Climate-related disclosures for asset managers by the FCA

Impact on asset managers

The ESG disclosure requirements come from different regulations and have the following impact on asset managers:

• If a fund pursues ESG it needs to ensure that references to ESG in its name, policies, strategy and holdings are consistent, not misleading and hold substantive meaning. These should also be clear and accessible to investors.
• Where non-financial objectives are measured or referenced in fund documents, these need to be carefully considered and articulated in a fair, clear and non-misleading way.
• Fund managers must have adequate mechanisms in place to ensure the effective exercise of voting rights in investee companies, in accordance with a fund’s investment objectives.
• Fund managers are to validate and confirm whether they are in scope of the disclosure requirements, such as those in the ESG sourcebook, and to consider information requests that may come from EU financial services firms where there may be cross-border application of EU regulation.
• Firms should consider their exposure to external ESG ratings and data to ensure that there is appropriate governance around this.

Some of these regulations come from the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD recommendations were driven by the Financial Stability Board (FSB) and set out climate-related financial disclosures to provide a standardised approach to ESG reporting. At a high-level, the ESG sourcebook sets out the following requirements:

• Annual public disclosure of climate-related reports on how climate-related risks and opportunities are factored in when managing or administering investments.
• Annual public disclosure of product-level reports to indicate a baseline of comparable disclosures. In client communications (such as annual fund reports and periodic client reports) that have an annual reporting deadline, a firm is to include its TCFD product report, or a reference and hyperlink to the report.

Further remedies

Following its Asset Management Market Study – which was published in 2017 and looked into whether competition is working effectively in the asset management sector and investors are getting value for money – the FCA published FCA PS 19/4 – ‘further remedies.’ This requires a fund’s ESG components to be articulated clearly in the fund’s name, objectives, investment strategy and holdings. Additionally, ESG covers both financial and non-financial aspects of a fund, and therefore disclosure of the latter is important from the perspective of the consumer for them to measure whether a fund is meeting non-financial objectives.

The fund should be clear on the measurement of how non- financial objectives are met.

The FCA’s 2019 feedback statement on climate change and green finance, (FS) 19/6, addresses the FCA’s concern about the risk of greenwashing by firms through the overuse of buzzwords referencing ‘green products.’ This may mislead investors, which in turn could undermine confidence in the green sector. Therefore, ESG references in a fund’s name should align with the fund’s investment objectives, amongst other things. Any other fund- related documentation, including marketing material, should also be screened for such language.

Stewardship approach

The FCA supports arrangements for effective stewardship across the institutional investment community. Stewardship can be summarised as engagement with investee companies – through monitoring and interaction – as well as exercising voting rights attached to shares. This approach to stewardship ties in with the provisions in the requirements in the Shareholder Rights Directive as amended by SRD II, where relevant provisions have been included in the FCA’s Conduct of Business (COBS) sourcebook. The territorial scope is broad as investments in shares of investee companies in regulated markets outside the UK (which include EEA and certain non-EEA markets) require disclosure.

Authorised fund managers are required to develop and publicly disclose an engagement policy – or provide a reason why they have not – so that investors can better exercise stewardship.

Where ESG factors are included as part of a firm’s investment decisions when investing in an investee company, disclosure to certain institutional investors is required.

Cross-border application

Under the Sustainable Finance Disclosure Regulation (SFDR), certain EU financial services firms are required to disclose sustainability information about their investments. Such disclosures are made in pre-contractual disclosures, reports and on the firm’s website. SFDR can still apply to UK firms where UK fund managers market funds into the EU or where in-scope EU firms delegate portfolio or risk management to a UK domiciled fund manager.

The FCA issued discussion paper (DP) 21/4, which looks to implement sustainability disclosure requirements and sustainable investment labels, and the FCA is considering two levels of disclosure, including a consumer-facing layer of disclosure with ESG-related information and a detailed underlying entity-level and product-level disclosure aimed at institutional investors. A sustainability labelling and classification system is also proposed, which ties in to the FCA’s agenda of combatting greenwashing.

ESG data and ratings providers

ESG ratings are rankings of the environmental, social and governance performance of companies or financial instruments. These form a benchmark for judgments.

Different ESG ratings agencies diverge on aspects of sustainability and their efforts may not always be comparable. Therefore, with little clarity and alignment on definitions, this may affect investment processes. A clear understanding of such ratings, in addition to ensuring transparency of the methodologies around such ratings, is becoming a key point of focus for the FCA. In line with the report by the International Organisation of Securities Commission (IOSCO) on this topic, we can expect due diligence requirements on ESG ratings and data products, public disclosure and transparency in ESG ratings and data products (including their methodologies and processes) and conflicts of interest requirements.

Author

Siffat Khan, Associate - Shoosmiths

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