FCA DP 23/1 “Finance for positive sustainable change” seeks views from across the financial services
With an eye to the journey to net zero, and the crucial role of the financial sector in this transition, the FCA has published a new discussion paper (DP 23/1) inviting views from regulated firms across the financial sector with the aim of encouraging an “industry-wide dialogue on firms’ sustainability-related governance, incentives, and competencies”. In a field where there are many initiatives taking place, the FCA’s aim is to help narrow this field and help with highlighting good, evolving practices if finance is to deliver on its potential to drive positive sustainable change.
The FCA is seeking views on how it can move most effectively beyond disclosure-based initiatives and firms are encouraged to reflect on the matters discussed, and consider, as appropriate, incorporating them as they review and refine their current approaches to governance, remuneration, incentives and training.
In the first part of DP23/1 the FCA:
- examines how governance, incentives and competence are considered in the TCFD recommendations, and how expectations in these areas are evolving with the work of the ISSB, the UK’s Transition Plan Taskforce and GFANZ;
- considers more deeply, firms’ sustainability-related objectives and strategies, and how these are supported by their governance and incentive arrangements. The FCA additionally reflects on how asset managers and asset owners organise and govern their stewardship activities to influence positive change; and
- considers firms’ training and competence.
In the second part of the DP, the FCA includes a collection of commissioned articles authored by external experts. The purpose of these articles is to encourage debate by providing different perspectives, and the FCA hopes this may, together with the FCA’s analysis, help firms reflect on how their approaches to governance, incentives and competence support positive change. This may encourage firms to review their practices, even without the FCA setting further regulatory expectations
The deadline for comments is 10 May 2023 (with opportunities to engage with the FCA ahead of this deadline).
The FCA will use the feedback to this DP, along with its ongoing analysis and supervisory engagement with firms, to consider how best to support the industry in the evolving field, and whether there is a case for further regulatory measures.
Key discussion points
Sustainability-related governance, remuneration and incentives in regulated firms
- Objectives, purpose, business and strategy
The FCA wants to understand how far firms are setting sustainability-related objectives and building these into their models and strategies. Where a public sustainability commitment has been made, for example, the FCA considers it reasonable to expect a firm to develop and articulate a credible strategy to deliver those commitments (this may include a suitable timeframe, milestones, consideration of the interaction with other parts of the business plan, identification of roles and responsibilities, and link with incentive structures – potentially including remuneration). With an eye to the shifting focus from commitments to implementation, the FCA highlight the value of well-designed transition plans in providing internal focus and discipline, while also helping stakeholders track progress.
The FCA is inviting views on whether all financial service firms should be expected to embed sustainability related considerations in their business objectives and strategies, and if so, what the scope of these expectations should be.
- Culture as an enabler
The FCA expects senior leaders to take responsibility to nurture healthy cultures in the firms they lead, focusing on four key drivers, purpose, leadership, governance and a firm’s approach to rewarding and managing its people. Work has already been done in this area to set expectations by the FRC, the FCA in their work on D&I, and the TPT. Furthermore the Consumer Duty, once in effect, will focus firm’s minds on their culture and will require them to consider how their behaviours and culture support positive outcomes for consumers. Nevertheless the FCA is considering whether, beyond this, it should be setting regulatory expectations or guidance on how firm’s culture and behaviours can support positive sustainable change.
- Governance, responsibility and accountability
The FCA is exploring the steps that firms should take to ensure that they have the right skills and knowledge relating to material climate and sustainability related risks, opportunities and impacts on their boards, as well as the management information used to monitor and oversee developments – and whether regulatory expectations or guidance should be set in this area. External experts have identified that there remain gaps in the expertise on many boards – and an urgent need for assessment of whether board members and senior executives have the skills, knowhow and commitment to oversee the transition of an enterprise to net zero.
Focus is also on strategies for embedding climate/sustainability considerations across a firm’s operations such that it becomes BAU (as well as the practical challenges of doing so). There is no one size fits all model, and a number of approaches could be equally effective.
In terms of accountability the FCA is considering whether more in the way of regulatory expectations or guidance is needed. For dual regulated firms SS3/19 sets expectations on firms to allocate responsibility for identifying and managing financial risks from climate change to an appropriate existing SMF, and including this in that SMF’s SOR. Meanwhile, for solo-regulated firms, while the SMCR applies, the FCA has not prescribed responsibilities for delivery of climate/other sustainability related objectives.
