ESG disclosure divergence

The FCA’s climate-related disclosure proposals are part of the first substantive policy proposals for the UK asset management sector since Brexit. “This is a post-Brexit divergence between the UK and the EU,” explains Eve Ellis, funds regulatory partner at Ropes & Gray. “SFDR never came into force in the UK, so it effectively needed its own ESG-related regulation.”

Same same but different

Similar to SFDR, the FCA’s proposals require entity and product/portfolio level disclosures. The key difference between the two is SFDR covers the broader scope of ESG, whereas the FCA’s proposals concentrate on climate risk.

“The FCA’s approach is less prescriptive than SFDR and more outcome focused,” Ellis says. “The regulation aligns with the Taskforce for Climate Financial Disclosure (TCFD), which is more of a global standard and involves publishing annual reports in relation to how you address climate risk and opportunities. There’s some proportionality because it won’t apply on a blanket basis to all regulated firms.”

“While TCFD doesn’t take into account the general ESG scope, it takes into consideration the positive and negative social aspects of climate change risk,” explains Robert Sroka, ESG director and ethics officer for CE at Abris Capital Partners. “But it still has a way to go to reach a broader scope like SFDR.”

Ellis is confident a broader scope will be achieved in the future. “I suspect as the FCA’s climate disclosures are still in its preliminary stages, it will evolve to include a broader ESG scope over time.”

Another differentiation is around categories. “With SFDR, firms have to classify their funds as article 6, 8 or 9,” explains Ellis. “The UK proposals aren’t looking to have product categories, which scale disclosures to match the products. The proportionality only applies to a firm’s AUM level.”

A problem shared

One mutual challenge is interpretation of the regulations themselves. “TCFD and SFDR’s RTS both include questions about policies,” explains Sroka. “It’s subjective because each firm might have its own understanding of what a policy is or its content, for example.”

Compared with SFDR, Sroka isn’t convinced TCFD is the best methodology to evaluate climate change risk and opportunities within the portfolio. “The challenge with any ESG regulation is showing how changes of ESG factors impact on the financial data or company value,” he says. “For TCFD, the challenge will be effectively communicating portfolio analysis results to investors. It’s not easy to assess the financial impact back to the strategy. Firms will need a better understanding and evaluation of what climate change means in terms of acquired investments and possible business opportunities.”

It will take time before TCFD processes are considered robust. “Whilst the FCA’s proposals are in consultation with the industry providing its input, many managers will need to comply with differing regimes in the UK and the EU, which will prove challenging,” adds Ellis.

According to Sroka, to improve ESG data collection in Poland, the Polish Association of Listed Companies, the Association of Insurance Companies and Banks Association set up a common working group. “The group invites experts and produces short guides with templates to ensure the data required across industries is received and delivered in the same formats, making the process easier for everyone,” he says.

As these regulations are continually evolving, firms need solid ESG expertise. “It’s becoming increasingly important for managers to have ESG expertise to ensure they can deal with the increasing complexities,” adds Ellis.

Sroka agrees in-house ESG experts are now a must. “It would be impossible to implement SFDR and now TCFD by only using external consultants.”

Time delay

In parallel to the FCA’s consultation, the European Commission has delayed the application of SFDR’s second phase to 1 July 2022. The Drawdown understands the decision was taken due to the length and technical detail of SFDR’s RTS. However, Sroka believes it’s also related to the Corporate Sustainability Reporting Directive (CSRD), which is currently being phased in and will continue to do so until 2023.

“CSRD also requires corporates to disclose ESG data,” he notes. “We have this situation now where fund managers require ESG data from their investee companies to fulfil SFDR. In parallel, the EU is also preparing CSRD, which covers more or less the same areas. Consistency between the two is advisable, therefore this changes the sequence.”

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CSRD was created to replace the EU Non-Financial Reporting Directive (NFRD), which came into force in 2017. The regulation, which was introduced in April, aims to increase investments in truly sustainable activities across the EU. In scope firms, including small and medium-listed companies as well as larger non-listed firms, are required to provide ESG data.

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According to Sroka, it makes sense to hold back on SFDR implementation until CSRD is in place. “CSRD supports the overall goal of collecting ESG data,” he explains. “Not a lot of this type of data is currently analysed by companies. SFDR postponement gives fund managers and portfolio companies more time to implement processes to analyse and measure new ESG KPIs. From my experience, it takes more than one year to prepare a good reporting system and gather appropriate data.”

Overall, managers in scope of SFDR and the FCA’s proposals must remember they are two separate regimes. “There’ll be an element of being able to repurpose certain pieces of information, especially in light of CSRD, but SFDR and TCFD are two completely different regimes and need to be treated as such,” Ellis notes.

As TCFD is still in its preliminary stages, the industry is slightly more forgiving about its initial content, but less convinced about how successful it will be. But SFDR’s delay won’t impact this.

It’s clear ESG regulations are continually increasing and evolving, along with reporting and workload. “We’ve got SFDR, CSRD, TCFD and Taxonomy regulations which all impact financial services,” says Sroka. “There will also be changes around AML activities, cyber and data security. But SFDR and TCFD are two of the most important on that list. If fund managers can adapt to timelines and implement these two properly, it will be far easier for them to analyse and implement the other regulations as time goes on.”

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TCFD: Who’s in scope?

The proposals apply to FCA-regulated portfolio managers, UK UCITS ManCos, full-scope UK AIFMs and small authorised UK AIFMs. According to the regulator, the proposed rules, “will not apply directly to overseas firms, including those currently in the Temporary Permissions Regime (TPR). Firms within the TPR are required to seek full authorisation by us or the PRA to continue to access the UK market.”

Additionally, the proposals don’t apply to asset managers/owners with less than £5bn in AUM or AUA on a three year rolling average, which will be assessed annually.