25 Oct 2021

As COP26 approaches, climate change and sustainability are firmly on businesses’ agenda – no more so than in the financial markets, which are under more scrutiny than ever on these issues.

The UK Government has recently published its ‘Roadmap to Sustainable Investing’, confirming its commitment to introducing UK Sustainable Disclosure Requirements (UKSDR) and a UK Green Taxonomy aligned to the EU’s equivalent regime.

The roadmap sets out the UK Government’s intention that, by 2022, requirements for environmental disclosures will be in place for UK-registered companies, asset managers and owners (including life insurers providing investment products, FCA-regulated pension schemes and occupational pension schemes), and investment products.

The disclosures will be aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD). The roadmap also outlines the UKSDR framework and signals the publication of a discussion paper on the UKSDR in November 2021.

In the meantime, the FCA (supported by other bodies, such as the UK’s Financial Reporting Council (FRC)), has continued its efforts to ensure climate-related risks are appropriately “priced in” to financial products, instruments, and services which it regulates.  In doing so, it is seeking to fulfil multiple objectives; (i) enabling investors to make well-informed decisions about the sustainability of their investments in response to increasing consumer demand, and (ii) ensuring that investors have the information they need to perform their stewardship obligations.

Increasing pressure on listed companies to report on climate issues

The FCA recently published its consultation regarding the proposed introduction of climate-related disclosure requirements for issuers of standard listed equity shares (the consultation has now closed and the FCA’s response is due).

The FCA’s focus on climate-related disclosures is not new.  As of 2021, all premium-listed companies in the UK have been required to include a statement in their annual financial reports explaining how they have made TCFD disclosures.  The FCA now intends to expand this disclosure requirement to standard listed issuers (excluding shell-companies and investment entities).

It is highly likely that the proposed expansion of the existing TCFD disclosure regime will be adopted.  Assuming this is the case, standard listed companies will be required to include a statement in their annual financial reports explaining:

  • whether they have made disclosures consistent with the TCFD’s recommendations and recommended disclosures (and if not, an explanation as to why, and the steps being taken to ensure such disclosures are published and by when); and
  • where the disclosures have been published in the company’s annual financial report; or
  • where the disclosures have been published by the company, if not in its annual report (and an explanation as to why such disclosures are not in the annual report).

The FCA’s consultation also sought to engage stakeholders on issues relating to ESG-oriented debt instruments and ESG data and rating providers.  Any regulatory changes in this respect are likely to be preceded by a further consultation.

Investors in equities and funds pursuing a responsible or sustainable investment strategy will welcome the expansion of the existing disclosure requirements to standard listed issuers; not only will it better inform their stewardship activity, but it will facilitate the fulfilment of their own reporting obligations in this vital area.

Climate change and investor stewardship

In January 2020, the FRC released its updated UK Stewardship Code.  The Code consists of a set of voluntary stewardship principles which signatories, including asset owners, asset managers and service providers, are expected to adopt and use to hold investee companies to account.  It aims to represent a benchmark of best practice for those involved in the investment of capital on behalf of UK savers and pensioners, and those supporting them.  

The Code encompasses a range of stewardship methods or modes of engagement with investee companies, from cooperation to escalation. Signatories are expected to report on their compliance with the Code publicly on an annual basis via a stewardship report.

ESG factors, in particular, climate-change risks, are mentioned in the Code under the following principles:

  • Principle 4: signatories should explain how they have identified and responded to systemic risks including climate change.
  • Principle 7: signatories should systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities.

The FRC published a status report on early-stage stewardship reporting in September 2020. It pointed to the lack of specific evidence referred to in signatories’ reports, the absence of reporting on outcomes and effectiveness of stewardship approaches, and the lack of detail to explain why certain ESG issues had been prioritised or considered to be material.

In September 2021, the FRC announced the new list of signatories to the Code, which revealed that the previous list of about 300 had been reduced to 189.  This must be deeply concerning for the FRC having consulted widely on the updates to the Code.  This is also disappointing for anyone who believes in enhanced investor stewardship.  Many investors had either failed to meet the higher benchmark set by the updated Code or did not re-apply for signatory status.

FCA’s letter to Authorised Fund Managers

The FRC’s disappointment with the quality of stewardship reporting pursuant to the Code is similarly echoed in the FCA’s recent “Dear Chair” letter to Authorised Fund Managers.  In the letter, the FCA recognises that ESG and sustainable investment funds represent the fastest growing segment of the European funds market.  

