The UK Government has committed to a net-zero economy by 2050. At the same time, heightened investor demand for sustainable investments means that Environmental, Social and Governance (ESG) issues are at the top of the UK regulators’ agenda at the moment. Against this backdrop, the Financial Conduct Authority (FCA) has published new draft rules regarding climate-related financial disclosures for asset managers, life insurers and FCA-regulated pension providers. The relevant requirements are expected to come into force from 1 January 2022 for some of the larger firms. Market participants active in the ESG space should be working to put in place processes to comply with both the existing and upcoming regulatory requirements.
FCA climate-related financial disclosure regime
The FCA’s proposed climate-related financial disclosure regime is set out in consultation paper CP21/17 (Consultation Paper). The consultation closed in September 2021 and the relevant Policy Statement is expected to be published shortly. The new rules aim to promote high-quality disclosures on how climate-related risks and opportunities are being managed by firms.
The new rules are in line with the relevant recommendations of the Financial Stability Board's (FSB) Taskforce on Climate-related Financial Disclosures (TCFD). The TCFD recommendations are based on four overarching pillars covering governance, strategy, risk management and metrics and targets.
Scope of rules
The new rules will form part of a new ESG sourcebook in the FCA Handbook and will apply to the following firms:
- Asset managers – this includes investment portfolio managers, UK UCITS management companies, full-scope UK alternative investment fund managers (AIFMs) and small authorised UK AIFMs; and
- Asset owners - life insurers and FCA-regulated pension providers.
The FCA proposes a phased approach for the implementation of the new rules, with larger firms expected to comply first, followed by the rest of the sector in due course. In particular:
- Phase 1 – the proposed rules will start to apply from 1 January 2022 to asset managers with assets under management (AUM) of more than GBP50 billion and asset owners with GBP25 billion or more in AUM or administration relating to in-scope business. These firms will be required to publish the first set of disclosures by 30 June 2023.
- Phase 2 – Remaining asset managers and asset owners will need to comply from 1 January 2023 with the first disclosures being due by 30 June 2024.
Asset managers and asset owners with less than GBP5 billion in assets under management or administration on a 3-year rolling average (to be assessed annually) are out of scope of the proposed rules. The FCA expects that the majority of firms would still be captured, with only the smaller entities being outside the remit of the regime.
Overview of requirements
The new rules introduce two main sets of obligations for in-scope entities:
- Entity-level disclosures: Firms will need to publish an entity-level report in line with the TCFD recommendations, explaining how they take climate-related risks and opportunities into account in managing or administering investments on behalf of clients. This report should be published annually 30 June. In doing so, firms should have regard to the TCFD's Guidance for all Sectors and Supplemental Guidance for Asset Managers and Asset Owners, as appropriate.
- Product or portfolio-level disclosures: In addition, firms will be required to produce, on a yearly basis, a baseline set of consistent, comparable disclosures regarding their products and portfolios, including a core set of metrics.
The EU has adopted its own set of rules relating to ESG disclosures, which are set out in the Sustainable Finance Disclosure Regulation (SFDR). As these came into force after the end of the Brexit transitional period, they were not onshored into UK legislation and therefore do not apply in the UK. That being said, UK-based market participants may still need to comply with the SFDR requirements where they undertake cross-border business in the EU – in which case they will need to set up processes which are compatible with both sets of rulebooks. The FCA acknowledges that this may prove challenging for firms, and has therefore clarified that the FCA rules are outcomes-focused and generally aim to be consistent with the relevant EU disclosure requirements where these cover similar issues (e.g. certain carbon emissions metrics). This indicates that firms should, in principle, be able to use their SFDR-compliant processes as a basis for their UK equivalent processes, where the relevant requirements overlap.
Firms caught by the climate-related disclosure regime should be preparing for the new rules. More broadly, firms marketing and selling ESG-related products or applying for authorisation concerning such activities should be aware how the existing rules under the FCA Handbook may affect their relevant operations.
In the FCA Handbook, firms are required to communicate information to their clients (including financial promotions) in a way which is clear, fair and not misleading. Claims that an authorised investment fund or authorised firm pursues a responsible or sustainable investment strategy - which are not based on objective criteria and identifiable metrics - could potentially fall short of such requirements. The FCA has issued informal guidance indicating that a number of recent applications for authorisation of investment funds, with an ESG or sustainable focus, failed to meet the FCA standards. The FCA generally expects such funds to describe their investment strategies clearly and ensure that any assertions made about their goals are reasonable and substantiated.
This generally means that all firms active in the ESG sector should consider how their approach is consistent with the regulators’ expectations and standards. The UK Climate Financial Risk Forum (CFRF), co-chaired by the FCA and Prudential Regulation Authority (PRA) has published helpful guidance to assist the financial sector in developing its approach to climate-related financial risks and opportunities. You can read more about this in our relevant Finbrief – available here.