The Financial Conduct Authority has launched two consultations on mandatory reporting in line with the Task Force on Climate Related Disclosures, one for asset managers and providers, and another for standard listed companies. It is also seeking input on extending the rules to debt issuers and introducing regulations for ESG data providers. 

 

The FCA’s consultations follow the draft regulations and statutory guidance recently published by the Department for Work and Pensions for trust-based pension schemes, whose disclosures will need to rely on information from asset managers, which in turn need to seek the information further down the investment chain from investee firms. It is part of the Treasury’s Roadmap to implement TCFD rules across the investment chain by 2025.
 

    

"Managing the risks of climate change and transitioning to a cleaner and less carbon-intensive economy will require high quality information on how climate-related risks and opportunities are being managed throughout the investment chain," said executive director of consumer and competition, Sheldon Mills.

"However, climate-related disclosures do not yet meet investors’ and market participants' needs. The new rules will help markets, investors and ultimately consumers better understand the impact of climate change and make more informed decisions," he added.

For asset managers and life insurers, the FCA is proposing to apply the TCFD rules to firms that have more than £5bn in AuM on a three-year rolling average. It justified the cut-off saying: “We observed that the incremental costs of implementing our proposals would potentially be high, as a proportion of the firms’ assets under management or administration.” 

 

   

The proposed threshold would capture 98% of the firms in scope – 140 asset managers and 34 asset owners – covering £12.1tn of assets managed in the UK, it said. 

 

The disclosures would have to be made annually, both at an “entity level” and at a “product or portfolio level”, and would need to be published on the website or made available to institutional clients on request. 

 

The rules are planned to be introduced in two stages, with the first phase starting in January next year capturing asset managers with more than £50bn AuM and asset owners at least £25bn under management or administration. The FCA said this would include 12 firms with a combined £1.2tn in AuM. 

 

In a second phase starting in January 2023, all other firms above the £5bn threshold would start to be included. 

 

The FCA defines portfolio management relatively widely, proposing to bring into scope “investment advice provided by a UK entity to institutional clients within a group where substantive investment decisions are based on that advice”, and also “asset management activities conducted by private equity and other private market firms”. 

 

The watchdog says it is introducing a new ‘Environmental, Social and Governance (ESG) Sourcebook’ in the FCA Handbook to set out its proposed rules and guidance. 

 

 

Asset managers will need to seek information from investee firms, and the FCA is now extending the rules it introduced recently for premium listed companies to standard listed companies. 

 

   

In addition, “we are also using this CP as an opportunity to generate discussion and engage stakeholders on issues related to ESG-oriented debt instruments and the increasingly prominent role of ESG data and rating providers. These may potentially require further policy intervention to address any potential harms”, the FCA added. 

 

Issuers of standard listed shares, under the proposals, will need to state annually in their financial report: 

• whether they have made disclosures consistent with the TCFD’s recommendations and recommended disclosures in their annual financial report; 

• where they have not made disclosures consistent with some or all of the TCFD’s recommendations and/or recommended disclosures, an explanation of why, and a description of any steps they are taking or plan to take to be able to make consistent disclosures in the future and the timeframe within which they expect to be able to make those disclosures; 

• where they have included some, or all, of their disclosures against the TCFD’s recommendations and/or recommended disclosures in a document other than their annual financial report, an explanation of why; and 

• where in their annual financial report (or other relevant document) the various disclosures can be found. 

 

The FCA said it would issue guidance to support compliance with the new rules, including on the level of detail of the disclosures. 

 

Debt issuers could come into scope in future, but the regulator is seeking views on the bond market first, which it divides into ‘use of proceeds’ type green bonds and ‘sustainability-linked bonds’. It notes that “in recent years, there has been a significant increase in the amount of ESG labelled debt”, with 2020 having been another record year for issuance. Global ESG bonds and syndicated loans reached a combined volume of $239.1bn in early 2021, representing 8.8% of the total fixed income market. 

 

The concern with bonds seems to be that “while only a small proportion of all issuance, there have been cases where the issuer has failed to deploy the proceeds in the types of projects that it originally set out to fund. This has sometimes led to significant market disruption and significant price fluctuations,” according to the FCA. 

 

It points out that the French and Dutch regulators have also looked at “the disconnect between an issuer’s green bond framework and the contractual terms of issuance”, suggesting some additional minimal information in the use of proceeds section of a prospectus. The FCA wants to hear if it should go further in creating its own rules. 

 

 

It also sees “a number of potential sources of harm” in the second-party opinion and verifier market, such as a conflict of interest between the SPO provider/verifier and the investors reliant on it in an ‘issuer pays model’.  

 

“This is potentially exacerbated by the lack of transparency on the methodology used to support the SPO. This relationship may be further complicated where the SPO provider/verifier is also providing ESG ratings and other related services to the issuer," it observes. 

 

For SLBs, it says there could be harm from “a potential challenge in building the skills and gaining the necessary access to the issuer to effectively assess KPIs”. 

 

ESG ratings, used mainly by asset managers, are an area the FCA is also looking at closely, with estimates that the market for ESG data was worth around $600m in 2019, with an expected annual growth rate of 20% for ESG data and 35% for ESG indices; it could approach $1bn in 2021. The market is becoming more concentrated.  

 

The FCA notes that the correlation between different providers’ ESG ratings is relatively low, with one study finding an average overall correlation of 0.54 across the six rating providers, much lower than the 0.98 correlation observed between the largest three credit rating agencies. It identifies a number of harms, from lack of transparency of methodologies to conflicts of interest, and suggests that soft or hard regulation could be introduced in this area.  

Should there be guidance, best practice or regulations for ESG data providers?

Nick Spencer

Mike Clark

Claire Jones

Stuart OBrien

Catherine Howarth