Despite this exponential growth, the FCA points to the lack of clear and accurate information available to consumers regarding funds branded as “ESG” or “sustainable”. This a clear concern for the regulator, which regards potential “green-washing” of this nature to impede its objective to build trust in the financial markets.

The letter cites examples of fund authorisation applications reviewed by the FCA, all of which contain misleading information about the relevant fund’s ESG credentials and the inappropriate use of labels such as “ESG” and “sustainable”.  These include:

  • a proposed passive fund which tracked an index which was not held out as being ESG-focussed (the index had limited exclusions)
  • an application for a fund which claimed to have a “positive environmental impact”, but did not invest in any companies which obviously contributed to the net-zero transition
  • an application for a fund which was described as “sustainable” but invested in two high-carbon emissions energy companies in its top-10 holdings (and pointed to no stewardship strategy to help the two companies to transition to net zero).

To assist Authorised Fund Managers of “ESG” or “sustainable” funds to accurately describe their portfolios and to appropriately design such funds in the future, the FCA issued guidelines in the Annex to its letter. The guidance intends to elaborate on existing statutory requirements in the FCA Handbook, including PRIN 2.1 (Principle 7, COBS 4.2.1R), COLL 6.6.3R(3)(a) and COLL 8.5.2R(3)(a).  The guidance centres around 3 principles, which in summary are as follows.

  • Principle 1: The design of the responsible or sustainable investment funds and disclosure of key design elements in fund documentation.
    • References to ESG (or related terms) in a fund’s name, financial promotions or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.
  • Principle 2: The delivery of ESG investment funds and ongoing monitoring of holdings.
    • The resources (including skills, experience, technology, research, data and analytical tools) that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way that a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives on an ongoing basis.
  • Principle 3: Pre-contractual and ongoing periodic disclosures on responsible or sustainable investment funds should be easily available to consumers and contain information that helps them make investment decisions.
    • ESG/sustainability-related information in a key investor information document should be easily available and clear, succinct and comprehensible, avoiding the use of jargon and technical terms when everyday words can be used instead.
    • Funds should disclose information to enable consumers to make an informed judgment about the merits of investing in a fund. Periodic fund disclosures should include evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of the fund’s stated aims.

In its ‘Roadmap to Sustainable Investing’, the UK Government recognises that accurate and consistent information needs to flow from companies to the financial sector and its financial products in order to support asset owners and managers to perform their stewardship obligations and meet consumer demand for sustainable financial products.  Ahead of COP26, it has already committed to increase the quality and consistency of disclosures on sustainability in the financial markets.  Although its initial focus will be on climate change, it is clear that this will be expanded to focus on a broader range of sustainable/ESG factors in due course.

Key take home points  

  • UK regulation of ESG, sustainable or responsible investment funds is set to increase and is likely to reflect the UKSDR framework set out in the UK Government’s ‘Roadmap to Sustainable Investing’.  If you are an in-scope Authorised Fund Manager and not already complying with the European Sustainable Financial Disclosures Regulation, you should be taking steps to prepare accordingly.
  • UK standard-listed companies are highly likely to be required to make disclosures consistent with the TCFD’s recommended disclosures, in line with premium-listed companies’ existing obligations.  This will inevitably increase the reporting burden of UK listed companies, but given the obvious need for reporting, it is to be applauded. Further, UK listed companies must take the reporting requirements seriously, given the “securities litigation risk” arising from disclosures which might fall foul of s.90A of the Financial Services and Markets Act 2000 (i.e. which entitles investors to seek compensation from issuers if the issuer has published material which is untrue or misleading or omits or delays the disclosure of required information and the investor has suffered loss as a result of a drop in the issuer’s share price).
  • In an effort to combat “green-washing” in the financial markets, the FCA is increasingly scrutinising applications for so-called ESG, responsible or sustainable investment funds, to ensure the key investor information documents avoid misleading consumers. Ensure that you consider the FCA’s guidance (3 principles) in detail before submitting your application for an ESG, sustainable or responsible investment fund. Failing to do so could result in your application being rejected.  Existing funds should also ensure that published information is accurate in order to avoid facing regulatory sanctions and increased litigation risk.

Contact us

If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak with your usual Fox Williams contact.


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