In November 2020, the Government published its Roadmap towards mandatory climate-related financial disclosures across the UK economy by 20251 ("the Roadmap"), aligned with the recommendations of the Financial Stability Board's Taskforce on Climate-related Financial Disclosures ("TCFD").
In support of the Roadmap, on 22 June 2021, the Financial Conduct Authority (FCA) published proposals2 for enhanced climate related financial disclosures by standard listed companies and the asset management sector. In this Insight, Sushil Kuner from our Financial Services Regulatory team, focuses on proposals for the asset management sector contained within the FCA's Consultation Paper 21/17 ("the CP") and summarises who the proposals apply to, the key rules being introduced and the next steps for firms.
Who will the proposed rules apply to?
Firms in scope
The FCA's proposed climate-related financial disclosure rules will apply to FCA regulated firms in the asset management sector with respect to their assets managed or administered from the UK, notwithstanding where the client, product or portfolio is based. In particular, it is intended that the following firms will be in scope ("In-Scope Firms"):
- Asset managers including:
- investment portfolio managers;
- UK Undertakings for Collective Investment in Transferable Securities ("UCITS") management companies;
- full-scope UK Alternative Investment Fund Managers ("AIFMs"); and
- small authorised UK AIFMs.
- Life insurers and FCAregulated pension providers (to which
the FCA refer collectively as 'asset owners'),
- life insurers (including pure reinsurers) in relation to insurance-based investment products and defined contribution ("DC") pension products; and
- non-insurer FCA-regulated pension providers, including platform firms and Self-invested Personal Pension ("SIPP") operators, to the extent that SIPPoperators provide a ready-made selection of investments.
The FCA has proposed an exemption for asset managers and asset owners that have less than £5 billion in assets under management ("AuM") or administration on a three year rolling average, to be assessed annually, with respect to their business activities relating to the products and portfolios subject to the proposed rules. The FCA has suggested that this threshold would capture 98% of both the UK asset management market and held by UK asset owners (covering £10.4 trillion and £1.7 trillion in assets, respectively).
The FCA's proposals relate either to the assets a firm manages or administers overall, at an entity level, or to the assets relating to particular financial products or services. The intended target audience for the disclosures are investors, including institutional clients (e.g. pension scheme trustees, employers, corporate investors) and end-user consumers (e.g. pension scheme members, retail investors). Throughout the CP, the FCA refers to these two types of investor as 'clients' and 'consumers', respectively.
Products and portfolios in scope
The FCA's proposed rules and guidance would apply to the firm, which would be responsible for relevant disclosures at product or portfolio level.
- Asset managers – the products and portfolios directly
within scope of the FCA's proposed rules for asset
- authorised funds, excluding feeder funds and sub-funds in the process of winding up or termination;
- unauthorised Alternative Investment Funds ("AIFs"); and
- portfolio management services.
- Asset owners – the scope of the activities to which the
proposals would apply relate to the firm's role as a manager or
administrator of the underlying assets for clients and consumers.
The products in scope include:
- insurance-based DCpension schemes (e.g. personal pension and stakeholder pensions, including both workplace and non-workplace pensions);
- non-insurance DCpension schemes (e.g. funds-based, offered by platform firms or similar); and
- SIPPs, either insurance or non-insurance based, where the SIPPoperator offers investments to be held within its SIPP
Key Disclosure Requirements
The FCA has published proposed rules and guidance through a new 'Environmental, Social and Governance' ("ESG") Sourcebook which will be applicable to all In-Scope Firms. The proposals in the CP relate solely to climate-related disclosures, but the FCA anticipates that the ESG Sourcebook will expand over time to include new rules and guidance on other climate-related and wider ESG topics. The ESG Sourcebook will require firms to make climate-related financial disclosures at both an entity level and product or portfolio level.
Entity level disclosure requirements
- TCFDEntity Report - the proposed new rules require each
In-Scope Firm to publish a TCFD Entity Report, consistent
with the TCFD's recommendations and recommended
disclosures, on an annual basis by 30 June each calendar year. The
report must be published in a prominent place on the main website
for the business of the firm. However, the FCA is
adopting a flexible approach to the TCFD Entity Report
which allows firms, in certain circumstances, to cross-refer to
disclosures made in other reports where those cover the relevant
content (e.g. allowing entity-level disclosures to be made in a
group level report). The TCFD Entity Report may therefore
be relatively short for some firms, provided that firms set out the
rationale for cross-referring to disclosures in another report,
within the TCFD Entity Report.