The FCA is also considering its expectations on the governance and oversight of products with sustainability characteristics. Central to this is the expectation that all firms making sustainability-related claims about their products or services should maintain appropriate governance arrangements to deliver the product in line with these – and for firms to have appropriate arrangements in place to ensure those claims reflect the sustainability profile of the product. The FCA’s work on its disclosure and labelling regime (see our client note on CP22/20) will inevitably feed into this.
- Integration, remuneration and incentives
Where a firm has made climate or sustainability related commitments, linking reward outcomes to these could – if appropriately designed – play a role in supporting delivery. This is not always straightforward, and the FCA warns firms about the use of soft targets or metrics that could amount to little more than greenwashing.
Executive pay is only part of the picture, and the FCA notes that firms may also wish to think about how the whole organisation is mobilised towards delivery. Firms may therefore consider performance measures linked to sustainability-related factors for their wider workforce or for cohorts of staff (provided within those employees influence and control, and with a mind to ensuring this doesn't become a tick box exercise). This could take many forms – both financial and non-financial.
The FCA is interested in exploring further the matters firms should take into consideration when designing remuneration and incentive plans linked to their sustainability‑related objectives.
- Governance of investor stewardship to influence positive change: focus on asset managers and asset owners
Investor stewardship can play an important role in influencing positive sustainability outcomes. The FCA is therefore particularly interested in gathering further feedback on how asset managers and asset owners organise and govern their stewardship activities to support firm-wide sustainability objectives.
The FCA’s past work in this area remains relevant and continues to support the FCA’s thinking. One of the key barriers previously identified was that firms’ governance arrangements did not place sufficient value on effective stewardship.
Recognising that stewardship has in recent years extended beyond its origins, to a wider range of asset classes, as well as influencing the functioning of financial markets (i.e. macro or systemic stewardship), the FCA emphasises its view of collaborative investor engagement as an important tool to influence positive market-wide and systemic sustainability outcomes. In Primary Market Bulletin 42, the FCA reiterated its view that shareholder engagement can be an important mechanism to challenge and influence corporate issuers’ strategies and decisions, for the benefit of investors and society – the FCA is keen to ensure that concerns about the operation of market abuse rules ‘do not inhibit or stifle high quality engagement’ between issuers and their shareholders. The FCA also stated in that bulletin its intention to ‘provide clarity so as to aid issuers, directors and shareholders in understanding the FCA’s concerns and rationale’.
With this in mind, the FCA is keen to explore whether additional measures to encourage effective stewardship should be considered, and is inviting views on the additional measures that would encourage firms to identify and respond to market‑wide and systemic risks to promote a well‑functioning financial system.
Training and competence on sustainability in regulated firms
The FCA want to see that the financial sector is appropriately equipped with the relevant skills and expertise, and is keen to promote genuine capability building and ensure its expectations about sustainability-related skills, knowledge and expertise are clear.
The main knowledge gaps the FCA has identified through past work are on ESG data and metrics, key definitions (e.g. responsible investment’, ‘impact investing’) and a lack of expertise that cuts across sustainability topics, and there is a growing awareness that knowledge gaps, including a failure to identify interdependencies between sustainability issues, may hinder a firm’s ability to make informed decisions, and a consensus that familiarity with material sustainability-related matters should be part and parcel of how financial services professionals undertake their role. Through the FCA’s wider engagement internationally it notes that other jurisdictions have identified gaps and challenges relating to climate risk training and education within the banking sector.
One question the FCA is considering is whether introducing new qualification requirements and/or guidance can help to build sustainability-related capabilities within the financial services sector – lessons can be learnt from existing UK and global initiatives (for example the Monetary Authority of Singapore (MAS) set out 12 technical skills and competencies needed for professionals to perform various roles in sustainable finance) and the work that some firms are already doing to provide their staff with the training they need.
The FCA is continuing its engagement with sector specific groups through 2023, and welcomes feedback on, among other aspects, the main sustainability related knowledge gaps across the financial sector, how can these best be addressed, and the potential harms to market integrity, consumer protection or competition arising from these knowledge gaps.