On 17 December 2021, the UK Financial Conduct Authority (FCA) published its policy statement (PS21/24) setting out final rules and guidance relating to the requirements under a new climate-related disclosure regime for asset managers as well as “asset owners” (i.e., life insurers and FCA-regulated pension providers). The new regime is based on the Recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD).
While the final rules include certain changes, the architecture of the regime and the principal disclosure requirements are consistent with the FCA’s original proposal from June 2021, as consulted on in its consultation paper CP21/17 and as discussed in our Update ESG - UK FCA Consultation on Climate-Related Disclosure Requirements — Implications for Asset Managers (July 2021).
The rules, taking effect through a new Environmental, Social and Governance (ESG) sourcebook in the FCA Handbook, came into effect on 1 January 2022 for the largest firms with more than £50 billion in assets under management (or £25 billion assets under administration for asset owners). The first set of reports for these firms will be due by 30 June 2023, reflecting the 2022 calendar year.
Other firms, with assets greater than £5 billion (such threshold to be reviewed after three years of disclosures), will be subject to the new rules from 1 January 2023, with reports for calendar year 2023 due by 30 June 2024. The FCA expects that the rules, once fully implemented, will apply to 140 UK-based asset management and 34 asset owner firms, together representing 98% of the UK asset management market.
The new regime will require in-scope firms to make disclosures on an annual basis at:
- Entity-level — an annual TCFD entity report published in a prominent place on the main website of the firm setting out how the firm takes climate-related matters into account in managing or administering investments on behalf of clients and consumers.
- Product-level — disclosures (including a core set of climate-related metrics) on the firm’s products and portfolios made publicly in a prominent place on the main website of the firm and included or cross-referenced in an appropriate client communication or made on request to certain eligible institutional clients.
Under the new rules, firms’ entity- and product-level reports must be consistent with the TCFD Recommendations and Recommended Disclosures, that is, the four recommendations and the 11 recommended disclosures set out in Figure 4 of Section C of the TCFD Final Report. Firms must also take reasonable steps to ensure that their disclosures reflect relevant sections of the TCFD Annex, that is, Section C: Guidance for All Sectors, which includes requirements relating to the disclosure of net zero transition plans, and Part 4, Section D: Asset Managers.
We refer below to the new regime for asset managers and asset owners as the “FCA’s ESG rules”; however, note that the FCA has also published final rules for ESG disclosures by standard listed companies for accounting periods commencing on or after 1 January 2022 (see FCA policy statement PS21/23), and premium listed commercial companies are already subject to TCFD-aligned disclosure regime for accounting periods commencing on or after 1 January 2021 (see FCA policy statement PS20/17) (albeit the first annual reports containing the disclosures will be published from spring 2022 onwards).
We set out below the key points to note for asset managers, with a particular focus on U.S. (and other non-UK) managers, including those with UK sub-advisors.
1. The FCA’s ESG rules will not apply to non-UK asset managers that market funds under the UK implementation of the AIFMD (for now)
Unlike the EU’s rules for sustainability disclosures under the Sustainable Finance Disclosure Regulation (SFDR), the FCA’s ESG rules will not apply to foreign asset managers that market their funds to investors in the UK under the UK Alternative Investment Fund Managers Regulations 2013 (which implemented the EU Alternative Investment Fund Managers Directive. For a discussion of the SFDR, please see our Updates EU Sustainable Finance Disclosure Regulation: European Commission Q&As and Implications for Non-EU Fund Managers (August 2021) and EU ESG Disclosures Required from March 10, 2021 — Action Points for Non-EU Fund Managers (January 2021).
The FCA’s ESG rules will apply only to asset managers, life insurers, and pension providers that are authorised by the FCA. In respect of unauthorised alternative investment funds (AIFs), only those that are managed by a UK alternative investment fund manager (AIFM) will be in scope.
The FCA notes that it is exploring how overseas funds marketed into the UK should be treated as part of the forthcoming Sustainability Disclosure Requirements (SDR), in relation to which the FCA published a discussion paper DP21/4 in November 2021. As such, it is possible that the scope of the FCA’s ESG rules (and any future SDR requirements) could apply to non-UK asset managers marketing under the NPPR in future.
Regardless, as noted in our July 2021 Update, the FCA’s ESG rules (as well as regulations published by the Department for Work and Pensions for occupational pension schemes) may result in in-scope UK asset managers and asset owners requesting a non UK asset manager to provide certain product-level information in order for the in-scope UK asset managers or asset owner to discharge its own disclosure obligations.
2. UK sub-advisors with discretionary investment authority are in scope
The FCA’s ESG rules apply to any UK firm that performs “TCFD in-scope business,” which includes the investment service of portfolio management under the UK’s implementation of the Markets in Financial Instruments Directive (MiFID).
Accordingly, UK sub-advisors with discretion to manage assets on behalf of a fund managed by a U.S. (or other) affiliate will be in scope of the FCA’s ESG rules with respect to such activities.
