With the rollout of the FCA’s Sustainability Disclosure Regulations (SDR) now well underway, pension schemes should consider how their ESG and sustainability objectives could be impacted by the regime in the long-term, according to AXA Investment Managers (AXA IM).

One of the key components of SDR is fund labelling, with qualifying asset managers having been able to use the four new sustainability labels for asset managers – Focus, Improvers, Impact and Mixed Goals – from 31 July 2024.

Being a voluntary regime for institutional investors, the regulations have had a minimal impact on most pension schemes.

But according to Jane Wadia, Head of Core Sustainable Product Strategy at AXA IM, having a good understanding of the framework will be beneficial for those trustees looking to fulfil their ESG and sustainability objectives over the long-term, in particular for DC.

Wadia commented: “Demand for ESG and sustainable investing has skyrocketed in recent years, but it’s become increasingly difficult for investors to make optimal decisions due to the lack of a common framework.

“Aimed at driving up trust and transparency in the market for sustainable investment products, SDR is not only a positive force for retail investors, but also pension schemes who are under increasing pressure to invest in a way that supports the transition to a more sustainable economy, while continuing to maximise members’ financial outcomes.”

Wadia acknowledges that, between net zero objectives and ESG disclosure and reporting, trustees already have a lot to juggle in the realm of sustainability.

“As a voluntary regime, it’s no real surprise that institutional interest in SDR has until this point been fairly limited. But for DC schemes in particular, the regime could become of increasing importance as they look to further diversify their allocations to UK-domiciled funds and pressure builds for them to demonstrate competitive edge to members who are keen to prioritise sustainability alongside returns.”

Research from the Investment Association (IA) conducted between March and April 2024 regarding SDR adoption found that just under 40% of UK fund managers had no plans to introduce SDR labelling, with 7% believing they would never get one. According to Wadia, this means the proportion of UK funds with a label is likely to be a relatively small minority.

“While consumer demand for labels may be muted now, we expect this to grow as the benefits of the framework become clearer and triggers wider adoption across the industry. It would therefore be prudent for schemes to have a good understanding of how SDR works in practice.

Wadia notes that an often-overlooked aspect of SDR is that, alongside the labels, The FCA has established broader guidelines to categorise funds still incorporating ESG and sustainability as Sustainable ‘non labelled’. Funds with this classification won’t have met the criteria for specific labels, but will be viewed as better aligning with the regulator’s definition of sustainability.

She added: “If a pension scheme is investing in a fund for ESG reasons, then the absence of a label should not give cause for concern. However, in line with fiduciary duty schemes need to be certain that their investments continue to support their ESG and sustainability objectives.

“This means that long-term investors, regardless of whether the funds they invest in have a label, should keep a firm focus on how managers are approaching different aspects of ESG in a way that represents the scheme’s interests and helps create a more sustainable world for the benefit of their members.”

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