FCA director highlights areas of concern in relation to ESG reporting and provides recommendations.

By Paul A. Davies, Nicola Higgs, Michael D. Green, and Anna Lewis-Martinez

Richard Monks, Director of Strategy at the UK Financial Conduct Authority (FCA), recently delivered a speech on the environmental, social, and governance (ESG) reporting regime and how it can be improved as part of SRI Services and Partners’ Good Money Week, held in October. The speech draws particular attention to the increasing use and relevance of ESG ratings.

Issues for firms to address

Monks noted that the FCA wants to assist firms in connection with delivering reliable sustainable investment products and helping consumers make better-informed choices.

Sustainable investment strategies

Consumer and investor interest in sustainability continues to grow. As a result, an increasing number of products addressing sustainability are coming to the market. Monks highlighted that it is ‘crucial that consumers understand the sustainable products they are offered and the differences between them’. However, there are currently few safeguards ensuring that consumers purchase products that actually deliver sustainable solutions. In order to prevent greenwashing, firms must ‘ensure their communications are clear, fair and not misleading’. Transparent disclosure will also benefit investors by providing them with accurate information.

Informed consumer decisions

Companies’ non-financial disclosures are ‘often incomplete and difficult to compare across companies’, according to Monks. However, many companies have taken significant steps in the right direction, most notably by voluntarily reporting in accordance with the recommendation of the Taskforce on Climate-related Financial Disclosures (TCFD). Nonetheless, significant gaps remain and more is required to fully render accurate and comparable data and inform investors efficiently.

Monks pointed to the fact that another problem lies in relation to product design and disclosure. Specifically, product names often do not align well with the product’s objectives, investment strategies, or asset composition. Terms such as ‘green’, ‘ESG’, and ‘climate’ are overused and create expectations that are not met. He emphasised the need to prevent firms from making misleading claims about their ESG credentials.

Future developments

Measuring impact

While reporting on financial performance is well-established, measurement of performance against non-financial objectives is still evolving. It is thus ‘difficult to reliably attribute a quantifiable impact’ to the actions of some companies, according to Monks.

In this regard, the FCA considers certain actions to be key, including:

• Improvements to the flow of data and information: The FCA has already consulted to require premium-listed issuers to make better disclosures about how climate change affects their businesses. (See “FCA Consultation Anticipates Enhanced Climate-Related Disclosures for Premium Listed Commercial Companies”.)
• Improvements to disclosures on how firms are managing sustainability factors: Next year, the FCA will consult on TCFD-aligned disclosures by asset managers, life insurers, and contract-based pension providers. The FCA will also draw insights from an industry guide that it is currently co-chairing with the Prudential Regulation Authority.
• Incorporation of regulatory initiatives pursued by the EU under its Sustainable Finance Action Plan: The FCA will continue to work closely with the UK government and other regulators on the implementation of any EU proposals in the UK.
• Facilitation of ESG-related research: The FCA is developing online consumer behaviour experiments to test consumers’ understanding and expectations of key ESG terms.

ESG guiding principles

Monks announced that the FCA is considering articulating a set of guiding principles to help firms improve ESG product design and disclosure, based on five proposed supporting principles:

1. Consistency in messaging and approach with regards to a product’s ESG focus
2. The clear and fair reflection of an ESG focus in the product’s objectives
3. Documented investment strategies to set out clearly how a product’s sustainable objectives are to be met
4. Ongoing reporting by firms of their performance against declared sustainable objectives
5. Assurance of ESG data quality by firms

These guiding principles are a material indication of the FCA’s preferred approach, since it was announced, via trade associations, that the FCA would not be onshoring the Sustainable Finance Disclosure Regulation (SFDR). The FCA is expected to consult in 2021 on a UK regime. The principles also indicate that the FCA is focused on developing standards and values in this area, rather than direct legislation.

The extent to which these suggestions will be consulted on and eventually implemented remains to be seen. Latham & Watkins will continue to monitor developments in this area.

This post was written with the assistance of Sabina Aionesei and Timi Afolami in the London office of Latham & Watkins.