Will disclosing ‘unexpected’ holdings lead to greater transparency?

Groups say SDR proposal is 'innovative' but subjective

The Financial Conduct Authority’s (FCA) proposed requirement for fund managers to make public holdings that clients might find surprising in a sustainable fund has been welcomed as an “innovative idea” but one that needs further consideration.

At the end of January this year, the UK regulator collected responses to its consultation paper, Sustainability Disclosure Requirements (SDR) and investment labels, in which it set out proposals for three new fund labels and a set of disclosure requirements.

Click here to read ESG Clarity’s coverage of the sustainable investment industry’s response to the fund labelling proposals.

When it comes to disclosure requirements, the FCA set out product and entity-level proposals, as well as proposing two levels of disclosure requirements for funds: one for consumers that outline the product’s key sustainability-related features, and more detailed disclosures for institutional investors.

“We want our regime to be compatible with other initiatives internationally as far as possible, while remaining appropriate for the UK market,” it said.

Asset managers, industry bodies and data firms have broadly welcomed the two-tiered structure as well as the regulator’s product and entity-level proposals.

Unexpected disclosures

But the ‘unexpected’ disclosures rule, in which details of holdings clients may not expect is given, “is among those areas in the consultation that requires the most further detailed consideration by the regulator and the DLAG [Discosures and Labels Advisory Group]”, the UK Sustainable Investment and Finance Association (UKSIF) said.

“We are hugely supportive of this in principle, as in theory it could strengthen clients’ trust in their investment choices by offering much greater transparency on those holdings that may conflict with their initial expectations,” the association’s response said.

But it highlighted the subjectivity of unexpected holdings – varying by person but also by time and event – could make things tricky.

The Institutional Investors Group on Climate Change gave an example: “A carbon-intensive holding in a sustainable portfolio may appear ‘unexpected’, but if it has a credible plan to align its business model and strategy with net zero and it is essential for that industry to transition along with the wider economy, then such a holding could represent a considerable opportunity for outsize impact on real world emissions.”

UKSIF pointed out no company is perfect when it comes to sustainability, so a line would need to be drawn. The group was joined by the Investment Association (IA) in highlighting that unexpected holdings in disclosure should not be needed if the labelling and disclosure regime works as expected.

“The IA proposes that a more pragmatic approach would be for investment managers to show what is held in portfolios – at the sector (which is already being provided) or thematic level, not individual stock level – and let consumers decide whether there is anything ‘surprising’ held,” its response said.

“Alternatively, there could be a uniform set of 47 of 61 activities and firms would have to confirm if a product has exposure to those activities, which would aid comparability.”

However, Morningstar called the disclosure of unexpected holdings an “innovative idea” despite the challenges.

“To an extent, this disclosure could mitigate the absence of specific ‘do no significant harm’ criteria, but we would recommend that all three types of labels should include (a set of) screens that avoid sectors or holdings that are associated with significant negative impacts, even if defined by fund managers initially,” it said.

“This would align better with current practice, and be easier for investors to understand what the fund will not hold, without having to be familiar with individual companies or securities.

“For labelled funds, we recommend requiring products include their definition of ‘sustainable’, given that it is at firms discretion. This could sync with, and add clarity to, the references to ‘unexpected securities’ that investors may be surprised to see in the portfolio.”

Asset management firm Castlefield, which, unlike data agencies and industry bodies would be implementing the final rules, said it was very supportive of the proposed ‘unexpected disclosures’ rule.

“We would welcome guidance on how to treat a company that by its nature is not controversial but becomes so due to negative press coverage. e.g. a food retailer that receives negative press coverage regarding allegations of misconduct in its supply chain.”


Natasha Turner

Natasha is global editor at ESG Clarity, part of Mark Allen Financial, and has been a financial journalist for seven years. She has been shortlisted for Story of the Year and Investment Journalist of the...