Pension schemes should consider how their environmental, social and governance (ESG) objectives could be impacted by the Financial Conduct Authority’s (FCA) Sustainability Disclosure Regulations (SDR) in the long-term, AXA Investment Managers (AXA IM) has warned.

AXA IM pointed out that one of the key components of SDR was fund labelling, with qualifying asset managers having the ability to use the four new sustainability labels (focus, improvers, impact and mixed goals) for asset managers since 31 July 2024.

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

Despite this, AXA IM head of core sustainable product strategy, Jane Wadia, said that having a good understanding of the framework would be beneficial for trustees looking to fulfil their ESG and sustainability objectives over the long term, particularly for defined contribution (DC).

“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,” Wadia continued.

“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.”

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

She said that as a voluntary regime, it was “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 keen to prioritise sustainability alongside returns,” she added.

Additionally, the Investment Association conducted research on SDR adoption between March and April 2024 found that just under 40 per cent of UK fund managers had no plans to introduce SDR labelling, while 7 per cent believed they would never get one.

Wadia suggested that this meant that the proportion of UK funds with a label is likely to be a relatively small minority.

She explained that while consumer demand for labels may be muted now, AXA IM expects this to grow as the benefits of the framework become clearer and trigger wider adoption across the industry.

“It would therefore be prudent for schemes to have a good understanding of how SDR works in practice,” Wadia added.
 
Wadia also noted that an often-overlooked aspect of SDR was, alongside the labels, that the FCA has established broader guidelines to categorise funds still incorporating ESG and sustainability as sustainable ‘non labelled’. 

Indeed, funds with this classification will not have met the criteria for specific labels but would 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 cause 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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