UK: FCA's ESG Sourcebook and the mandatory TCFD disclosure rules for asset managers and asset owners

The UK’s ambition to make TCFD reporting mandatory for corporates and the financial sector by 2025 is underway.

First up was reporting by premium listed issuers, introduced last year. Then on 1 January this year, the rules for (a) standard listed issuers and (b) large UK asset managers and asset owners were implemented (with the first annual report due by 30 June 2023 (based on this year’s data)). The rules for the rest of the asset managers and asset owners, other than those excluded under a de minimus £5bn AUM threshold, will be implemented on 1 January 2023, with first reports due the following year.

This note addresses the obligations faced by asset managers and asset owners who will be expected to annually report on TCFD compliance at both an entity and at a product level.

Introduction to the new rules for asset managers and asset owners

Following its June 2021 consultation paper, the FCA published a policy statement at the end of December, just in time for the implementation of the new rules.

These final rules are now included in the ESG sourcebook, which is a new section of the FCA Handbook, as well as a handful of amendments to the Collective Investment Scheme sourcebook. The ESG sourcebook is expected to expand over time to include rules and guidance beyond TCFD and climate topics.

Key takeways:

• Entity and product level reporting. The product level reporting requirements were a new development that had not been previously suggested in the government’s TCFD roadmap, and follow similar metrics to the climate principal adverse indicators in SFDR - although unhelpfully, the FCA’s proposed calculation methodologies differ in some regard such that firms will need to prepare separate SFDR and FCA product level disclosures;
• Senior management responsibility. The entity level report must include a compliance statement, signed by a member of senior management (who does not need to be an SMCR Senior Manager), confirming the disclosures made including any cross referenced from third parties or group entities;
• Data gaps. The FCA will not require firms to disclose information (e.g., in relation to metrics or quantitative scenario analysis or examples) if data gaps or methodological challenges cannot be addressed through use of proxies and assumptions, or if to do so would result in disclosures that are misleading. But firms are required to explain where and why they have not been able to disclose, as well as the steps they will take to improve the completeness and the quality of disclosure. FCA expects data gaps to reduce over time data availability increases.
• Data in respect of currencies and derivatives. FCA acknowledges data challenges in respect of certain asset classes and does not (initially) expect marketing materials relating to such asset classes to contain quantitative climate-related data. However, as is generally its approach to data gaps, the FCA does expect this situation to be resolved over the longer term.
• Core and additional metrics. Given the FCA’s policy approach is to remain consistent with the TCFD framework, it is only mandating disclosure of core metrics using TCFD methodologies ‘as far as reasonably practicable’, a lower standard that the originally proposed “best efforts” basis.
• Scenario analysis. FCA regards scenario analysis as an important analytical tool. FCA requires firms to disclose their approach to scenario analysis and how it is used in decision-making at entity level. This disclosure is to be accompanied by quantitative examples only ‘where reasonably practicable’ (acknowledging concerns around the ability to provide these at present given lack of data). Scenario analysis at product level is also required. Limitations on the ability to disclose must be disclosed, with an explanation of the steps being taken to address those limitations. The approach to scenario analysis is to be kept under review, with the expectation implicit that the challenges around it will lessen over time.
• Cross-referencing to delegated managers’ reports. Such cross-referencing is permitted, provided to do so does not conflict with the requirements of any other relevant jurisdiction, or prevent the client from easily accessing and understanding the disclosure being made (the example given is where the cross-referenced disclosure is behind a paywall). Cross-referencing other disclosures is likely to be of most use in the entity level disclosures; the ability to cross-reference in coming to product level calculations is less likely.
• Transition plans. Heralded for the UK at the end of COP26, disclosure of transition plans is now expected by these rules on a “reasonable steps” basis (ESG 2.1.6R, which leads to the TCFD’s “all sector guidance”. The FCA has provided guidance which reiterates the recommendation made in the TCFD guidance, that where a firm is based in a jurisdiction which has made a net zero commitment, such as the UK, that firm is encouraged to assess the extent to which it has considered that commitment in developing and disclosing its transition plan. A UK Government taskforce will undertake undertake further work on transition plans and we expect guidance at the end of this year.

Entity Scope 

The rules apply to all FCA regulated managers (including firms with portfolio management permissions, full-scope UK AIFMs, small UK AIFMs and UK UCITS ManCos) and asset owners (life insurers and FCA regulated pension providers such as platform firms and SIPP operators providing a ready-made selection of investments) unless they fall below the £5 billion threshold noted below. Additionally, the FCA has expanded its definition of “portfolio management” for the ESG sourcebook to include the activities of UK private equity firms that advise group entities / clients to invest in unlisted securities on an ongoing basis.

