Financial advisors are not explicitly included in the design of the labeling system proposed by the Financial Conduct Authority (FCA). To tackle greenwashing, the Sustainability Disclosure Requirements (SDR) have been established, which, after several delays, should be in effect before 2024.
Furthermore, there is still no prescribed guidance or regulation (outside of the COB) that prescribes best practices for integrating sustainability preferences into financial advice, for example in relation to information collection such as ‘know your clients’ (KYC) requirements. This leads to a number of problems.
We expect the advisor community to rely on product labels in their advisory and eligibility process once finalized. Against this background, SDR in its current form represents a missed opportunity by not explicitly including advisors in the consultation document for the proposed labeling system.
It has the potential to address some of the key barriers advisors face. It could provide a framework for asking questions, a framework for assessing the relative suitability of different sustainable investment products, and reducing the risk of poor advice due to a lack of expertise.
To ensure that the labeling system works in the best interests of the retail customer, labels must be easy to implement, provide sufficient options (through effective decomposition of the sustainable product market) and deliver a variety of options across the risk spectrum.
The proposed labeling system is likely to result in most funds and model portfolio services (MPS) adopting the ‘sustainable focus’ label, even though they have very different objectives. In this case, the quality marks will not significantly assist advisors in the suitability assessment, because further analysis is required to distinguish within the quality mark.
In addition, the proposed scheme could result in higher risk MPS and fund products being labeled (particularly ‘sustainable impact’), with fewer options for clients taking prudent risks. Most customers do not have a high risk tolerance and this can exclude large parts of the retail customer market from access to suitable products with a sustainable label.
It is essential that the system is set up in such a way that portfolio management services (or MPS) can achieve a relevant sustainable label and differentiate objectives.
Most retail customers will access discretionary sustainable products through these types of services, rather than through a single investment fund. If only funds from one asset class can meet the criteria and qualify for labels, this is likely to divert consumers from appropriate investment choices towards more limited and risky mandates.
While we welcome regulation and guidance for portfolio managers, further work is needed to find a more pragmatic solution.
When it comes to integrating sustainability preferences into financial advice, we have noticed that advisors we work with are increasingly willing and ready to offer different investment options for sustainability preferences – especially given consumer duty.
It is our experience that advisors with interest and basic knowledge request and implement sustainability preferences, while advisors who are not do so (or remain customer-focused). Advisors are afraid to open a ‘Pandora’s box’ of discussion about this sector.
There should be an FCA regulation on advisers’ expectations regarding information gathering (e.g. KYC requirements) and educating clients about sustainability preferences in the advice process. We would welcome a demonstration of best practice.
This is evident from the fact that at the top of our advisors’ wish list is more guidance on ESG/sustainability questionnaires and explicit links to investment products.