In our previous client alert, Back to Work: The FCA's 2022-23 Priorities for Private Fund Managers, we mentioned the need for FCA-authorised private fund managers with assets under management (AuM) of over £5 billion and who are subject to the FCA rules and guidance contained in the FCA’s Environmental, Social, and Governance Sourcebook (ESG Rules set out in PS21/24), to be in a position to comply from 1 January 2023.
The output which compliance is designed to achieve are climate-related disclosures under the ESG Rules, which managers will have to make by 30 June 2024.
For large managers, with AuM of over £50 billion (and asset owners with £25 billion or more assets under management or administration in relation to their in-scope business), to whom the ESG Rules already apply, having come into force on 1 January 2022, the disclosure deadline is 30 June 2023.
The FCA reiterated its focus on ESG for asset managers in its recent Dear CEO Letter (as also discussed in our alert), in which it notes that it expects those within the scope of the ESG Rules to consider the steps they need to take to make the disclosures from 2023/24. In addition, ESG themes feature in the FCA’s Authorised ESG & Sustainable Investment Funds: improving quality and clarity letter from July 2021, in particular that managers offering ESG funds and investments should expect to be subject to review to ensure marketing materials accurately describe their product, with funds offering clear and consistent disclosure.
In this alert, we consider the impact of the ESG Rules on private fund managers. Once fully implemented, these rules will apply to 140 asset management and 34 asset owner firms, representing £12.1 trillion in AuM and administered in the U.K. and capturing 98% of both the U.K. asset management market and held by U.K. asset owners. We conclude with some overview action points.
WHO IS WITHIN SCOPE OF THE ESG RULES?
The ESG Rules apply to full-scope U.K. AIFMs and authorised small U.K. AIFMs, and those managers that undertake portfolio management, defined to include:
- Managing investments
- Private equity or other private market activities consisting of either advising on investments or managing investments on a recurring or ongoing basis in connection with an arrangement of which the predominant purpose is investment in unlisted securities
The obligations will, therefore, bite on those FCA-authorised firms that advise on private equity investments and not only on those that manage such investments.
WHAT HAS TO BE DISCLOSED?
The U.K. government has chosen to align the disclosure requirements with the principles set out in the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD). Broadly, the ESG Rules impose the disclosure requirements below:
- A TCFD entity report, in which a firm provides or explains how as an entity it takes climate-related risks and opportunities into account regarding the overall assets managed on the behalf of clients.
A firm should refer to any material differences in its approach to the TCFD governance, strategy, or risk management pillars for specific investment strategies, asset classes, or products (or this can be cross-referenced in the relevant TCFD product report). A firm is also required to disclose (as part of its TCFD strategy disclosures) its transition plans. TCFD entity reports must be signed off by a member of senior management confirming disclosures comply with the ESG Rules.
- A TCFD product report, in which a firm provides a core set of TCFD-aligned metrics (on greenhouse gas emissions, carbon emissions, carbon footprint, and weighted average carbon intensity) that it supplements with additional metrics as far as reasonably practicable.
For the first year of reporting, metrics are to be contextualized (including explaining how the metrics should be interpreted and their associated limitations, e.g. any particular assumptions or proxies used — see below for more on this) and from then on, historical annual calculations of core metrics provided.
WHERE DO THE DISCLOSURES GO AND WHAT’S THE TIMING?
Both sets of TCFD reports are to be published annually in a prominent place on a firm’s website. However, for U.K. AIFMs of unauthorised and unlisted AIFs (as well as bespoke account managers, portfolio managers, and investment advisers within scope), the TCFD product report is not public and needs only to be made available annually on request where a client needs the product level information for its (or its clients’) own climate-related financial disclosure obligations. In this case, the reports are to be provided at a single reference point consistent with public disclosures, or at a date agreed between client and firm, and in a ‘reasonable’ format (noting that an industry template may follow) from 1 July 2023/24. Whilst allowing managers to streamline their client TCFD product reporting, it does not of course reduce any product level disclosures they have to produce (pre-contractual, website, and annually), for instance under EU sustainable finance legislation.
WHAT ABOUT DATA GAPS?
To reflect industry concern around data availability, consistency, and reliability (for example, how to compare disclosures when calculation methodologies vary between metrics), the ESG Rules allow firms to use proxy data or assumptions that are backed up with adequate explanations and methodologies. The FCA expects underlying data gaps and methodological challenges to be transitional and only apply to certain asset classes (e.g. asset backed securities and currencies).
WHAT ABOUT RELIANCE ON GROUP LEVEL DISCLOSURES AND DELEGATE REPORTS?
Firms can cross-refer to relevant disclosures in another report (e.g. on a group or consolidated basis, by a delegated manager, or under a TCFD-aligned listing rule) if the rationale is stated, any disclosures and hyperlinks are clearly signposted, and any material deviations explained. Delegating firms must also explain in their TCFD entity reports the reason for selecting a delegate, including how climate-related matters have been taken into account in selection and service/product reliance.
WHAT STEPS DO MANAGERS HAVE TO TAKE?
To ensure that they are in a position to make the disclosures that the ESG Rules require, managers should, therefore:
- Engage proactively with the ESG Rules and start to consider, identify, and gather necessary data and metrics and prepare the required disclosures
- Note that the disclosures under the ESG Rules may be different from other disclosure requirements they are subject to, whether under EU sustainable finance regulation or U.K. listing rules or other corporate requirements
WHAT ABOUT FUTURE DEVELOPMENTS?
Managers also need to monitor future developments as the ESG Rules are likely to expand over time to encompass broader sustainability themes and rules (beyond climate). Initially, we would expect this expansion to encompass the outcomes of a pending FCA consultation on Sustainability Disclosure Requirements (SDR) and product labelling, noted in DP21/4, as well as the U.K. Green Taxonomy (which is being developed).
Chris OrmondKnowledge Management Counsel
Ajay PathakPartnerCo-Chair, London Office