Finance for positive sustainable change

May 2023  |  SPECIAL REPORT: FINANCIAL SERVICES

Financier Worldwide Magazine

May 2023 Issue

If the mood music around environmental, social and governance (ESG) regulatory developments was marked with musical terminology, then the annotation prestissimo – the fastest possible tempo – would not be far off the mark.

Those doing business in the EU have had to keep pace with a rapidly developing sustainability framework, including the regimes established under the EU Sustainable Finance Disclosure Regulation (which has applied since March 2021) and the EU Taxonomy Regulation, which has applied in a staggered manner since January 2022, the sustainability changes to MiFID II suitability and product governance requirements (which have applied from August 2022 and November 2022 respectively) and the EU Corporate Sustainability Requirements Directive (which is due to apply in stages from January 2024).

In the US, changes are also being mooted with the Securities and Exchange Commission issuing a number of ESG-related proposals in 2022, including a proposed disclosure regime for issuers and fund advisers and restrictions regarding the use of sustainability-related words in funds’ names.

In the UK, regulators have implemented in earnest the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) as part of the government’s commitment to introduce TCFD-aligned disclosures across the economy by 2025, the Financial Conduct Authority (FCA) is currently developing a sustainability requirements and investment labelling regime, and the government formed a Transition Plan Taskforce (TPT) in April 2022, which consulted in November 2022 on a disclosure framework for climate-related transition plans, which will also in time become mandatory.

At the international level, the Glasgow Financial Alliance for Net Zero (GFANZ), which was established in advance of COP 26 in 2021, includes over 550 members across 50 jurisdictions and has developed a number of voluntary, pan-financial sector net-zero transition planning tools and guidance. Finally, the International Sustainability Standards Board (ISSB) has been developing disclosure standards, which build on other reporting initiatives such as TCFD. The standards, which are expected to be finalised at the end of Q2 2023 and come into effect in 2024, are intended to create a global baseline of sustainability disclosures.

Now and again though, policymakers and regulators must signal a decelerando to industry and provide stakeholders with an opportunity to think and reflect. The FCA’s discussion paper DP23/1 entitled ‘Finance for positive sustainable change’ (DP) does precisely this. Published on 10 February 2023, the DP asks for views on a wider set of ESG considerations, namely sustainability-related governance, incentives and competence in regulated firms.

Context

The DP should be seen against the backdrop of the FCA’s ESG strategy (which it launched in November 2021), referred to as “a strategy for positive change” and which revolves around the themes of transparency, trust, tools, transition and team. This strategy includes developing a policy approach to ESG governance, remuneration, incentives, and training certification in regulated firms. The DP is also aligned with the government’s letter to the FCA of December 2022, which asks the FCA to “have regard to the government’s ambitions for the provision of sustainable finance”, and a proposed amendment to the Financial Services and Markets Act 2000, which will create a new regulatory principle for the regulators to “have regard to the need to contribute towards achieving the [g]overnment’s target of reaching net zero greenhouse gas emissions by 2050”.

Outline of the DP

The FCA introduces the DP with a reminder of the fundamental role that good governance and a healthy culture play in making sure regulated firms deliver value to clients and consumers and support market integrity. Furthermore, the governance, purpose and culture of a firm are of paramount importance to how it integrates “environmental and social factors into business, risk and capital allocation decisions for the benefit of clients and consumers”. Governance is also central to the FCA’s new Consumer Duty.

The DP is made up of two parts. Part 1 considers how governance, incentives and competences are looked at in the TCFD’s recommendations and how the various outputs of the ISSB, TPT and GFANZ are shaping this area. The DP then examines firms’ sustainability-related objectives and strategies and how governance and incentive arrangements support these. It then, with a focus on asset managers and asset owners, explores the role that governance and organisation of investor stewardship can play in influencing positive sustainability outcomes. The FCA’s observations and discussion questions arise out of consideration of three sources: commissioned articles, a review of relevant literature, and its own analysis, which includes a review of firms’ public sustainability-related disclosures, such as TCFD-aligned disclosures. In the penultimate chapter of part one, the FCA considers what aspects of the training and competence requirements in regulated firms may need to be adjusted to address the principal sustainability-related knowledge gaps and, in the final chapter of Part 1, it sets out the next steps.

Part 2 of the DP includes 10 commissioned articles from experts, which together with the FCA’s analysis may assist firms in reviewing whether their current approach to governance, incentives and competence supports positive change. The articles are written by a selection of industry practitioners, academics and other thought leaders, who have relevant insights on sustainability-related governance, incentives and competence. While their views do not necessarily reflect the FCA’s views, the FCA believes that the inclusion of such material encourages diversity of thought and wide-ranging debate and will complement its own policymaking process.

The articles included in Part 2 are split into three categories by the FCA, as set out below.

First, sustainability-related governance, remuneration and incentives in regulated firms: (i) “Joining the dots – taking a holistic and purpose-led approach to net zero”; (ii) “Using pay to create accountability for ESG goals”; (iii) “Transition to net zero: increasing investor confidence in corporate carbon commitments”; (iv) “Adding purpose to principles and products”; (v) “How to build an effective culture to support climate- and sustainability-related objectives in the financial sector”; (vi) “Board level governance of climate-related matters”; (vii) “How a chief sustainability officer can most effectively support a firm in achieving its climate- and sustainability-related objectives”; and (viii) “Governing climate transition implementation at banks”.

Second, governance of investor stewardship to influence positive change: (ix) “Effective governance of investor stewardship to support net zero: a practitioner’s view”.

Third, training and competence on sustainability in regulated firms: (x) “Preventing greenwashing: time to stop marking our own homework”.

What is next?

Comments on the DP are requested by 10 May 2023. Annex 1 to the DP contains a full list of questions that are raised in the paper, 11 of which relate to ESG governance, remuneration and incentives in regulated firms and four to training and competence in regulated firms. The FCA will consider the feedback to the DP alongside “ongoing analysis” and observations from its supervisory engagement with firms to assess whether further regulatory measures in relation to governance, incentives and competence are needed to ensure that finance contributes to positive change. Firms are also encouraged to explore the topics addressed in the DP when evaluating their arrangements regarding governance, remuneration, incentives and training and may wish to incorporate the matters covered in the DP as appropriate. For now, the metronome for this particular ESG regulatory workstream is perhaps best set at andante than prestissimo although it is clear that the regulator will be keeping a watchful eye on how firms approach sustainability-related governance, incentives and competence, and firms in turn will need to follow the regulator’s baton at all times.

 

Charlotte Hill is a partner and Daniel Hirschfield is a senior knowledge lawyer at Taylor Wessing LLP. Ms Hill can be contacted on +44 (0)20 7300 7011 or by email: c.hill@taylorwessing.com. Mr Hirschfield can be contacted on +44 (0)20 7300 4107 or by email: d.hirschfield@taylorwessing.com.

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Charlotte Hill and Daniel Hirschfield

Taylor Wessing LLP

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