The United Kingdom’s new ESG fund labels have struggled to gain traction. As Brussels prepares to overhaul the Sustainable Finance Disclosure Regulation (SFDR), a senior Morningstar expert warns Europe not to copy London’s model.
Hortense Bioy, global director of sustainability research at Morningstar, told Investment Officer the EU should resist adding new product categories, because new rules rarely arrive fully formed and end up dragging on for years with constant fixes that burden the industry without delivering clarity.
“I am not in favour of adding anything new, even if in theory it could be an improvement. There’s no appetite for that, because you also introduce a risk of complexity. Every time you introduce something new, there’s always something to fix,” she said in an interview.
Not every sustainability expert sees it that way however. Dan Grandage, chief sustainability officer at Aberdeen, argues the British regime, despite early problems, offers clarity the EU should not dismiss. “The UK labels have the merit of being simple and intuitive. For investors, having a clear badge on a product is more powerful than wading through annexes of disclosure,” he told Investment Officer.
EU delay
After a comprehensive review last year, the European Commission now is working on SFDR 2.0, the update to the disclosure regime introduced in 2021. But the timetable has slipped. The wide-ranging Omnibus package, which swept up dozens of financial market files, has forced a delay. Until Brussels provides clarity, investors remain in limbo.
At issue is whether the EU will introduce product categories such as “sustainable” or “transition” funds to replace or supplement the current Article 8 and Article 9 disclosures. Policymakers argue that labels could help investors choose with confidence. Industry fears added complexity and higher compliance costs.
UK labels
The Financial Conduct Authority launched four sustainability labels in 2023 and its experience is seen as an example for where EU fund labelling could go next. “Focus” funds invest mainly in sustainable assets. “Impact” funds promise measurable positive outcomes. “Improvers” target companies expected to enhance their practices. “Mixed Goals” capture multiasset approaches.
In theory the UK framework was comprehensive. In practice, investors have largely ignored three of the four categories. “I think they have 150 funds that are labelled, and it’s mainly one label, like three quarters. They created four labels, but in effect, it’s only one that is being used, the others are not labelled,” Bioy said. That label is Focus. The Improvers category, once seen as a promising home for transition strategies, has barely registered.
For Bioy, this is a cautionary tale. “It has created a niche segment of sustainable products, with still a lot of funds, like four times more funds, that have ESG characteristics but that are not labelled,” she said.
Grandage countered that the FCA experience highlights the benefits of drawing sharper lines. “A label forces asset managers to be clear about what they stand for. Yes, the Improvers category has been slow to take off, but that is more about market readiness than about the concept itself. Over time, such a category could become essential in channelling capital toward transition strategies,” he said.
Disclosure drift
SFDR was never intended to be a labelling regime. Article 6 funds make no sustainability claims; Article 8 promote environmental or social characteristics; Article 9 pursue sustainable objectives. But in the market’s shorthand, Article 8 quickly became “light green” and Article 9 “dark green.” Asset managers and distributors leaned on the distinction as if it were official certification.
Bioy’s message is to resist repeating that mistake. “The commissioners always say it’s not a labelling regime, it’s a disclosure regime. So let’s leave it at that. I think everyone now understands that Article 8 and 9 are not labels. Let’s leave it as a disclosure,” she said.
Flows and fatigue
The debate comes at a fragile moment for sustainable finance. ESG flows in Europe have shown signs of life after months of stagnation, but only in certain corners of the retail and wealth market. “These flows only represent one corner of the market. It’s just funds and primarily funds bought by retail and the wealth segment. It’s not those big asset owners, pensions,” Bioy said.
Regulatory fatigue has also set in, she noted. Managers complain of endless questionnaires, annexes and revisions. Investors remain skeptical, wary of greenwashing and unconvinced of performance benefits.
“Sustainable investing is here to stay as a framework. Climate change is not going away. There’s still support from governments. And even though you’ve heard about different market participants exiting some of their alliances, they still have targets. More and more companies are still setting targets. What is missing is more action,” Bioy said.