The regulator is concerned that ESG-related disclosures are not meeting expectations.

By Nicola Higgs, Becky Critchley, Anne Mainwaring, Ella McGinn, and Charlotte Collins

The FCA has published a Dear CEO letter sent to benchmark administrators on 20 March 2023, expressing concerns about the quality of their ESG-related disclosures. The FCA’s concerns are based upon a preliminary review of ESG benchmarks, which assessed the disclosures made by a sample of UK benchmark administrators. The review found the quality of ESG-related disclosures to be poor, and the letter sets out the FCA’s specific findings in this regard. The FCA states that it is acutely aware that poor practices in this area could lead to claims of greenwashing and dilute trust and confidence in ESG labelling. Therefore, the FCA is not only concerned about technical compliance with disclosure requirements, but also about ensuring the integrity of ESG-related products.

Key Findings

In particular, the FCA explains that:

  • Details are lacking on the ESG factors considered in benchmark methodologies. The FCA highlights that benchmark administrators have significant discretion when designing their benchmark methodologies, including deciding which ESG factors will be considered and how these are applied in the methodology, making transparency around methodologies of particular importance. According to the FCA, the underlying methodology for ESG benchmarks needs to be accessible, clearly presented, and explained to users. The FCA is concerned that poor disclosures could lead to greenwashing, particularly when the application of ESG factors results in a similar outcome to benchmarks that are not marketed as ESG benchmarks.
  • All benchmark administrators in the review failed to sufficiently explain in their benchmark statements how ESG factors are reflected against each of the requirements in the UK Benchmarks Regulation.
  • Some descriptions of the market or economic reality measured by benchmarks were generic, particularly in benchmark statements for families that covered a broad range of benchmarks. The FCA emphasises that, if such information is made available in other documents, links to such materials must be clearly signposted and easily accessible.
  • Administrators’ explanations of how ESG factors are reflected in the benchmark statement and methodology, as required by the UK version of the Low Carbon Benchmarks Regulation, were lacking. The FCA found that most disclosures omitted key information required by the templates.
  • All benchmark administrators in the review failed to provide sufficient information on the data and standards used to calculate the weighted average scores for their ESG factors. Descriptions of the data sources and the extent to which they are estimated or reported were particularly poor. The FCA also found that several firms were not disclosing average weighted scores against all of the mandatory ESG factors, and warns that administrators that do not have access to the relevant data should consider whether they should cease offering the benchmarks in question. It is also worth noting with regard to data sources for ESG benchmarks that the FCA’s statement accompanying the Dear CEO letter flags that a consultation is expected shortly on the potential regulation of ESG ratings providers. Whilst such proposals will take some time to work their way through the legislative process, regulation of ESG data providers would change the current landscape significantly and presumably provide a more structured framework for benchmark administrators seeking data for their ESG benchmarks.
  • Most administrators in the review omitted vital information required by the UK version of the Low Carbon Benchmarks Regulation from descriptions of their methodologies. The FCA emphasises that it expects firms to state which factors are being applied to which benchmarks and whether these factors are used to select, exclude, or weight constituents. It also observes that descriptions as to how data is verified, and how the quality of data is ensured, were particularly poor.
  • The review exposed several instances in which benchmarks had been miscalculated due to the incorrect application of ESG factors, and the FCA highlights the requirement for administrators to notify the regulator when certain incidents occur. The FCA also found that some administrators did not have adequate controls to verify that ESG factors had been correctly applied in their ESG benchmarks.

Takeaways for Benchmark Administrators

Overall, the letter takes a heavily critical tone and highlights a number of issues for benchmark administrators to be aware of. The FCA already highlighted the risk of poor disclosures in relation to ESG benchmarks in a letter sent to benchmark administrators in September 2022. This further letter may be seen as a final warning about these issues. The FCA indicates that it will be doing more work in this area and is prepared to use its various supervisory (and, ultimately, enforcement) powers to take action if administrators do not address the issues it has raised.

The FCA expects CEOs to engage senior leadership and Boards to determine what steps need to be taken, indicating that the letter should be discussed at the highest level. The FCA specifically flags that benchmark administrators should implement strategies to address the regulator’s concerns, and should be able to explain these strategies to the FCA on request.