Leonard Ng, Co-head of Sidley Austin’s UK/EU Financial Services Regulatory group, explains the implications for asset managers of the UK FCA’s Consultation on Climate-Related Disclosure Requirements.
On 22 June 2021, the UK Financial Conduct Authority (FCA) published its consultation paper CP21/17 (the Consultation Paper) on new climate-related disclosure requirements for asset managers, life insurers and FCA-regulated pension providers, with a phased-in approach starting 1 January 2022 for the largest firms. The new disclosures would be based on the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD).
It should be noted that, although the rules are expected to apply directly to around 140 UK asset managers (with a £5 billion assets under management (AUM) threshold), it is likely that the new rules will also impact non-UK (such as US and EU) asset managers indirectly.
The proposals are aligned with the TCFD’s recommended disclosures, which were finalised in June 2017. In November 2020, the UK government announced its intentions to introduce these disclosure requirements by 2025, with a significant portion in place by 2023.
The new FCA rules will be implemented through a new ‘Environmental, Social and Governance (ESG) Sourcebook’ (ESG Sourcebook) in the FCA Handbook. Over time, the FCA envisages the expansion of the ESG Sourcebook to cover more ESG-related topics.
The EU has already adopted certain ESG-related disclosure requirements for asset managers and others via the Sustainable Finance Disclosure Regulation (SFDR). More information can be found in Sidley Austin’s January 2021 update EU ESG Disclosures Required from March 10, 2021 — Action Points for Non-EU Fund Managers and June 2020 update ESG Disclosures for Asset Managers Under the EU Sustainable Finance Disclosure Regulation and Taxonomy Regulation. The UK is not implementing the SFDR. Unlike the SFDR, which covers the breadth of ESG, the UK’s approach is to focus almost exclusively on climate-related matters. Where appropriate, this update will briefly cover the key similarities and differences between the proposed UK requirements and those under the SFDR.
Which UK asset managers are in scope?
The FCA proposes that the new rules will apply to FCA authorised firms responsible for managing investments from an establishment maintained by the firm in the UK. These include:
- Portfolio managers – note that this term has a special meaning, discussed below
- UK UCITS management companies
- UK AIFMs – both full scope and small AIFMs are in scope
‘Portfolio management’, for the purposes of ESG-related matters, is defined in the draft ESG Sourcebook as capturing entities:
- managing investments; or
- for private equity or other private market activities, advising on investments or managing investments on an on-going basis.
That is, the term ‘portfolio management’ goes beyond what one might expect that term to cover, in that the term would typically be expected to apply to discretionary investment management activities only. However, for purposes of the ESG Sourcebook the term will also include investment advice in the context of private equity business.
It is proposed that only asset managers with AUM of £5 billion or more (on a three-year rolling average) will be caught by the new rules. The Consultation Paper notes that, with that threshold, 140 UK asset managers would be caught by the new rules. However, the Consultation Paper does not define AUM and how it is to be calculated.
Are non-UK asset managers directly in scope?
No. As noted above, the new rules are proposed to apply to FCA authorised firms carrying on specified activities from an establishment maintained by them in the UK. To be clear, a non-UK firm that simply markets its funds into the UK (for example under the national private placement regimes pursuant to the UK Alternative Investment Fund Managers Regulations 2013) would not be an authorised firm for this purpose.
Accordingly, the scope of the proposed UK TCFD disclosure requirements is narrower than the scope of the EU’s SFDR. Whereas the SFDR applies to “financial market participants” – currently understood to include non-EU AIFMs that market their funds into the EU.
However, note that non-UK managers are likely to be affected indirectly by the new rules – see below.
What kinds of UK life insurers and pension providers are in scope?
The Consultation Paper uses the term “asset owner” to refer to UK life insurers and FCA-regulated pension providers that will be in scope of the new rules. In relation to pension providers, the FCA seeks to support disclosures required under the Department for Work and Pensions’ (DWP) draft regulations and statutory guidance (the DWP Draft Regulations) for in-scope trustees of occupational pension schemes, which take effect from 1 October 2021.
Similarly to asset managers, asset owners that have less than £5 billion under administration are proposed to be exempt from the disclosure requirements. As with AUM for asset managers, no definition of “administration” is provided. The Consultation Paper notes that, with that £5 billion threshold applied, 34 asset owner firms would be in scope of the new rules.