- Compliance Statement – under the proposals,
the TCFDEntity Report will need to include a statement, signed
by a member of senior management, confirming that the disclosures
comply with the requirements set out in the relevant chapter of
the FCA's Handbook. In determining whether the disclosures
are consistent with the TCFD's recommendations, firms will
be expected to take reasonable steps to ensure their disclosures
reflect the TCFD's all sector- guidance and supplemental
guidance for asset managers and asset owners, as
should consider allocating responsibility to a Senior Manager under
the FCA's Senior Managers and Certification Regime.
- Contents of the TCFDEntity Report - the disclosures must
be consistent with the TCFD's recommendations, covering:
- governance, strategy and risk management –
the FCArecognises that the disclosures under these pillars may
either be broad, covering a wide range of investment strategies,
asset classes or products, or may need to be more tailored. As
such, it is proposing that firms must explain any material
differences in their approach to governance, strategy or risk
management for specific investment strategies, asset classes or
products, where relevant. Depending on the number and nature of its
different investment strategies, asset classes or products, a firm
may make more tailored disclosures or highlight material
differences within its product or portfolio-level disclosures.
Where this is the case, the firm must cross-reference to these
disclosures within the TCFD Entity Report;
- scenario analysis – scenario analysis involves the
consideration of various plausible future scenarios under a set of
assumptions and constraints, to arrive at a range of hypothetical
outcomes. With respect to climate change, the FCAmakes clear
that the purpose is to explore and better understand the potential
impact of climate-related risks and opportunities over time.
The FCA recognises that scenario analysis tools and
capabilities are still evolving and so has proposed that firms
- their approach to climate related scenario analysis;
- how they apply climate-related scenario analysis in their investment and risk decision-making process; and
- quantitative examples to demonstrate their approach to climate-related scenario analysis, where reasonably practicable; and
- metrics and targets – given the government's legislative commitment to achieving net-zero emissions by 2050, the new rules will require firms not yet setting climate-related targets to explain why not. Where firms have set a climate-related target, they must describe the target, including the key performance indicators ("KPIs) used to measure progress, within the TCFDEntity Report. The rules will require disclosure of carbon emissions on an aggregate AuM basis at entity level with more targeted information, such as information relating to a specific asset class, investment strategy or product.
- governance, strategy and risk management – the FCArecognises that the disclosures under these pillars may either be broad, covering a wide range of investment strategies, asset classes or products, or may need to be more tailored. As such, it is proposing that firms must explain any material differences in their approach to governance, strategy or risk management for specific investment strategies, asset classes or products, where relevant. Depending on the number and nature of its different investment strategies, asset classes or products, a firm may make more tailored disclosures or highlight material differences within its product or portfolio-level disclosures. Where this is the case, the firm must cross-reference to these disclosures within the TCFD Entity Report;
The FCA has made clear that it favours retaining the largely principles-based approach in the TCFD's recommendations as the basis for its proposed entity-level disclosure rules as it views a prescriptive approach could risk stifling innovation and/or deviating from a globally-accepted disclosure framework.
Notably, where an In-Scope authorised fund manager ("AFM") delegates investment management to a third party portfolio manager which is not in the same group, the AFM will remain responsible for producing the TCFD Entity Report that sets out its approach to the TCFD's recommendations, including a signed compliance statement. The AFM must also briefly explain the reasons for selecting the delegate, where relevant to the TCFD's recommendations. This must include how climate-related matters have been taken into account in selecting delegates and relying on their products and services. While AFMs can cross-refer to relevant climate-related financial disclosures made by delegated managers within their TCFD Entity Reports, any material deviations from the firm's own approach must be clearly identified and explained.
For asset owners, the FCA is proposing that they must produce a TCFD Entity Report that sets out their approach to managing climate-related risks and opportunities for the part of their business offering products where the performance of the underlying investments impacts the benefits accruing to consumers, i.e. where a life insurer or pension provider acts as a manager or administrator of underlying assets for consumers. However, the level of detail required in the report would depend on the extent to which the asset owner takes an active role in investment decisions and product design.
The FCA has made clear that through these requirements, its intention is that clients and consumers are provided with information to help them understand the firm's approach to climate-related risks and opportunities, thereby enabling them to make informed decisions about their investments and hold their providers to account.
Product or portfolio level disclosure requirements
The proposals include a minimum baseline set of consistent, comparable product or portfolio level disclosures, included a core set of metrics. The aim would be to meet the needs of clients and consumers to have reliable and comparable information about the assets to which they have economic exposure. It also aims to support consistent onward disclosure to clients that may be subject to their own disclosure obligations.
- Public TCFDProduct Reports –
the FCA proposes that for many firms, product or
portfolio level disclosures would be made annually in a prominent
place on the firm's main website, using the most up-to-date
data at the time of reporting. These firms would also be expected
to include their product or portfolio-level disclosures in the
appropriate form of client communication which follows most closely
after the annual reporting deadline of 30 June. This could
- the annual long report or half-annual report of an authorised fund, provided that the disclosures are always included in the annual report;
- a periodic client report;
- an annual report to with-profits policyholders; or
- an annual pension benefit statement or pension drawdown statement.
