ESG: The Regulator’s Perspective


Environmental, Social and Governance (ESG) is becoming an increasingly popular topic with both investment institutions and investors alike, with many investors now using these non-financial factors as part of their overall investment analysis. With this in mind, it is also becoming an increasingly popular metric being utilised by the FCA is using to supervise firms. Within this framework, the FCA is applying particular emphasis on assessing each firm’s culture, diversity and environmental impact.

FCA’s focus turns to ESG

A company’s culture has become central to how the FCA assess firms, with the FCA reporting that they believe firms with healthy cultures are less prone to misconduct, with FCA Executive Director Jonathan Davidson saying that ‘unhealthy cultures and purposes have been at the root cause of too many misselling and other conduct scandals in financial services’. In light of this, being able to measure and assess a firm’s culture in line with the FCA has become grown in significance.

The FCA measures each firm’s culture against four standards: purpose, people, leadership and governance. The FCA wants firms to have a clear and meaningful “purpose”, which the FCA defines s the goals a firm sets itself and the value it provides to its customers, that creates a healthy culture that permeates throughout the staff allowing them to appreciate the wider culture to the work they do. The FCA want firms to allow employees to feel safe and confident in voicing their opinions, without fear of repercussion, as they believe this fosters a culture that promotes innovation, efficiency and reduced misconduct. Great importance, therefore, is placed on ensuring that people have a safe environment that promotes constructive debate and discussion. The FCA will look to each firm’s leaders to support these ideologies and will take note of the different strategies they are engaging in such as business restructures and speak-up policies. If any grievances in a firms culture, the FCA may issue a range of disciplinary measures from requiring independent oversight to withholding permissions or taking enforcement action.

Shifts in ESG

With these shifts in FCA focus in mind, it’s important to consider how the pandemic, and the resultant swap for a large number of firms to a hybrid working policy, has impacted each firm’s culture. A hybrid working policy can help to facilitate a healthy culture by benefiting staff’s wellbeing and increasing their productivity and connection to the firm’s leaders. It can, however, also lead to a lack of control, oversight, collaboration or feelings of isolation. The purpose and values of the firm may also become diluted as people feel disconnected and there is a fear that this could lead to feelings of reduced accountability in some employees which in turn, may lead to greater risk-taking. A firm’s ability to navigate this situation therefore will be crucial to ensuring a healthy culture and regulatory approval.

The FCA also rate a firm’s culture on its diversity and inclusion policies. They have called for action by regulated firms to foster a culture of inclusion, promote diversity, remove any potential barriers and embrace initiatives such as the black leaders mentoring programme. Additionally, the FCA has also asked firms to record and collect data regarding diversity and have undertaken a consultation on their proposals to make firms disclose annually how their board and executive management are meeting proposed diversity targets. This consultation, however, has come under scrutiny as it relies on firms implementing adequate measures for data capture, something which has so far proved to be difficult for many firms. Arguments have also been made that Firms looking to meet diversity targets through the use of positive action, will have to be careful in their approach as this is largely limited and not permitted under the Equality Act 2010.

Another core ESG focus for the FCA is each Firm’s environmental impact. They believe that investment managers have real power to influence the firms they invest in and raise environmental standards and will point towards the number of asset managers who have signed up to net-zero initiatives, currently 128, as a clear example of progress in this area. Criticisms have been made, however, that this pressure from regulators for ESG-Compliant products, combined with an absence of any clear market definition of what that constitutes, can lead to some firms, misrepresenting and packaging their products as sustainable when they are not, also known as ‘greenwashing’. The FCA would argue that they are taking steps to address this problem by introducing their new ESG Roadmap, which outlines enhanced disclosures for firms in line with recommendations from the Task Force for Climate-Related Financial Disclosures (TCFD). These enhanced requirements should make it more difficult for firms to engage in greenwashing, but there is a fear that the increased reporting could lead to unintentional greenwashing.

If you’d like to find out more click here to read out guide on how to build a robust ESG Program

Overall, firms and their management are needing to become proactive in fostering a healthy culture and will need to continue to make a concerted effort to promote inclusion and diversity going forwards. Firms will also have to become more aware of their environmental impacts and will need to engage in the FCA’s forthcoming disclosure requirements.

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