Investors failing to disclose ‘effectiveness’ in assessing systemic risks, UK audit watchdog reveals

Asset managers in the UK are failing to explain how they use stewardship to address systemic risks like climate change, according to the Financial Reporting Council (FRC). 

The regulator that warned that most signatories to its Stewardship Code failed to disclose their “effectiveness” in assessing such risks, and that the few that did so used “a general boilerplate statement”.  

The annual review of signatory reports, published today, concluded that current levels of disclosure are “not sufficient to satisfy the reporting expectation”. The FRC said it expects “all reports in 2022 to address this.”   

The UK’s Stewardship Code, developed in the wake of the 2008 financial crisis, is a set of voluntary principles that lay out expectations on how investors manage and engage with portfolio companies.  

It was updated in 2019 to include requirements on real world impacts, integration of climate factors into decision making and an annual signatory review process. Signatories are now also required to assess their “effectiveness in identifying and responding to market-wide and systemic risks to promote well-functioning markets”. 

The FRC highlighted systemic risks flagged by the International Corporate Governance Network in 2019, which include: Environmental risks, like climate change, water scarcity and pollution; Social risks, such as human rights, income inequality and populism; and Macroeconomic risks, including political, legal, and regulatory and fiscal instruments.  

“Investors and service providers should consider and reflect on the effectiveness of their internal processes in identifying risks, as well as their impact on the overall market in responding to these,” the FRC stated in the report. 

Although signatories were found to be poor at discussing their effectiveness at addressing systemic risks, they did better at explaining how their investments aligned with such risks. 

Today’s review also contained a guide to effective engagement, in which the regulator warns asset managers not to “overly rely on examples of general information-gathering or monitoring to demonstrate effective engagement.” When reporting on engagement efforts, investors “should distinguish between interaction that has clear objectives and seeks changes and activities that seek to gather information,” the FRC stated. 

The FRC added that asset managers must also get better at reporting on asset classes beyond listed equities, although it noted that there was “some strong reporting on fixed income in both sovereign and corporate debt.” Reporting on real estate, infrastructure and private equity “remained less developed by comparison,” it said.