The FCA has published its ESG sourcebook on mandatory disclosure requirements affecting all asset managers, insurers, and FCA-regulated pension providers. Irina Velkova and Paul Young look at how firms can comply with the current requirements and meet best practice.
The FCA has crafted new ESG rules to create a regulatory framework aimed at supporting firms in their contribution to achieving a net-zero economy by 2050. This is in line with the regulator's own objectives and the government’s commitment to work towards mandatory TCFD-aligned disclosure obligations across the UK economy by 2025.
The new climate‑related disclosure rules will apply from 1 January 2022 for the largest in‑scope firms and will be in force a year later for smaller firms that are above the £5 billion exemption threshold. The FCA expects firms to publish their first disclosures in line with the FCA requirements by 30 June 2023. The regulator notes that firms need to make themselves familiar with the new rules, as well as introduce changes to their existing arrangements in order to meet the new obligations.
Which firms are in scope?
The FCA has been relatively conservative by deciding to exclude asset managers and asset owners with less than £5 billion in assets under management (AUM) or administration – calculated on a 3‑year rolling average basis with respect to specified “TCFD in-scope business”.
This is driven by their willingness to take a proportionate approach, but has been the subject of several queries as to whether the threshold needs to be lower. As such, a review of the threshold has been promised following a three-year cycle of disclosures.
These rules will apply to in-scope FCA-authorised firms for their TCFD business, which falls within the scope, carried out from an establishment maintained by the firm in the UK, irrespective of where the clients, products or portfolio are domiciled.
Two levels of ESG disclosures
Firms will also be required to do annual disclosures on two levels. These include disclosures at the entity level and product level.
At the entity level, firms are required to produce an annual TCFD entity report to be published in a prominent place on their main website, setting out how they take climate-related matters into account in managing or administering investments on behalf of clients and consumers.
At the product level, there is a requirement to provide disclosures (including a core set of climate-related metrics) on the firm’s products and portfolios. These should be published and made visible at a prominent place on the main website of the firm’s business and should be included or cross-referenced in an appropriate client communication or made upon request to certain eligible institutional clients.
There is also a specific set of information that firms should disclose in their TCFD product reports for each product. These include greenhouse emissions, total carbon emissions, total carbon footprint and weighted average carbon intensity.
Additionally, disclosures at a product level should contain relevant context explaining how the disclosed metrics should be interpreted, what assumptions have been made, any limitations and whether proxies have been used. This should be accompanied by data relating to historical annual calculations after the first year of preparing a TCFD product report, as well as any specific disclosures under the governance, strategy and risk management recommendations under the TCFD recommendations and recommended disclosures, where the firm’s approach in relation to a TCFD product materially deviates from the firm’s overarching approach disclosed in their overall entity report.
In line with the updated TCFD guidelines, the FCA’s rule requires firms to disclose their transition plans to a low-carbon economy. This has been driven mainly by the civil society sector, which has been very vocal in encouraging full transparency with regards to the plans in place to achieve net-zero. The FCA has clarified that it will be doing further work to support firms in their transition plans.
Firms that sit within a wider group structure will also be able to cross-reference disclosures made by the group, or an affiliate member of the group, but they would also be required to set out the rationale for doing so, explain any material deviations, and make sure to clearly signpost to the relevant disclosures, including hyperlinks.
Similarly, when an in-scope firm delegates investment management to a third-party portfolio manager, the firm could cross-refer to relevant climate-related financial disclosures by the third party.
On demand disclosures
In response to the received feedback, the FCA has softened its requirement for the provision of on demand disclosures compared to the previous consultation. The new provisions enable clients to request a product-level climate disclosure at a single reference point consistent with public disclosures, or at a date mutually agreed between the client and the firm. These options are intended to avoid overburdening firms by compelling them to provide information to multiple clients at different times.
Governance, strategy and risk management
The rules proposed by the FCA are in line with the TCFD‘s recommendations and recommended disclosures on governance, strategy, and risk management. The FCA requires that firms explain any material differences in their approaches to these pillars for specific investment strategies, asset classes or products, where relevant. In addition, firms are expected to disclose their approach to climate-related scenario analysis and how it's applied in their investment risk and decision-making process, including quantitative examples where reasonably practicable.
Moreover, firms who have not yet set their targets in relation to achieving net-zero targets are mandated to explain why not.
Specific proposals for asset owners
There is also a specific proposal that applies to asset owners. The FCA rules specify product-level disclosures for default strategies where these represent 10% or more of overall amounts in defaults, or £100 million or more in assets under administration in the default. The exclusion threshold only applies to the default arrangements of workplace pensions, where there is a large number of such products.
The FCA has explained that, as part of the proposals supporting the SDR, it's developing a further tiered approach, suggesting a separate layer of consumer-facing disclosures produced as a subset of the more detailed disclosures. In addition, the regulator will be testing consumer-facing disclosure templates with consumers to better understand what information they find decision-useful.
Inevitably, firms will have to swiftly undertake an impact assessment to evaluate how they comply with the upcoming requirements. This will enable them to understand what changes they need to make to their current arrangements in preparation for the new disclosure regime.