UK: FCA Portfolio Letter: where are improvements needed in ESG Benchmarks?

The FCA has published a further letter to benchmark administrators setting out their expectations in the context of ESG benchmarks.

In September 2022, the FCA sent a portfolio letter to benchmark administrators outlining its supervisory priorities and view of the risks of the sector – one of the FCA’s observations was that the subjective nature of ESG factors and how ESG data and ratings are incorporated into benchmark methodologies could increase the risk of poor disclosures, and the FCA highlighted its concern that the quality of benchmarks may not align with the expectations of users and end investors. 

Since publishing that portfolio letter, the FCA has completed its preliminary review on ESG Benchmarks  and in its March 2023 letter, the FCA has found that the overall quality of ESG-related disclosures has been poor.

The issues identified in the letter include:

• Insufficient explanations in benchmark statements on how ESG factors are reflected against each of the requirements referred to in paragraph 2 of Article 27 of the UK BMR.
• Not enough detail in benchmark methodologies. For example, there was little explanation on the ESG factors used in benchmarks and the thresholds benchmark administrators choose to apply when measuring these (with the risk that this could lead to or contribute towards greenwashing).
• Not ensuring that the underlying methodologies for ESG data and ratings products used in benchmarks are accessible, clearly presented and explained to users.
• Not fully implementing ESG disclosure requirements (tis included simply omitting vital information contained in the disclosure template).
• Benchmark administrators failing to implement their ESG benchmarks’ methodologies correctly – for example, using outdated data and ratings or failing to apply ESG exclusion criteria when rebalancing, or having inadequate systems and controls in place to verify that ESG factors had been correctly applied in ESG benchmarks.

Next Steps

The FCA expects recipients, their senior leadership, and their Boards to carefully consider the messages the FCA have set out as applicable to their business, and ensure that appropriate strategies are in place to address them (and be prepared to explain these strategies at the FCA’s request).

Where firms fail to consider the FCA’s feedback, the FCA commits to deploying its formal supervisory tools and, where appropriate, will consider enforcement action.

Given the importance of ESG benchmarks and the FCA’s initial supervisory findings, the FCA confirms it will be doing more work in this area across the portfolio and will holistically consider the risks of harm related to ESG benchmarks across the value chain.

The FCA press release is available here.