FCA Highlights Issues with ESG Benchmarks

The FCA has recently issued a ‘Dear CEO’ letter regarding its concerns for the overall quality of ESG-related benchmarks.

This continues on from a portfolio letter, which was sent to benchmark administrators in September 2022. The letter summarised the FCA’s supervisory priorities and view of risks within the sector. Following the initial review on ESG benchmarks, it was concluded that there were widespread failings by administrators, with the quality of disclosures sampled cited as “poor”.

Among the issues identified:

• A significant lack of detail and description on ESG factors considered in benchmarking methodologies.
• Failure to ensure that the underlying methodologies for ESG data and ratings products used in benchmarks are accessible, clearly presented and explained to users.
• Failure to fully implement ESG disclosure requirements.
• Lack of “robustness and reliability” resulting in failure to correctly implement ESG benchmarks methodologies, such as using outdated data and ratings or failing to apply ESG exclusion criteria.

Based on these results, there is a worrying trend in regard to firms taking a critical view on ESG-related efforts. The FCA has already previously warned firms on the dangers of misleading consumers by exaggerating the sustainability of their services (or ‘greenwashing’), the practice of which could increase the risk of consumer harm. The lack of detail or understanding on ESG measures within benchmarking methodologies, as mentioned above, is a contributing factor for greenwashing, which is particularly concerning.

Sustainability remains a high priority. At a time where consumers are becoming increasingly environmentally conscious, firms need to be more transparent about their ESG impacts, alongside making products and services more sustainable. Unless the industry starts setting an example in its commitment to sustainability, it will become increasingly difficult to maintain trust and integrity within the market.

One of the main problems that should be addressed, is the level of confusion towards how ESG impacts the industry. It is not just about what businesses can do to reduce their carbon footprint. Rather, it concerns how firms intend to measure their exposures to risk by monitoring environmental, social, and governance factors likely to challenge their financial resilience over the next few years.

Another issue highlighted within the report is a lack of a standardised method for measuring ESG strategies. How does a firm know they are heading in the right direction if they have nothing to compare it with?

The FCA are aware of these issues and are working closely with other relevant financial regulators, as well as the UK government, to negotiate a coordinated approach toward ESG regulation. In the meantime, firms will need to refocus their efforts by reviewing their own existing operations and highlighting opportunities to incorporate ESG elements to boost resilience. Targets should be set to work towards sustainability goals and measures, and implementation plans should be outlined to ensure those targets are achieved.