Firms that manage a listed unauthorised AIF will need to include their product or portfolio level disclosures in the TCFD Entity Report. To avoid unnecessary burden on firms, the FCA would permit firms to cross-refer relevant product or portfolio level disclosures made on websites, within client communications. Again, where a firm delegates the management of assets to a third party portfolio manager, it may choose to cross-refer to disclosures made by the delegate, provided it sets out the rationale, outlines any material deviations and cross-refers appropriately.
- On-demand TCFDProduct Reports –
the FCA recognises that in some client relationships
(e.g. discretionary portfolio management services to individuals
and full-scope UK AIFMs or small authorised
UK AIFMs in respect of non-listed
unauthorised AIFs), public disclosure may not be appropriate.
In such circumstances, the FCA is proposing that
disclosures should be made to the client once a year, on
- Provision of data – all In-Scope Firms would be required
to provide data on the underlying holdings of their products to
clients that request it to satisfy their own climate-related
financial reporting requirements. Firms would be required to
respond to a single request within the annual reporting
- Core metrics – in an attempt to promote consistency and
comparability and to support the flow of information along the
investment chain, the FCAis proposing a baseline set of core,
mandatory, carbon emissions and carbon intensity metrics that
In-Scope Firms would be required to disclose. The proposed metrics
are a subset of the metrics listed in the TCFD's
recommendations and are set out as follows:
Metric Proposal Scope 1 and 3 Greenhouse Gas (GHG emissions) These metrics are widely used in the markets – the FCA proposes to mandate this metric from when the proposed rules come into force Scope 3 GHG emissions Although widely used, the FCA acknowledges that methodologies may differ and there may be significant data gaps among investee companies. The FCA is therefore proposing that firms should disclose scope 3 emissions from no later than 30 June 2024, one year later than the deadline for the first disclosures in accordance with the remainder of the proposals *Total carbon emissions As total carbon emissions are the sum of the GHG emissions above, the FCA proposes to mandate disclosure of this metric from 30 June 2024. *Carbon footprint As this is a widely used metric in the market, the FCA proposes this be disclosed on a mandatory basis from when the proposed rules come into force. *Weighted average carbon intensity (WACI) Given limitations with this form of carbon footprinting due to data availability, the FCA has referred to the TCFD's recommendations that asset managers and owners disclose a financed-emissions metric based on WACI and the Partnership for Carbon Accounting Financials ("PCAF") methodology, if relevant or a comparable methodology. The PCAF provides methodologies for asset managers, asset owners and banks to measure or estimate financed emissions for different asset classes. It also provides for alternatives solutions when data is not available.
The FCArecognises that there are some common elements in the TCFD's recommendations and the EU's Sustainable Finance Disclosure Regulation ("SFDR"), including certain metrics. It also recognises that there are key differences in the calculation methodologies which are marked with an asterisk above. When prescribed calculation methodologies differ between the TCFD's recommendations and the final report on draft Regulatory Technical Standards for the SFDR, the FCA is proposing that they be reported according to the formulae under both regimes as this would promote consistency and comparability with both EU and international firms and reflect the global reach of many In-Scope Frms' AuM.
All metrics will need to be supported by contextual information to explain how they should be interpreted and any limitations and assumptions, so that disclosures are fair, clear and not misleading. The FCA is also proposing that metrics be accompanied by a historical time series for comparison, after the first year that product or portfolio-level climate disclosures are reported in accordance with FCA rules.
- Targets – where a firm makes a claim regards plans to achieve certain climate-related targets at product-level, it will need to determine and communicate the key performance indicators it uses to measure progress against those targets, in accordance with the TCFD's recommendations.
Timings and next steps
The FCA is proposing a phased implementation beginning with the largest, most interconnected firms, having two phases of implementation as follows:
- First phase – effective from 1
January 2022 - rules would come into force for the following firms:
- Asset Managers with AuM of more than £50 billion, capturing 34 firms with £8 trillion in AuM
- Asset owners with £25 billion or more in AuM or
administration in relation to In-Scope business, capturing 12 firms
with £1.2 trillion in AuM
Under Phase one, the first disclosures would need to be made by
30 June 2023. Subsequent disclosures would be made by 30 June in
each calendar year.
- Second phase - effective from 1 January
2023 – rules would take effect for the remaining firms above
the proposed £5 billion threshold for both asset managers and
asset owners. This would capture 106 asset managers with £2.4
trillion in AuM and 22 asset owners with £0.5
trillion in AuM.
Under phase two, first disclosures would need to be made by 30 June 2024. Subsequent disclosures would be made by 30 June each calendar year thereafter.
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