The Financial Conduct Authority (FCA) issued a letter to benchmark administrators on the review of environmental, social, and governance (ESG) benchmarks. The review results show that the overall quality of ESG-related disclosures made by a sample of UK benchmark administrators was poor. The benchmark administrators did not provide sufficient detail and description of the ESG factors considered in their benchmark methodologies and some firms failed to fully implement the disclosure requirements introduced in the Low Carbon Benchmarks Regulation.
The letter sets out assessment of the risks observed, along with the below issues identified based on the preliminary review of ESG benchmarks across the value chain:
- Benchmark administrators failed to provide specific information on how key elements of the methodology reflect ESG factors for each benchmark or family of benchmarks, considering the underlying assets on which the benchmark is based. In some instances, benchmark methodologies did not clearly describe why certain ESG factors were applied.
- Administrators did not ensure that the underlying methodologies for ESG data and ratings products used in benchmarks are accessible, clearly presented, and explained to users. Without transparency of these underlying methodologies and clarity on how they are being applied to a benchmark, it may be difficult for users to interpret and compare outputs across administrators, potentially harming competition and end investors.
- Adminstrators did not fully implement the ESG disclosure requirements. Benchmark administrators failed to provide sufficient information on the data and standards used to calculate the weighted average scores for their ESG factors as defined under the Low Carbon Benchmarks Regulation. Several firms were not disclosing average weighted scores against all of the mandatory ESG factors detailed in Annex II of the same regulation.
- Benchmarks administrators failed to implement their ESG benchmark methodologies correctly. Benchmark administrators are required to list the ESG factors taken into account in their benchmark methodology and state whether these are being used for selection, weighting or exclusion. Benchmark administrators must provide information on the data and standards used, describe how data is verified and the quality of data is ensured, and describe any international standards used in the benchmark methodology.
FCA expects all benchmark administrators to ensure that they have appropriate strategies to address the issues identified in this letter and are prepared to explain these strategies on request. FCA expects benchmark administrators to have sufficient systems and controls in place to ensure they comply with the requirements of Article 12 of the UK Benchmarks Regulation on an ongoing basis. This means that administrators are expected to ensure that all these requirements are met each time the methodology is implemented, and the benchmark is determined. Going forward, FCA will work closely with the Government to consult on whether and how to extend the FCA's perimeter to include ESG ratings providers as well as provide support for the development of a voluntary Code of Conduct for ESG data and ratings providers.
Keywords: Europe, UK, Banking, ESG, Benchmarks Regulation, ESG Benchmarks, Disclosures, ESG Ratings, BMR, Low Carbon Benchmarks, FCA
Hasan leads Moody’s Analytics ESG methodology development. He is expert on carbon transition, nature related risks and is a guest lecturer at ESSEC Business school on sustainable finance.
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