We consider the content of the reporting obligations in the context of a sub-advisory relationship below. In practice, for UK firms without its own external clients, the disclosure requirements are likely to be less extensive.
3. UK private equity firms are subject to an extended scope
Although the FCA’s ESG rules refers to “asset managers,” in the context of private equity and venture capital firms, the meaning of “portfolio management” is extended to include activities that consist either of advising on investments or managing investments on a recurring or ongoing basis.
As such, FCA-authorised private equity firms (which may otherwise have fairly limited permissions) that provide investment recommendations to an offshore general partner entity or to a non-UK investment manager could be in scope of the FCA’s ESG rules, even though such UK firms might not have ultimate investment discretion for the fund and would not be designated as the AIFM of the relevant fund.
4. Most UK sub-advisors will likely not be in scope until 2023, meaning first reports will not be due until June 2024
As noted above, the application of the FCA’s ESG rules is deferred until 1 January 2023 for asset managers with assets under management less than £50 billion.
This figure is calculated by reference to the FCA’s Senior Managers and Certification Regime (SMCR) under the FCA Senior Management Arrangements, Systems, and Controls (SYSC) sourcebook. In particular, the FCA’s ESG rules contain transitional provisions under which ESG 2 is disapplied where a firm does not meet the requirements of an “enhanced scope SMCR firm” under SYSC 23. The relevant provisions of SYSC 23 provide that an enhanced scope SMCR firm (unless a firm has voluntarily elected enhanced status) is a firm whose assets under management are £50 billion or more, calculated in accordance with the “Total funds under management” reported by firms to the FCA in report FSA038 (Volumes and Type of Business).
In practice, we would not anticipate that a large proportion of UK sub-advisory firms (at least in the hedge fund sector) would be in scope from 1 January 2022. Accordingly, the first reports of such firms should not be due until 30 June 2024, for the calendar year 2023. As noted below, in 2024 or 2025, asset managers will be required to make additional disclosures under the SDR and UK Green Taxonomy.
The FCA’s ESG rules do not apply to a firm that would otherwise be in scope if and for as long as its assets under management (or administration) in relation to its TCFD in-scope business amount to less than £5 billion calculated as a three-year rolling average on an annual assessment. However, it is not entirely clear in the final rules how the £5 billion threshold is to be calculated.
5. In practice, UK sub-advisors whose sole client is an affiliate will be required to make only entity-level disclosures, as product-level disclosures are required only “on demand” by a client
All firms that are in scope of the FCA’s ESG rules will be required to make entity-level disclosures and publish these in a prominent location on their website.
In PS21/24, the FCA notes that it had received feedback that it would not “add value to bring sub-advisory/investment management services provided to non-UK affiliates on limited, ad hoc, transactions into scope”; however, the FCA did not make any changes to its rules that would exclude sub-advisory firms from the scope of the entity-level disclosures. The FCA notes that its intention is to cover “as far as possible, the full range of asset management activities conducted in the UK.”
Entity-level disclosures must include climate-related financial disclosures regarding the overall assets managed by the UK sub-advisor in relation to its TCFD in-scope business (i.e. portfolio management activities); however, where the UK sub-advisor takes a materially different approach in respect of a particular investment strategy, asset class, or product, this must be disclosed. See below regarding consolidated group reporting.
Entity-level reports must include an explanation of the firm’s approach to climate-related scenario analysis and how the firm applies climate-related scenario analysis in its investment and risk decision-making process. Where reasonably practicable, firms must provide quantitative examples to demonstrate its approach to climate-related scenario analysis. Entity-level reports must also include a description of any targets it has set to manage climate related risks and opportunities, including the key performance indicators it uses to measure progress against these targets.
The FCA acknowledges that in some client relationships, public product-level disclosures would not be appropriate — for example, for firms that provide discretionary portfolio management services to individuals or institutional investors, and unlisted unauthorised AIFs. Accordingly, the FCA’s ESG rules permit product-level disclosures to eligible clients to be made “on demand.”
In the final rules, the FCA has amended the “on demand” obligation to require that firms provide a report to clients at a single reference point consistent with public disclosures or at date agreed between the client and the firm, and in a “reasonable” format.
In practice, entity-level reports will be more high-level in their disclosures than product-level reports would be. In particular, product-level reports are required to include quantitative metrics relating to scope 1, 2, and 3 emissions; total carbon emissions; total carbon footprint; and weighted average carbon intensity of the relevant product as well as qualitative summaries of the impact of an orderly transition, disorderly transition, and hothouse scenarios on the assets underlying the relevant product. In addition, product-level reports must, as far as reasonably practicable, include climate value-at-risk calculations and metrics that show the climate warming scenario with which the product is aligned (such as using an implied temperature rise metric).