How might non-UK asset managers be indirectly affected by the new rules?
The new rules imposed on in-scope UK asset managers and UK asset owners are likely to result in non-UK asset managers (as well as other non-in-scope UK managers) being indirectly affected as well. The FCA’s proposals (and DWP Draft Regulations) would result in in-scope UK asset managers and asset owners requesting that a non-UK asset manager (or a non-in-scope UK asset manager) provide certain product-level information in order to discharge the in-scope UK asset managers’/asset owners’ own disclosure obligations.
For example, a US fund manager could receive a request for information from an investor that is an in-scope UK pension provider, which is trying to discharge its disclosure obligations under the new FCA rules or the DWP Draft Regulations.
What are the disclosure requirements for in-scope firms?
The FCA is proposing new rules that will impose climate-related disclosure obligations on asset managers (amongst others) at entity-level and at product-level. These disclosure requirements are intended to provide market participants with clear and accessible information on the climate-related risks and opportunities of certain investments.
Entity-level reports must be published on an annual basis in a prominent place on the firm’s main website. The criteria for these reports are based on the TCFD recommendations which cover governance, strategy and risk management, scenario analysis, and metrics and targets. The FCA proposes a flexible approach to entity-level reporting, which may relieve firms of the burden of producing multiple disclosure reports. Circumstances where relief may be available include:
- Group reporting. In-scope firms sitting within a group structure may cross-refer to climate-related disclosures made at group-level.
- Delegation of investment management.
- Where the asset manager is an “authorised fund manager” (AFM), and it delegates investment management to a third-party portfolio manager which is not in the same group, the delegating AFM remains responsible for producing a TCFD entity report. However, a delegating AFM’s entity-level TCFD report may include hyperlinks and cross references to relevant climate-related financial disclosures made by delegated managers, where available. Note that an AFM is defined in the FCA Handbook to mean an “authorised corporate director,” an “authorised contractual scheme manager,” or an “authorised unit trust manager” only. The Consultation Paper does not explain why this proposal on delegation is restricted to AFMs only, and not other types of asset managers.
- Asset owners will be permitted to cross-refer to other third-party or delegate reports (in addition to group reports as noted above). For example, where an asset owner’s underlying funds are managed by an external asset manager, the firm would be able to cross-refer to the appointed asset manager’s TCFD disclosures.
Product and portfolio-level reports
Like entity-level reports, product/portfolio-level reports are to be published on an annual basis on the firm’s main website. They should also be included in appropriate forms of client communication. Asset managers are expected to produce these reports for:
- authorised funds (excluding feeder funds and sub-funds in the process of winding up or termination);
- unauthorised AIFs; and
- portfolio management services (as defined above).
The contents of these reports should include mandatory core metrics (in line with TCFD supplemental guidance) and additional metrics provided on a ‘best efforts’ basis. Where the approach of a specific product differs from the overarching approach described in the entity-level reports, firms are expected to cover these deviations in the product-level reports.
Where a firm delegates the management of assets to a third-party portfolio manager, it may choose to cross-refer to disclosures made by the delegate.
The FCA notes that in some instances product-level public disclosures will not be appropriate (for example, where firms provide discretionary portfolio management services to individual investors, or for unlisted unauthorised AIFs). Where this is the case, the Consultation Paper suggests that firms should be prepared to provide ‘on-demand’ disclosures to their clients, which may be made upon request, once a year.
Under the FCA’s proposal, implementation of the disclosure requirements will occur in two phases. The rules will come into effect for asset managers with assets under management of more than £50 billion from 1 January 2022, with the deadline for the first disclosures falling on 30 June 2023. For other firms, the rules will take effect from 1 January 2023, with the disclosure deadline falling on 30 June 2024.
The consultation closes on 10 September 2021.
With this Consultation Paper, the FCA shows that, although the UK Government has agreed to match the ambitions of the EU Sustainable Finance Action Plan, of which the SFDR forms part, the UK is taking its own approach when it comes to climate-related disclosures. The patchwork of different standards that asset managers have to comply with grows ever more complex, when one considers that proposals for ESG-related disclosures are also being developed in the United States and certain countries in Asia. Asset managers are therefore likely to find that they are either directly subject to new requirements (in some cases such as the SFDR on an extraterritorial basis) or indirectly affected because their investors are themselves subject to new local requirements.