From advocating a more proportional approach in the application of Mifid to smaller firms, to an ill-concealed criticism of the EU’s already infamous Packaged Retail and Insurance-based Investment Products Regulation (PRIIP), the UK has always been known for its pragmatism for what concerns the regulation of financial services. However, both to retain its competitiveness in the market for financial services with neighbouring Europe and to avoid an excessive increase in the costs of business for its market participants, the majority of the most significant pieces of the EU rulebook on financial services has been timely onshored in corresponding UK laws and regulations well in advance of Brexit.
In the wake of its regained sovereignty, however, the UK decided to revert to its original approach on climate-related disclosures. Far from being oblivious of the pivotal role played by financial firms in determining future outcomes on these issues, the UK Financial Conduct Authority (FCA) very recently issued a paper to kick off the consultation process aiming at the introduction of a legislative framework on mandatory climate-related financial disclosures.
Design of the climate-related disclosure regime
The FCA’s consultation proposes an approach that is consistent with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosure (TCFD) and is applicable to asset managers, life insurers and FCA-regulated pension providers. The Task Force, chaired by Michael Bloomberg, consists of various members across the G20 countries representing both end users and those tasked with compiling financial disclosures, and has the ambitious goal of developing recommendations for more effective climate-related disclosures to promote more informed decision on investment, credit and insurance underwriting. The TCFD recommendations are based on four pillars – governance, strategy, risk management, metrics and targets.
The fact that the regime will be designed on the basis of the widely-recognised TCFD recommendations is one of the reasons why the FCA proposal appears interesting at different levels. A highly practical reason lies behind this choice, which takes into account the needs of UK market participants with European interests and marketing reach, aiming to make compliance with Sustainable Finance Disclosure Regulation (SFDR) and other EU sustainability-related regulations less burdensome.
The FCA proposal articulates disclosure requirements at two levels. There will be entity-level disclosure requirements, required on an annual basis and to be made on the main firm’s website. These disclosures will describe how firms take into account climate-related risks and opportunities in the administration or management of assets on behalf of clients, thus covering the main pillar of the TCFD recommendations. The idea behind this level of disclosures is to offer clients and consumers information to understand and evaluate firms’ approach to climate-related risks and opportunities when selecting providers or granting mandates.
The second-level disclosures will be at the product/portfolio level. Firms will be required, on an annual basis, to disclose information on the products or portfolio management services they offer. Disclosures will be required both on firms’ websites and in appropriate client communications, or else upon client request in selected circumstances. These disclosures will concentrate on mandatory carbon emissions and intensity metrics, additional metrics – if any – and scenario analysis.
Where governance, strategy and risk management approaches adopted for the products and services diverge from the ones adopted at firm level, disclosures should be integrated accordingly to provide investors with these additional details. Once again, the purpose here is to ensure that clients and consumers have sufficient and reliable information about the assets they have invested in.
Another interesting choice in the proposed FCA approach comes from the fact it focuses exclusively on climate-related disclosures – without concern, for the time being, for any of the other elements of the ESG paradigm.
Scope and exemptions of the FCA proposal
Overall, the proposal on a climate-related disclosure regime will seek to apply to all FCA-regulated firms for what concerns their activities of asset management and asset administration carried out from the UK, irrespective of where either the client or the product/portfolio are based.
For what concerns asset managers, in scope entities will include i) portfolio managers; ii) UK Ucits management companies; iii) full-scope UK alternative investment fund managers (AIFMs); as well as iv) small authorised UK AIFMs.
For what concerns so-called asset owners, the FCA proposes to include i) life insurers in relation to insurance-based investment products and DC pension products; as well as ii) FCA-regulated non-insurer pension providers, including platform providers and self-invested personal pension (SIPP) operators, to the extent that the latter provide a selection of ready-made investments.
The FCA proposes disclosures to cover the full range of activities carried out in the UK, in line with current TCFD practices on disclosures for global firms. Such a broad coverage, in the eyes of the regulator, will allow for transparency and support the necessary flow of information required by trustees and occupational pensions schemes, subject to climate-related reporting obligations themselves too.
Where the pragmatism of the FCA proposal really shines is with regards to the threshold for exemptions to the disclosure regime. Asset managers and asset owners with less than 5 billion in assets under management (AUM) or administration – on a three-year rolling average – will be exempted from producing disclosures under the climate-related disclosure regime. The rationale of the exemption is fundamentally based on the results of a cost/benefit analysis carried out in advance of the consultation. Given that the costs of implementation of the proposed regime will increase as a proportion of the firms’ assets under management and administration, the idea is to avoid the unintended consequence of passing those increased costs of compliance to end clients as well as potentially undermining competition in the marketplace for financial products. At the same time, according to the FCA consultation paper, the given threshold would nevertheless allow to capture nearly 98% of the UK asset management market.
Extraterritorial effects of the two regimes
The threshold exemption envisioned in the FCA proposal well exemplifies the considerable divergence of the UK proposed regime from the EU approach on sustainability-related disclosures.
In the EU ecosystem for sustainable finance disclosures, there is an all-encompassing definition of market participants. This definition not only does not cater for any AUM-size threshold, but also triggers compliance with the sustainable-finance disclosure regulation requirements on each and any market participant that are marketing their products to European investors. The industry also seems to believe – for the lack, at least at present, of a clear interpretation of this point by the EU Commission – that such definition does not even take into account the relevant domicile of establishment of market participants.
Due to the very generic reference to AIFM as a market participant contained in the regulation, which could as well be a non-EU AIFM, the EU ecosystem for sustainable finance disclosures is purported to have extra-territorial reach to all market participants active in the EU, whether Europe-domiciled or not.
More clear-cut is the position of the UK proposal for what concerns extra-territorial effects of the new regime. On the one hand, the FCA consultation paper makes it clear that the regime will not be applicable for the time being to so-called overseas schemes (e.g. EEA Ucits or their management companies) marketing in the UK under the so-called Temporary Permission Regime (TPR). However, with such overseas schemes being required to seek for a national UK authorisation by the end of the TPR, due in 2023, at that time also those overseas schemes will be brought in scope with the new regime on climate-related disclosures.
On the other hand, the fact that EEA products currently marketed in the UK might not be mandatorily required to abide to the new climate-related disclosure regime, will have the very natural consequence of restricting the choice of investable products for UK trustees and pension funds, should the managers of those products not decide to voluntarily comply with the new rules. In fact, as we see already with the EU sustainable finance disclosure regulation, compliance is mostly driven by the classification needs of certain institutional investors.
Few months into Brexit’s official start and we can already see the possible ramifications, for certain areas of the financial sector, of the UK’s decision to regain sovereignty on its laws, regulations and courts – starting with a very hot theme, which will take centre stage for years to come.
Although we cannot say nor predict whether, down the line, there will be a further move towards deregulation of the market in the UK, compared to Europe, it is very interesting to see the UK regulators’ choice to opt for globally-accredited standards for the climate-related disclosures regime.
While, for EEA market participants, marketing in the UK will entail an additional burden of compliance under new EU ESG rules, the FCA’s move on climate-related disclosures would possibly not increase the burden for either UK or EU market participants in their cross-border marketing endeavours.