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FCA sounds alarm over ESG benchmarks

FCA sounds alarm over ESG benchmarks

The FCA has warned of the risks of ESG benchmarks and will be scrutinising how they are constructed and labelled.

In a “Dear CEO” letter released last week (September 8), the FCA’s director of infrastructure and exchanges, Edwin Schooling Latter, said the regulator has concerns over the benchmarks.

“We have concerns that some benchmark administrators have not accurately described the economic reality that their benchmarks measure,” he said.

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Schooling Latter added that the regulator has particular concerns over ESG benchmarks.

“We believe that the subjective nature of ESG factors, and how ESG data and ratings are incorporated into benchmark methodologies, give rise to an increased risk of poor disclosures in ESG benchmark statements.”

The quality of these benchmarks may not therefore align with the expectations of both their users and the end investors. 

“This may also impact the transition to a net zero economy,” he warned.

Flows into ESG funds have grown in recent years, with £91bn of the total £1.4tn in funds under management in the UK sitting in responsible funds, according to data from the Investment Association.

However, concern is growing that without any official definitions, there is the possibility that the make-up of ESG or sustainable funds will not match the desires of end investors.

There are currently no rules in the UK on what qualifies as a ESG or sustainable fund.

Advisers in particular have been struggling amid a lack of transparency on definitions of the various terms used, and concerns are mounting that advisers will be judged on asset allocation decisions made today by criteria developed in the future.

The FCA will soon require advisers to take sustainability issues into account when advising clients, and it is currently consulting on criteria to classify and label investment products for firms involved in investment management and decision-making processes.

In the letter last week, Schooling Latter said the FCA will continue to monitor the quality of disclosures made by benchmark administrators, and it will also scrutinise the construction and labelling of these benchmarks.

“We have observed occurrences of poor data quality and controls (eg, calculation errors and poor validation of data inputs) and are concerned these may impact the reliability and representativeness of benchmarks,” he said.

“We will provide specific feedback to firms on our findings and assess the effectiveness of firms’ actions to address these.”