Richard Monks, Director of Strategy at the Financial Conduct Authority (FCA), recently delivered a speech on the FCA’s approach to sustainable investment. Significantly, the speech gave a flavour of the FCA’s direction of travel with respect to ESG authorised funds, informed by three key issues identified by the FCA’s work in this area to date.
- Lack of data and information: the availability of ESG data in respect of portfolio companies is still developing. As a result, non-financial disclosures are often incomplete and difficult to compare. Many firms use ESG ratings providers which rely on the availability of public ESG data and are therefore subject to the same data gaps.
- Misleading fund names: the FCA is concerned that using words such as “green”, “ESG”, “impact” or “climate” in a fund’s name or objective may create expectations among investors that are not met.
- Performance reporting is unclear: the FCA considers that some ESG funds do not track their performance against sustainability characteristics in a way that is clear to investors.
The FCA proposes to take the following actions in response to these findings:
- Consider wider corporate reporting on sustainability: the FCA will publish a policy statement in due course following its consultation on proposals to enhance climate-related disclosures by listed issuers (CP20/3) by requiring disclosures in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). The FCA is looking at whether it can do more internationally to agree common standards on corporate reporting on sustainability and is co-chairing a workstream on disclosures under IOSCO’s Sustainable Finance Task Force to drive international progress in this area.
- Improve disclosures on how firms manage sustainability factors: the FCA is proposing to consult next year on requiring asset managers, life insurers and contract-based pension providers to align their disclosures with the TCFD recommendations. The FCA will be drawing on insight from the guide published by the Climate Financial Risk Forum in June 2020.
- Implement the ambitions of the EU’s sustainable finance action plan: the FCA is working closely with Government and other regulators on how to implement the ambitions of the EU’s sustainable finance action plan in the UK. The FCA recognises the benefit of an internationally aligned approach to strengthen the UK’s status as a hub for sustainable finance but intends to take a more principles- and outcomes-based approach to regulating ESG funds and disclosures. The immediate areas of focus for the FCA will be implementing the ambitions of the EU’s objectives under the Disclosure Regulation and Taxonomy Regulation. See our blog post on our thoughts on the applicability of the Disclosure Regulation to UK firms.
- Research investor understanding of key ESG terms: the FCA is undertaking research on investor understanding and expectations of key ESG terms to determine whether additional guidance or rules might be needed. The FCA will look to publish results next year.
- Create guiding principles for ESG product design and disclosure: in an effort to tackle greenwashing concerns, the FCA is considering whether it would be helpful to articulate publicly a set of guiding principles to help firms with ESG product design and disclosure. The FCA has five principles in mind which it aims to discuss with the wider industry before taking this proposal forward:
- consistency in messaging of a fund’s ESG focus and its approach;
- a fund’s ESG focus should be reflected in its objective in a clear and measurable way;
- investment strategies should be clearly described in fund documents;
- firms should report on an ongoing basis performance against sustainable objectives; and
- firm should assure ESG data quality and articulate clearly and accessibly how it is used.
Sustainable investing is a fast-moving market and the FCA intends to play a positive role in enabling growth in this space to ensure that financial services plays its part in fighting climate change. However, innovation should not come at the expense of undermining trust in the sustainable finance market and the FCA is prepared to take hard regulatory action if firms do not uphold the FCA’s expected standards of communicating with investors in a way that is clear, fair and not misleading.