and tools are. Their discussion identified a number of ways advisers might build a powerful kit bag to ensure SDR compliance while also meeting clients’ sustainability preferences.

Key takeaways:

1. SDR implementation challenges: Achieving consistency in how asset managers assign the new sustainability label will take time, with the first disclosures expected to evolve over the next 18 months.
2. Regulation vs client needs: Advisers have to bridge the gap between regulatory requirements and client-specific needs through clear communication.
3. Education: The nuances of responsible investing can be hard to understand for novice investors. Providing ongoing education and guidance is one of the best ways an adviser can help clients meet their investment objectives.

What are the key challenges in implementing SDR?

Arguably, the principal obstacle to asset managers implementing the SDR labels is doing so with consistency. It may also be tricky to research funds with consistency too. Different data providers, for example, have varying levels of detail when appraising funds and their adherence to the new labels. While measures like percentage revenue or net-zero are more easily compared, measuring the contribution of the UN’s sustainable development goals (SDG) to performance is more subjective and open to interpretation. It may be that the first iteration of disclosures will not be perfect and will evolve over the next 18 months or so, as asset managers are likely to define aspects of sustainable investments differently.

Another challenge could be that clients themselves may be cautious about changing funds and marrying their investment needs to their sustainability demands. To exacerbate the issue, consumer understanding of the new sustainability labels is limited.

How do we overcome the challenges?

An adviser can provide more effective advice by arming themselves with the following tools and strategies:

1. Effective client communication

Bridging the gap between regulatory requirements and client-specific needs is crucial. Clients often rely on advisers to pick products that fit their sustainability preferences. Advisers must balance this against the FCA expectation that regulated firms must act in good faith towards their retail customers and to enable and support them to pursue their financial objectives. To do so, advisers must ensure clear communication to help meet clients’ aims. Detailed questionnaires can be a particularly useful tool for uncovering those aims and truly understanding client needs. The answers should help advisers tailor clients’ investment strategies accordingly. Questionnaires can also be a powerful way to help improve operational efficiency and offer scalable solutions for clients while still meeting regulatory demands.

2. Research and data accuracy

Conducting thorough and comprehensive research from a quantitative and qualitative perspective will be the backbone of an adviser’s work with a client. It is only with the right data that it’s possible to match client sustainability needs to relevant products – which is the fundamental idea underpinning the SDR framework. It will also be vital to determine first whether a client wants to target exclusionary solutions or whether they want to be socially responsible in their investment approach. From there, it will be possible to start aligning investments accurately with client preferences.

3. Client guidance and education

Given that most novice investors won’t have a solid grasp of the complexities behind responsible investing, clients are increasingly looking for guidance on how responsible investing and investment returns are related. Educating clients, to enhance their understanding of the benefits of responsible investing, while clearly explaining those complexities, is, therefore, a useful exercise.

For example, ethical exclusion funds aren’t necessarily the best way to meet sustainability objectives - yet it’s often what clients think is the best approach to sustainable investing. Instead, clients will need help matching the right product to their sustainability preferences. They will also need guidance to know the factor and style biases different sustainability approaches might have on a portfolio.

So, how should you build your SDR kit bag?

• Clear communication and detailed client questionnaires: For understanding and aligning client preferences, clear communication and providing detailed client questionnaires should bridge the gap between regulatory requirements and client needs.

• Comprehensive research tools: Completing exhaustive and accurate research will help ensure client sustainability preferences align with relevant products. Explore the rated strategies in Square Mile’s Academy of Funds - assessed using 3D Investing’s robust research process here >

• Educational resources: Providing ongoing education and guidance can be extremely effective in enhancing client understanding of sustainability labels and responsible investing.