ESG: FCA opens discussion on governance, incentives and competence

On 10 February 2023, the FCA published DP23/1, “Finance for positive sustainable change: governance, incentives and competence in regulated firms” (the DP).

Responses to the DP should be submitted by 10 May 2023.

The FCA will then consider feedback received when deciding what direction its future regulatory approach should take. This assessment will include consideration of proportionality and whether differentiation between firms on the basis of size (or some other characteristic) would be necessary when it decides on future action.

Why has the FCA published the DP?

The DP forms part of the FCA’s commitment, made in its strategy for positive change (November 2021), that it would engage with stakeholders on ESG governance, remuneration, incentives and training/certification in regulated firms. For our overview of the strategy paper, see here.

Its purpose is, in the words of the FCA, to open “an industry-wide dialogue on firms’ sustainability-related governance, incentives, and competence”.

In a field where the is no shortage of different initiatives being undertaken, the FCA is looking to “help narrow this field and help with highlighting good, evolving practices if finance is to deliver on its potential to drive positive sustainable change”.

What does the DP contain?

Key takeaways

The FCA makes several comments by which it frames its discussion:

• financial services firms have an important role to play in contributing to the transition to a net zero economy and a more sustainable long-term future
• in a changing world, they must continue to adapt their objectives, priorities, business models and strategies
• good governance and business culture are critical to such firms being able to deliver value to clients and supporting market integrity. Governance arrangements, incentives structures and capabilities must keep pace with the recently increased focus on sustainability.

It then sets out the areas in which, in particular, it is seeking industry feedback. Among other issues, the DP:

• invites views as to whether additional regulatory measures should be introduced to encourage effective stewardship at asset managers
• asks for feedback on how the collective stewardship efforts of asset owners and asset managers can be best directed "towards the most pressing systemic issues"
• considers whether there are any regulatory barriers to encouraging effective stewardship which could be removed
• notes that conflict policies are often generic and do not specifically consider issues as they relate to stewardship
• introduces the term “competence washing” – ie, claiming ESG related expertise without being able to substantiate the claims
• seeks views on the introduction of additional training and competence expectations within its existing rules or guidance
• explores whether there is a need to introduce additional regulation to extend individual responsibility for sustainability-related matters for senior management and whether to set specific expectations around the roles and responsibilities of governing bodies, such as fund boards and
• examines metrics and weights for linking remuneration to sustainability goals and what adjustments should be made when targets are not met.

Structure of the DP
As is usual with discussion papers, the DP contains no formal proposals. It is divided into two parts:

• the first part includes sections which look at:
• how governance, incentives and competence are considered in the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) and how expectations in these areas are evolving with the work of the International Sustainability Standards Board (ISSB), the UK’s Transition Plan Taskforce (TPT) and the Glasgow Financial Alliance for Net Zero (GFANZ) (Chapter 2)
• firms’ sustainability-related objectives and strategies, and how these are supported by governance and incentive arrangements (Chapter 3). This chapter also considers how asset managers organise and govern their stewardship activities to influence positive change.
• firms’ training and competence (Chapter 4), including the possible introduction of additional training and competence expectations within its existing rules or guidance.
• the second part of the DP contains a series of ten articles which the FCA has commissioned from a variety of industry experts – these look at firms’ arrangements in the areas of sustainability-related governance, incentives, competence and stewardship.

Next steps

The consultation period under DP 23/1 closes on 10 May 2023.

The FCA will then consider feedback received when deciding what direction its future regulatory approach should take.

This assessment will include consideration of proportionality and whether differentiation between firms on the basis of size (or some other characteristic) would be necessary when it decides on future action.

In parallel, the FCA will consider firms’ arrangements in many of the areas that the DP raises as part of its supervisory engagement with firms. It notes that, for instance, the issue of governance of ESG and stewardship is “a prominent theme in our recent letter to CEOs on our asset management supervision strategy”. For our summary of the FCA’s letter, see here.