UK's FCA signals sustainability regulation reform

The regulator has published a new discussion paper to explore the direction of its future regulatory approach to ensure finance is driving positive sustainable change. It focuses on financial service firms’ governance arrangements, incentives structures and capabilities, and how these arrangements can keep pace with the fast-evolving business imperative for the financial sector to contribute to a low carbon, more sustainable economy.

The paper is the latest of a series of endeavours by the FCA to bolster sustainability across the financial sector, following the publication of its strategy for positive change and environmental, social and governance (ESG) priorities in 2021, a consultation on sustainability disclosure requirements in 2022, and a recent open letter to asset managers (6-page / 174KB PDF) that emphasised ESG and sustainable investing as an important part of its new supervisory strategy.

The FCA said in the discussion paper that the focus on sustainability has widened, going beyond climate change to include other topics such as human rights, diversity and inclusion, nature and biodiversity. “There is increased scrutiny from investors and a demand for wider sustainability-related measures to be considered,” said the regulator.

In addition, the FCA pointed out that it is considering moving beyond disclosure-based initiatives and introducing frameworks that facilitate firms to adapt their governance, incentives and competencies to “better equip them to play their part in embedding and accelerating the transition”.

Sustainability expert Hayden Morgan of Pinsent Masons said that although these emerging sustainability and ESG challenges can seem like an a unwelcome administrative burden or cost, responding to these challenges could present the “growth opportunity of the 21st century”, as demonstrated by the recent UK ‘net zero’ review published by Chris Skidmore.

“To thrive in this changing landscape, firms have no option but to engage on sustainability matters.  Firms will need to evolve and adapt business models and strategies to respond to these shifting market forces, at a pace and scale previously not experienced,” said Morgan.

He urged firms and investors alike to respond and engage actively with the regulator on the issues and questions highlighted for the current consultation, as it offers “an opportunity to help shape the future of sustainability regulation”.

“Given the FCA is to consider the case for further regulatory measures in this area, this opportunity allows for stakeholders to express support, concerns and opportunities for harmonisation and consolidation,” he said.

While agreeing that the financial sector and the FCA has a crucial role in supporting the UK’s transition to a more sustainable long-term future, Morgan also addressed the importance of having a robust regulation on sustainability matters to support firms in navigating a sea of changes.

“The FCA’s role is absolutely crucial in ensuring the highest standards of governance are upheld to support the flow of capital required to meet economy-wide sustainability goals, including a net zero economy by 2050,” said Morgan.

“However, in a fast evolving and dynamic landscape, firms are faced with a growing and confusing ‘alphabet soup’ of sustainability-related acronyms related to various initiatives. Furthermore, they are encountering a growing wave of regulation emerging across many jurisdictions which, whilst not directly conflicting, are not currently harmonised or cohesive. Whilst there is ongoing work to resolve these aspects, there is a clear need for robust financial regulation of sustainability matters, which both facilitates the long-term global transition and supports firms in navigating these uncharted territories,” he added.

According to Morgan, the FCA is particularly interested in feedback on four main areas. Firstly, it wants to find out whether firms have environmental or social objectives and how these are reflected in their policies and strategies. Secondly, the regulator seeks information on how firms design their approaches to governance, remuneration, incentives, training and competence, to deliver effectively on these objectives. The third part relates to practical challenges, and observed gaps and shortcomings in firms’ current systems. The last part asks firms whether existing rules and guidance in these areas are appropriate, or need to be refined to adapt to the changing role of finance. The discussion period will end on 10 May 2023.