FCA blasts ‘poor‘ disclosures by ESG benchmark administrators, calls for improvement

Some administrators are miscalculating benchmarks due to outdated ESG ratings or failing to apply exclusion criteria in calculations, said the UK regulator.

The Financial Conduct Authority (FCA) has condemned ESG-related disclosures by benchmark administrators as “poor” and called on firms to address a series of issues identified in a review.

In September last year, the FCA sent a letter to benchmark administrators highlighting the risk of poor disclosures. Having now completed a preliminary review of a sample of administrators, it said that overall quality of ESG-related disclosures was poor and that its initial findings “indicate the potential for widespread failings”.

In a ‘Dear CEO’ letter, the FCA highlighted a series of issues it had found. It said that it had become aware of “several” instances where benchmarks had been miscalculated due to administrators using outdated ESG ratings or failing to apply exclusion criteria when rebalancing.

Some administrators also did not have adequate controls in place to ensure that ESG factors had been correctly applied, the FCA said.

The regulator identified a swathe of other issues with benchmark constructions and disclosures on ESG topics. It complained of a lack of detail in some benchmark methodologies, with little explanation on ESG factors and thresholds used when applying them.

The letter explicitly identified the area of methodologies as one that “can contribute towards or lead to greenwashing”, especially in cases where purported ESG benchmarks apply ESG factors in such a way that “the constituents are not materially different to a similar non-ESG benchmark”.

Also of concern were some instances where methodologies did not clearly describe why ESG factors were applied, such as a climate-focused benchmark which uses broader ESG metrics.

The letter said that the FCA will be doing more work in this area, which Responsible Investor understands will include a review of adherence to minimum requirements for Climate Transition and Paris-Aligned Benchmarks.

Recipients were told that the FCA expected them to ensure that they have strategies to address the issues identified and should be prepared to explain them at the FCA’s request. It also warned that the regulator will deploy “formal supervisory tools” and consider enforcement action where appropriate should firms fail to consider its feedback.

Other concerns raised included administrators not ensuring that underlying methodologies for ESG ratings and data were accessible, clearly presented and explained to users, and not fully implementing other ESG-related disclosure requirements under the UK Benchmark Regulation and Low Carbon Benchmarks Regulation.

Jon Relleen, the regulator’s director of infrastructure and exchanges, said that the FCA expected firms to take action to address the issues identified. These failures, he continued “could mislead consumers and erode trust in ESG products”.

The FCA has previously said it supports regulation of ESG ratings, and said today that the government will shortly be consulting on whether and how to extend its regulatory sphere to include providers. It also reiterated its support for a separate voluntary code of conduct.