FCA publishes good and poor practice for UK funds using sustainability labels

The Financial Conduct Authority (FCA) in its recent review of good and poor practice for Sustainability Disclosure Requirements (SDR) labelling makes it clear that UK fund managers cannot afford to get this wrong.  

Since the SDR was phased in during 2024, the FCA has enabled authorised UK fund managers of eligible UK funds to label their products according to four official label types. By doing so, the FCA aims to improve trust and transparency in sustainable investment products and minimise greenwashing.

The regime divides investments across four mutually exclusive sustainability labels for focus, improvers, impact and mixed goals.

Sustainability focus

For funds that predominately invest in assets that focus on sustainability for people or the planet.

Sustainability standard: Focus funds indirectly pursue positive environmental or social outcomes or both by investing in assets that meet a robust, evidence-based standard of sustainability.

Specific criteria: The fund’s sustainability objective must be consistent with the aim of investing in assets that are environmentally or socially sustainable or both and are selected by applying a  robust, evidence-based standard.

How key performance indicators (KPIs) are used: KPIs must be used to measure the sustainability of the assets held in the fund's portfolio.

To support assets in remaining sustainable and deliver long-term growth: To support assets in remaining sustainable and deliver long-term growth.

Sustainability improvers

For funds that predominately invest in assets that may not be sustainable now, with an aim to improve their sustainability.

Sustainability standard: Improver funds indirectly improve positive environmental or social outcomes or both by investing in assets that have the potential to meet a robust, evidence-based standard of sustainability.

Specific criteria: The fund's sustainability objective must be consistent with the aim of investing in assets that have the potential to improve environmental or social sustainability or both over time selected by the potential of those assets to meet a robust, evidence-based standard.

How key performance indicators (KPIs) are used: KPIs must be used to measure the sustainability improvements of the assets held in the fund's portfolio.

The role of stewardship: To support improvements and accelerate these over time.

Sustainability impact

For funds that predominately invest in solutions to sustainability problems with an aim to achieve a positive impact for people or the planet.

Sustainability standard: Impact funds directly pursue positive environmental or social outcomes or both through both the fund manager's investment activities and the sustainability characteristics of the assets.

Specific criteria: The fund's sustainability objective must be consistent with the aim of achieving a pre-defined, positive, measurable impact in relation to an environmental or social outcome or both.

Managers must specify a theory of change describing how the manager expects the fund's investment activities and assets contribute to achieving a positive and measurable impact.

Managers must also specify a robust method to measure and demonstrate that the fund is achieving this. 

How key performance indicators (KPIs) are used: KPIs must be used to measure the positive impact of both the assets held in the fund's portfolio as well as the investor's contribution.  

The role of stewardship: To support assets in delivering positive impact.

Sustainability mixed goals

For funds that mainly invest in assets that are a mix of the three first labels.

Sustainability standard: Mixed goal funds both directly and indirectly pursue or improve positive environmental or social outcomes or both in the same manner as the first three labels.

Specific criteria: The fund's sustainability objective must be consistent with the aim of each of the first three labels.

How key performance indicators (KPIs) are used: KPIs are used in the same manner as the first three labels in relation to each goal.

The role of stewardship: Stewardship applies in the same manner as the first three labels in relation to each goals.

The FCA review of sustainable investment labels in February identified clear themes in both good and poor practice, providing fund managers with a useful benchmark against which to measure their own approach.

Good-practice labelling 

Precise sustainability objectives

Precise sustainability objectives articulating a sustainability objective that is specific and measurable— not aspirational or peripheral.

Example wording. The fund aims to invest in assets that make a positive contribution to the environment and society through their products/services in areas such as: 

• Climate change mitigation and adaptation – which includes...
• Financial and digital inclusion – which we define as…
• Health and wellbeing – such as…

Transparent and evidence-based asset selection

Transparent and evidence-based asset selection which uses clear explanations of how assets are assessed against the sustainability objective and how the 70% threshold is calculated and monitored through key performance indicators.

Example. A fund has a sustainability objective to invest in products/services across several themes. It uses key performance indicators (KPIs) that show how the fund is invested across those themes. Separately, it includes a KPI which will confirm at least 70% of the fund is invested in line with its objective. Additionally, KPIs could measure environmental or social outcomes.

Example. Where a fund has an objective to invest in companies that focus on water and waste efficiency, it uses KPIs that measure water saved, waste reused and so on.

Clear explanation of theory of change

For sustainability impact labels, a theory of change should outline how investment activities and fund assets create a positive impact. FCA guidance on best practice stresses the need to use clear examples that offer measurable impacts.

Example. A fund’s assets aim to provide the general population with access to education. The firm clearly sets out what change it expects, such as:

• Expanding to less developed economies.
• Improving access to education through online resources.

Example. A health fund targets areas that lack services. Specified outcomes include increased hospital bed capacity and new clinical space, which are reflected in the KPIs.

Poor-practice labelling 

Vague and unverifiable sustainability objectives

Using broad, aspirational objectives – such as contributing to "a more sustainable world" – without specifying measurable outcomes, quantified targets or clear investment criteria capable of substantiation.

Example. Poor wording for the objective might say the fund aims to:

• "Make a positive contribution to planet and/or people."
• "Contribute to SDGs."
• "Create value for society."
• "Invest in companies that meet a robust standard of sustainability."

Inadequate explanation of the 70% threshold

Failure to explain with sufficient clarity how the 70% asset standard is applied, measured, and maintained over time, leaving investors without the information needed to assess the rigour of the fund's sustainability screening.

Example. An asset scores eight out of 10, based primarily on good governance policies and without a clear indication of environmental or social outcomes. (Governance enables these outcomes, but it’s not an end in itself.)

Boilerplate theory-of-change language

When a theory of change contains no explanation or generic and templated text on how assets and investment activities are expected to contribute to positive and measurable impact.

Example. A fund invests in banks or insurers providing basic financial services to the general population. However, the firm does not clarify:

• What change it expects by investing these assets, or why.
• How its investment activities will make a positive impact.  
   

Osborne Clarke comment

The FCA's review of good and poor practice should be read as a direct signal that the regulator is moving beyond the policy-setting phase and into active supervision of how sustainability labels are used in practice. The findings demonstrate that fund managers must be able to show that their chosen label is an accurate and honest reflection of how their portfolio is constructed, monitored and managed – and that every document touching the fund tells a coherent and consistent story.

For managers who have already adopted a label, a gap analysis against the FCA's best practice expectations may prove useful to cement the specificity of sustainability objectives and the robustness of KPI frameworks.

For those yet to make a decision to label their fund, the findings will be helpful in outlining the FCA's expectations. UK fund managers will still need to consider the rules around greenwashing and, to the extent relevant, naming and marketing.

Risk of regulatory action aside, with sustainable investing firmly embedded in the long-term landscape of UK asset management, the commercial and reputational costs of poor labelling is considerable.

Fabian Troutman-Drake, a trainee solicitor with Osborne Clarke, contributed to this Insight.