FCA addresses sustainability regulations ‘alphabet soup’

The FCA has published a discussion paper that requests views on the finance industry’s sustainability-related governance, incentives and competence, with the aim of preparing for reforms in the industry to incentivise positive change. It also proposes that environmental or social objectives should be reflected in funds’ policies and strategies.

The regulator wishes to drive the evolution of sustainability initiatives, considering other factors such as human rights, diversity and inclusion, biodiversity and nature, in addition to a focus on the impact of climate change.

Furthermore, it outlined a desire to drive a framework-based approach instead of relying on disclosure-based initiatives.

Hayden Morgan, partner and head of sustainable finance consultancy at Pinsent Masons, shared his insight into the paper’s publication, acknowledging the challenge faced by many firms to stay up to date with the latest regulation: “In a fast evolving and dynamic landscape, firms are faced with a growing and confusing ‘alphabet soup’ of sustainability-related acronyms related to various initiatives. Furthermore, they are encountering a growing wave of regulation emerging across many jurisdictions which, while not directly conflicting, is not currently harmonised or cohesive. While there is ongoing work to resolve these aspects, there is a clear need for robust financial regulation of sustainability matters, which both facilitates the long-term global transition and supports firms in navigating these uncharted territories.”

He outlined the four main areas of feedback requested by the FCA:

• Any environmental or social objectives firms have and the way in which they are outlined in their policies
• The approach firms have taken regarding governance, remuneration, incentives, training and competence to achieve the outlined objectives
• Feedback on obstacles or gaps in current systems
• Consideration of existing rules and suggestions for their improvement.

When asked about how the discussion paper could impact GPs specifically, Morgan added: “Typically, governance is a strength of the GP model, which is highlighted in the FCA paper. This is because there is usually an alignment of interest between portfolio policies and strategies of the portfolio company, that of the GP’s ESG objectives, and LP expectations on the matter. This alignment of interest should be facilitated by competent management, additional transparency in performance, supported by a credible and rigorous sustainability strategy. LPs will be increasingly applying enhanced due diligence in manager selection and performance monitoring.”

Morgan further suggested that there is a likelihood of innovative funds linking percentage carry and management fees to a sustainability coefficient, based on the KPIs set out in the fund formation documents.

The full paper can be downloaded here.

Firms have until 10 May 2023 to send feedback using the online form, or they can respond via this email address: dp23-1@fca.org.uk.

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A timeline
The journey began with the FCA publishing its ESG strategy in November 2021, releasing in tandem a discussion paper on what disclosures should be required at entity and product level.

The regulator then released a separate SDR consultation paper in October 2022, aimed at tackling greenwashing and improving transparency across the financial industry by proposing certain sustainability labels. The consultation period ended in January.

Subsequently, ESMA released a consultation on 18 November 2022, which proposed changes to the use of sustainability-related terms in fund names, making reference to the SFDR’s definition of ‘sustainability’. The consultation for this ended today (20 Feb).

Finally, at the beginning of this month, the FCA released an open letter to asset managers, detailing the importance of sustainable investing as part of its supervision strategy.