The rules do not apply to:

• FCA regulated asset managers and asset owners that have less than £5 billion in assets under management or administration (calculated on a 3-year rolling average basis); and
• Overseas firms accessing the UK under the temporary permissions regime (TPR).

The FCA estimates that the new rules cover 98% of assets under management in both the UK asset management market and held by UK asset owners, representing £12.1 trillion in assets managed in the UK.

Entity level disclosure obligations

In-scope firms must annually publish an entity level TCFD report on how they take climate-related risks and opportunities into account in managing or administering investments on behalf of clients and consumers. These disclosures must be published in a prominent place on the firm’s main website and cover all assets managed by the UK firm (including those that have been delegated to third-party managers – see below). The contents of the report must be consistent with the TCFD’s recommendations with disclosures required on (i) governance regarding climate risk and opportunities; (ii) strategy (including scenario analysis) regarding the same; (iii) risk management of climate risks; and (iv) metrics and targets used to assess and manage climate risks and opportunities. Additionally, firms that have set a climate-related target must provide detailed disclosures on their target, KPIs and how the measure progress. Whereas firms that haven't set such a target will be expected to explain why not.

As noted above, the FCA requires that the entity level report include a statement signed by a member of the firm’s senior management, confirming that all the disclosures (including any of those cross-referenced from other group or third party entities) comply with the FCA’s disclosure requirements.

Product level disclosure obligations 

In-scope firms must produce an annual report for each in-scope product (see below), with portfolio level disclosure on each of the following mandatory metrics:

• Scope 1 and 2 greenhouse gas (GHG) emissions
• Scope 3 GHG emissions (disclosure for Scope 3 is delayed until 30 June 2024)
• Total carbon emissions
• Carbon footprint
• Weighted average carbon intensity (WACI)

Firms are also expected to supplement these mandatory metrics with the following additional metrics on a ‘best efforts’ basis:

• Climate Value-at-Risk (VaR)
• Metrics that show the climate warming scenario with which a product or portfolio is aligned (e.g. implied temperature rise)
• Other metrics - firms should provide other metrics that they consider would be helpful for investor decision-making by referring to refer to the list of recommended metrics in the CFRF disclosure guide.

Some of these metrics are very similar to the climate PAIs set out in the EU SFDR RTS – however, as the FCA has noted, the calculation methodologies differ in some cases and the FCA then expects firms to report under both regimes. Additionally, any material deviations at a product level from the entity level approach towards governance, strategy and risk management (which would be covered in the entity level reports) must also be disclosed in these product level reports.

In terms of publication, firms will either need to make the product level report:

• public on the firm’s website – this is required for UK authorised or UK / overseas listed funds, with-profits / insurance linked funds and pre-set investment portfolios; or
• available to clients ‘on demand’, where clients need them for their own climate related financial disclosure obligations under any applicable laws – this will be the case for bespoke separate accounts as well as funds that are not listed / UK authorised. The ‘on demand’ obligation requires firms to provide a report to clients at a single reference point consistent with public disclosures, or at a date agreed between the client and the firm, and in a ‘reasonable’ format. The FCA reiterates that its rule on the provision of additional underlying climate-related data to clients is limited to where reasonably practicable and permitted under licensing arrangements.

In addition, all in-scope firms will be required to provide data on the underlying holdings of their products ‘on demand’ to clients that request it to satisfy their own climate-related financial reporting obligations. The ‘on demand’ option is potentially more helpful than similar SFDR rules on website product disclosures, as it rightly acknowledges that for certain products (such as bespoke separate accounts) public disclosures will be inappropriate.

Group level disclosures and delegations?

In-scope firms will be able to rely on group wide TCFD disclosures, provided they adequately cover the assets managed or administered by the firm. Additionally, any material deviations at the in-scope entity level from the group approach must be clearly explained (in either the TCFD entity report or group report).

The FCA has confirmed that (i) delegated mandates of asset managers; and (ii) external manager appointments by asset owners, are in scope of the firm’s entity and product level TCFD reports. However, firms will be able to cross-refer to TCFD reports published by their delegates / external managers, provided they disclose their rationale for relying on the delegate / external manager’s disclosure. In addition, delegating firms must also explain their reasons for selecting the delegate / external manager, where relevant to the TCFD’s recommendations (e.g. how climate-related matters have been taken into account in selecting delegates / external managers) and any material deviations between the delegate / external manager’s approach and the firm’s approach must be identified and explained. The approach raises some interesting questions and practical challenges – noting also that ultimately the delegating asset manager / owner’s TCFD report would need to be confirmed as compliant by senior management in an accompanying signed statement.