In practice, for UK sub-advisors whose sole client is a group affiliate (e.g., its U.S. hedge fund manager parent), the additional burden of producing product-level disclosures will likely mean that such disclosures will not be requested. For a firm that is headquartered in the U.S., the involvement of the U.S. entity will likely be required to produce TCFD-aligned disclosures, and so, in that sense, the client of the UK firm would already have access to the relevant information.
6. Entity-level reporting obligations could be discharged by cross-referring to TCFD reporting by other members of their group
In recognition of the fact that many asset management firms authorised in the UK are part of larger groups, in some cases with an overseas headquarters, and that group organisational structures, strategies, and activities will often be relevant to the UK firm’s climate-related financial disclosures, the FCA’s ESG rules provide flexibility for UK firms to cross-refer to disclosures made by the group or an affiliate member of the group. The UK firm would be required to set out the rationale for doing so and clearly signpost to the relevant disclosures, including hyperlinks.
The FCA’s ESG rules do not specify which climate-related disclosures of the group can be cross-referred to (these could therefore be voluntary disclosures made at group level or mandatory disclosures under another regulatory regime), but the cross-referenced report must contain relevant climate-related disclosures consistent with the TCFD’s recommendations. Where cross-referenced disclosures do not fully cover the activities of the UK firm, the UK firm is responsible for explaining any material deviations and providing additional information.
At present, the U.S. has not mandated TCFD-aligned reporting for asset managers, so this aspect of the FCA rules will provide flexibility only where a U.S. affiliate has chosen to comply with the TCFD standards voluntarily.
7. Firms may not have all the data in time to report; gaps must be identified and explained
In its final rules, the FCA has added further provisions to clarify that it will not require firms to disclose information if data gaps or methodological challenges cannot be addressed through use of proxies and assumptions or if to do so would result in misleading disclosures. Firms must explain where and why they have not been able to disclose as well as the steps they will take to improve the completeness and the quality of disclosure.
Interaction with other ESG requirements
8. The FCA’s ESG rules are narrower in focus than the EU’s SFDR; firms will not be required to disclose SFDR carbon metrics
The FCA’s ESG rules require firms to make disclosures in line with the TCFD recommendations. The TCFD’s framework focuses on climate-related financial disclosures and is accordingly much narrower in its focus than the EU’s SFDR, which covers sustainability more generally, including both environmental and social issues.
To promote consistency and support information flows along the investment chain, the FCA had originally proposed that the core disclosure metrics (relating to carbon emissions and carbon intensity) in the product report should be calculated and disclosed in accordance with both the TCFD and SFDR methodologies.
In light of responses to the FCA’s consultation that expressed concerns with the requirement to disclose metrics using two different methodologies, the final rules require disclosure of metrics using the TCFD’s methodology only.
9. UK asset managers will not be required to disclose in line with the International Sustainability Standards Board (ISSB) standards (unless they are also subject to ISSB corporate reporting)
During COP26, held in Glasgow in November 2021, the International Financial Reporting Standards (IFRS) Foundation launched the ISSB, which will provide a global baseline standard for corporate sustainability reporting. The ISSB standards will build on the TCFD’s recommendations; the standards will start with climate reporting and expand to other sustainability issues over time.
In PS21/24 the FCA indicates that it expects its ESG rules for listed issuers to be updated to reference the ISSB’s reporting standards (once these have been endorsed for use in the UK).
While some asset managers and asset owners will disclose against the ISSB standards in due course as part of their corporate group, the FCA does not make any proposal for asset managers or asset owners to be subject to a standalone requirement to comply with the ISSB standards.
10. The FCA’s ESG rules will be supplemented by additional SDR and UK Green Taxonomy disclosures in “2-3 years”
In October 2021, the UK government published a policy paper, Greening Finance: A Roadmap to Sustainable Investment, which sets out a high-level strategy through which the government intends to “green” the financial system to align it with the UK’s 2050 net zero carbon emissions target.
In November 2021, the FCA published DP21/4 on Sustainability Disclosure Requirements and investment labels, in which it sought initial views on disclosure requirements under the new SDR for asset managers and certain FCA-regulated asset owners as well as a sustainable investment labelling system.
Under the SDR, the FCA is proposing to bring together new and existing sustainability reporting requirements for businesses (including listed companies), the financial sector, and investment products. The SDR will extend the disclosure requirements beyond climate change and will link to the UK Green Taxonomy so as to cover sustainability impacts as well as sustainability risks and opportunities.
The FCA’s ESG rules are expected to be the foundation for these broader sustainability disclosures for asset managers and asset owners and the FCA currently envisages a three tier system consisting of sustainability product labels, consumer-facing disclosures, and more detailed entity and product level disclosures for institutional investors.
The FCA has stated that it intends to issue a consultation in Q2 2022 on proposed rules to implement the new SDR framework.
According to the Greening Finance policy paper, subject to consultation, mandatory SDR disclosures and UK Green Taxonomy alignment would apply in “2-3 years” for funds with assets under management equal to or greater than £5 billion; and in “+3 years” for funds with assets under management equal to or greater than £1 billion.
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