Update: FCA's ESG work

Scrutiny of environmental, social and governance (ESG) related issues have featured in previous Financial Conduct Authority business plans, but the topic receives higher billing in this year’s business plan and in the 2022-25 strategy. The Covid-19 pandemic has highlighted just how current ESG matters are. The FCA published their ESG Strategy in November of 2021, driving the industry towards greater awareness – of both ESG issues and of the impact on regulatory requirements.

The key issue for financial services firms is that ESG does not become a “hollow marketing opportunity”. This will affect investment and mortgage lenders in particular. The FCA wants firms that offer ‘green’ products to make sure that customer trust is merited, and that products are marketed to accurately reflect what the product can deliver in practice.

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The FCA will maintain a strong focus on ESG, so keeping up with the expectations is a must. In mid-2021 they appointed the FCA’s first Director of ESG, with a remit of embedding ESG considerations across their functions in a ‘golden thread’ approach. This bounces off the fact that the UK Government has asked the Regulator to ‘have regard’ to “the Government's commitment to a net zero economy by 2050.” But the FCA also wants to get the balance right for the financial services industry, making sure that firms can manage the risks from the shift to a low carbon economy, while making the most of the opportunities this presents.

The FCA have three main ESG outcomes:

• Trust and consumer protection from mis-leading marketing and disclosure around ESG-related products

• High-quality climate and wider sustainability-related disclosures to support accurate market pricing, helping consumers and market participants choose sustainable investments and drive fair value

• Active investor stewardship that positively influences companies’ sustainability strategies, supporting a market-led transition to a more sustainable future.

To do this, the FCA plans to embed ESG considerations in their methodology for authorization, particularly around Diversity and Inclusion and products and services on offer. They will also keep a close eye on disclosures by firms, lead ongoing development of a labelling regime for investment products, drive improvements in outcomes through D&I transparency through a consultation this summer and through recognizing and reducing harm. This last point means that the FCA will be looking to monitor firms and take enforcement action where it feels it is needed around how firms manage the impacts, risks and opportunities from ESG issues, as well as how they ensure that customers are treated fairly.

The FCA will also publish a report, during summer 2022, covering the recommended disclosures of the Task Force on Climate-related Financial Disclosures.

The FCA’s heightened attention comes at a time when the UK’s consumers report worry about the “state of the world” and “feel personally responsible for making a difference.” FCA research shows that this is having an impact on consumers’ choices, and combined with the direction of travel taken by the Government through a legislative commitment to net zero by 2050, the regulator is concerned with meeting the expectations of society and guiding firms towards behaviour that is in line with the FCA’s priorities. Social and governance issues such as diversity, inclusion, fair taxation and workers’ rights are also becoming more prominent and the FCA view is that ESG considerations will influence business and risk decisions, with the potential to significantly influence the integrity of the markets. Their priority, then, is making sure that “ESG claims and credentials stand up to scrutiny.”

The FCA’s initial priorities, disclosure and transparency, integrating consideration of climate change in firms’ business, risk and investment decisions, and promoting consumer access to genuinely green products and services, have developed since 2019, under three broad strategic themes. Transparency, Trust and Tools – later joined by Transition and Team - will push the FCA’s agenda, and they published an update, assessing the success of their delivery so far in November 2020.

The Core Principles support these five themes. They are:

• Global solutions to global problems – looking outwards but through a leadership role to help drive progress

• Walking the walk – the FCA will lead the way by taking similar steps to those expected of financial services firms

• Building an ESG capability beyond climate change – most of the FCA’s work in 2021 was focused on climate change, the FCA are now focused on a broader ESG perspective

• Supporting positive market-led solutions – Rather than dictating outcomes, the FCA will focus on building sound regulatory foundations, and aim to strike the right balance between principles and prescription

• Influence beyond rulemaking – The FCA will use the full breadth of their regulatory tools, both informal and formal, allowing them a more flexible approach

• Maximizing impact – Targeting interventions on sectors and activities that have the greatest impact

• Readying for a digital and data-led work – The Regulator will aim to take an innovative and data led approach.

The FCA’s latest publication sets out key actions for each of their five themes. Of interest to most firms will be:

• The FCA’s future plans to develop a policy approach to ESG governance, remuneration, incentives and training/certification, due as consultation in Q2 2022.

• The Regulator’s aim is to promote ‘well-designed, well-governed, credible and effective net zero transition plans by listed companies and regulated firms. Consultation and stakeholder engagement due in H2 2022.

• The aim is to embed the expectation that the FCA ‘has regard to net zero across FCA functions.’ The FCA’s work here aims to reflect ‘the scale and urgency of the climate challenge,’ and will affect how the FCA develops their own systems and processes.

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