On November 3, the Financial Conduct Authority published a strategy on environmental, social and governance, setting out its target outcomes and the actions to be taken to deliver these outcomes.
The FCA’s core objective is to support the financial sector in driving positive change, while also aiming to build trust in green financial markets and increase transparency around sustainability matters.
Alongside the ESG strategy, the FCA also published a discussion paper on implementing the government’s ambitions for Sustainability Disclosure Requirements and investment labelling.
The publications came during the United Nations Climate Change Conference (COP26), hosted in Glasgow, and unsurprisingly have a strong focus on climate change and the role of finance in supporting the transition to a net zero economy.
Themes
The ESG strategy is based on five core themes:
- Transparency – promoting transparency on climate change and wider sustainability along the value chain.
- Trust – building trust and integrity in ESG-labelled instruments, products and the supporting ecosystem.
- Tools – working with others to enhance industry capabilities and support companies’ management of climate-related and wider sustainability risks, opportunities and impacts.
- Transition – supporting the role of finance in delivering a market-led transition to a net zero, sustainable economy.
- Team – developing strategies, organisational structures, resources and tools to support the integration of net zero and ESG considerations into FCA activities.
The first three themes have been previously stated by the FCA, while the last two are additional themes that have been included in the ESG Strategy.
Key actions
Beneath each of the five themes, the FCA has outlined a range of measures that it intends to implement over the coming months and years.
Aiming to bolster ‘transparency’, the FCA intends to enhance climate-related disclosures by completing the roll out of requirements aligned to the recommendations of the Task Force on Climate-related Financial Disclosures to asset managers, life insurers and contract-based pension schemes, while bringing appropriate regulatory oversight to improve the quality of such disclosures.
The FCA will promote global consistency and comparability in corporate sustainability reporting, primarily through its work with the International Organisation of Securities Commissions, the Financial Stability Board and the International Financial Reporting Standards Foundation. It also aims to enhance transparency of diversity and inclusion performance among listed companies and regulated companies.
In order to build ‘trust’, the FCA will support fair and effective integration of ESG into financial market decision-making, and trusted delivery of ESG-labelled securities, products and services. This will include developing a policy approach to ESG governance, remuneration, incentives and training/certification; supporting the government in delivering the UK taxonomy, SDR and a new sustainable investment label; and following up with authorised fund managers in relation to the FCA’s guiding principles on ESG/sustainable investment products.
Amid industry concerns about the quality of ESG service providers, the FCA is looking to support the integrity and effectiveness of ESG data, ratings, assurance and verification services.
In relation to ‘tools’, the FCA is aiming to influence internationally consistent outcomes in ESG; deliver an ambitious innovation programme; work closely with industry, civil society and academics to promote collaboration; and coordinate with other UK regulators and the government to develop a consistent approach.
In order to facilitate a ‘transition’, the FCA will promote credible and effective net zero transition plans by listed companies and regulated companies, in line with the government’s call for the disclosure of transition plans across the UK economy.
Similar to the work of the European Banking Authority, the FCA also intends to focus on integrating ESG into the prudential framework, including the disclosure of information on how companies assess and manage ESG risks.
On stewardship, the FCA will monitor engagement between investors and issuers, and the exercise of investor stewardship, noting insufficient evidence of active stewardship to advance environmental and social goals, in relation to which it will consider further regulatory action.
With regard to its ‘team’, the FCA will embed ESG considerations across the organisation and meet the chancellor’s expectation that the FCA should ‘have regard’ to the government’s net zero commitments in all its regulatory activities, while acting as a ‘role model’ to the industry. This will include publishing its own report aligned with the TCFD recommendations, and continue its ‘systems thinking’ research on the ESG landscape.
Impact
The increased emphasis on supporting the financial sector to help deliver positive change and transition to net zero is significant, with the FCA placing this objective at the heart of the ESG strategy.
As a conduct regulator, the FCA was initially inclined to focus primarily on consumer protection issues such as preventing greenwashing.
However, it is recognising the importance of taking a more holistic approach to ESG by developing a regulatory framework that encourages the financial sector to deliver real world impact.
The industry has long argued that in order to achieve the government’s net zero targets, it is vital that the flow of investment and finance is not only encouraged to companies operating in green sectors, but also best-in-class companies that are taking active steps to transition.
This message has clearly hit home with the FCA given the significant focus on transition across its approach in this area. This is enunciated by the emphasis placed on stewardship and active ownership strategies as a means of driving positive change among investee companies.
This will be particularly important in relation to investee companies operating in carbon-intensive sectors that need to transition to net zero.
Firms are therefore likely to be afforded a degree of flexibility to continue investing in such investee companies, provided it can be evidenced that they are taking steps to transition, and firms take appropriate action (eg escalation or divestment) where changes do not materialise.
The FCA’s work on integrating ESG risks into the prudential framework may entail significant changes for companies, including the possibility for increased capital requirements. The FCA wants companies to recognise that ESG issues present genuine financial risks and therefore consider ESG risks in the same way they would any other risk, touching on every aspect of how they do business.
There is also a strong focus on contributing to international efforts to develop common standards in relation to ESG. The UK’s ambition is to provide global leadership in ESG standard-setting and it has been successful in doing so, such as through its work as co-chair of IOSCO’s Sustainable Finance Taskforce.
In order to facilitate capital flows at a global level, a degree of harmonisation around sustainability standards between jurisdictions will be essential to avoid undue regulatory barriers, particularly on taxonomy and disclosures.
Next steps
The FCA has set out the key milestones in its ESG work programme until the end of 2022. Interim updates will be provided on the FCA’s work as part of the Business Plan and Annual Report in 2022. The FCA will produce a more detailed stock-take on progress in early 2023.
Daniel Nevzat is regulatory affairs advisor at Norton Rose Fulbright
