Dear CEO | Release Date: 20th March 2023
To read a shorter summary of this Dear CEO letter, click here.
To access the original FCA document, click here.
Long Summary
The Financial Conduct Authority (FCA) has conducted a review of the Environmental, Social, and Governance (ESG) benchmarks as outlined in the September 2022 portfolio letter to benchmark administrators. This review underscores the FCA’s commitment to ensuring transparency and integrity within the ESG benchmarking sector, integral for the credibility of ESG-labelled products and the broader transition to a net-zero economy.
Review Outcomes and Concerns
The preliminary review conducted by the FCA highlighted several deficiencies across the sector, particularly in the quality of disclosures by UK benchmark administrators. Notable issues included inadequate detail in describing ESG factors within benchmark methodologies and non-compliance with the disclosure requirements mandated by the Low Carbon Benchmarks Regulation (LCBR).
Key Issues Identified
Poor Quality Disclosures: Many administrators failed to provide comprehensive details on the ESG factors considered, impacting the ability of users and investors to make informed decisions.
Non-compliance with LCBR: There was a significant lack of full implementation of LCBR disclosure requirements, with many administrators not adhering to the stipulations for clear and detailed ESG factor incorporation.
Ineffective Benchmark Methodologies: Instances were noted where ESG benchmarks were not applied correctly within methodologies, leading to potential risks of greenwashing and misrepresentation of ESG credentials.
FCA’s Regulatory Focus
Given these findings, the FCA emphasises the following regulatory focus areas:
Enhanced Disclosures: The FCA expects benchmark administrators to improve the quality of their disclosures significantly. This includes providing a detailed explanation of the ESG factors used, the methodologies applied, and the rationale behind these methodologies.
Compliance with Regulatory Requirements: Administrators must ensure full compliance with all relevant regulations, including the LCBR. This involves adhering to the detailed requirements for ESG disclosures and ensuring that all aspects of ESG integration are transparent and well-documented.
Accuracy and Reliability of Methodologies: Administrators must verify that their methodologies are robust, reliable, and consistently applied. This includes regular reviews and updates to methodologies to reflect current ESG standards and data.
Actions Required from Benchmark Administrators
In response to the review findings, the FCA mandates benchmark administrators to:
Review and Revise Disclosures: Administrators should reassess their current disclosures and methodologies, ensuring they meet the heightened standards set by recent regulatory updates.
Implement Strategic Changes: Firms are expected to integrate strategic changes that align with FCA expectations for transparency and efficacy in ESG benchmarking.
Prepare for Regulatory Scrutiny: Firms should be prepared for further reviews and potential regulatory actions if they fail to address the identified issues adequately.
Next Steps
The FCA plans to continue its scrutiny of the ESG benchmarking practices across the sector. This will include:
Ongoing Reviews: Further in-depth reviews of ESG benchmarks to ensure comprehensive compliance and effectiveness.
Regulatory Actions: Deployment of formal supervisory tools and, where necessary, enforcement actions against firms failing to meet the required standards.
Conclusion
The FCA’s review highlights significant areas for improvement within the ESG benchmarking sector. It is crucial for benchmark administrators to heed the regulatory expectations and enhance their practices accordingly. The FCA remains committed to facilitating a reliable and trustworthy market for ESG-labelled products, crucial for the broader agenda of sustainable finance.
For Further Assistance
Benchmark administrators seeking further clarification or assistance are encouraged to engage directly with the FCA through designated channels to ensure compliance and alignment with the regulatory expectations outlined in this update.