Imagine that you look up an investment and there is a simple, traffic light label, with all you want to know about the sustainability of that investment. Complex, technical information is packaged neatly into a familiar graphic, to help you choose an investment that aligns with your values. Wouldn’t it be grand?
Regulators around the world have set out to design just that. Only last week, the chair of the US’s Securities and Exchange Commission called for nutrition-style labels on sustainable funds. Meanwhile, an EU ‘Ecolabel’ for retail financial products has been under development for several years (with some way still to go). In the UK, the Financial Conduct Authority (FCA) will consult in the coming months on its proposals for something similar.
So what will this labelling system look like? And how clear will it really be? Let’s explore what’s going on in the UK.
First of all, the UK has rejected a traffic light system. It may be familiar, but it’s also used to indicate good versus bad. The regulator wants to avoid implying that some investments are better than others. Understandable, but also not that helpful.
Instead, the UK label looks set to draw on the EU’s approach in the Sustainable Finance Disclosure Regulation (SFDR). But with different terminology.
UK investment products will be labelled as ‘Not promoted as sustainable’, ‘Responsible’ or ‘Sustainable’. The ‘Sustainable’ category is divided into three sub-categories: ‘Transitioning’, 'Aligned’ and ‘Impact’.
Initial thoughts? Hmm...
Let’s delve slightly deeper into the categories, starting with the holy grail: an officially labelled ‘Sustainable’ investment. Remember, there are three sub-categories.
Investments labelled as ‘Transitioning’ and ‘Aligned’ will have sustainable characteristics, themes or objectives. What differs is the proportion of underlying activities that are ‘sustainable’, as defined in the new UK green taxonomy. The threshold will need to be carefully set. What’s particularly confusing is that the words 'transitioning' and 'aligned' have technical meanings in the ESG space, but the labels don’t match these meanings.
Finally, we have the ‘Impact’ label. These investment products will have the objective of delivering positive environmental or social impact. The label doesn’t say anything about whether such products achieve it, which seems fairly critical.
All other investments will be classified as either ‘Responsible’ or ‘Not promoted as sustainable’.
Responsible investments might have some sustainable elements (which is not particularly illuminating).
If an investment is labelled ‘Not promoted as sustainable’, it means sustainability is not prioritised as part of the investment strategy. It doesn’t mean the investment is not sustainable. It could, for example, hold companies that are inherently low carbon or adhere to high levels of corporate governance. This is not reflected in the label.
In summary, if the brief was a clear, consumer-friendly label, the current proposal falls way short.
This is an important and worthwhile mission. And it must be done well. The last thing we all need is yet another confusing sustainability metric to decipher along with all the others. Let’s hope the FCA uses the next consultation process wisely and delivers a labelling system that fulfils the brief. Watch this space.