As the old saying goes, you wait ages for a bus and then two come along at once. No sooner has the industry implemented (or ‘substantively’ implemented) the Consumer Duty, arguably one of the largest pieces of regulatory change for 20 years, then another seismic piece of regulatory change raises its head. I’m referring of course to the FCA’s Environmental, Social and Governance (ESG) strategy, which affects most sectors within financial services, but its impact will be particularly acute for the Asset Management and Wealth sector.
Financial services has a crucial role in supporting the economy adapt to a more sustainable long-term future, and the resulting changes required of firms to ensure good customer outcomes in a sustainable environment are considerable. Whilst the Consumer Duty and ESG have distinct elements, they also have significant synergies, lessons, and read across. Most importantly, they focus our attention, whether we are manufacturers or distributors of products, on meeting the needs and preferences of the end customer. We suggest that firms leverage actions and lessons from their Consumer Duty implementation programme, as they develop and implement their ESG programme.
Introduction to ESG
After much consultation, the ESG agenda is finding its way into new rules to provide common standards around clarity of investment labels so consumers know what they are buying.
Those firms with over £50bn AUM (£25bn for asset owners) were the first to undergo the Task Force on Climate-related Financial Disclosures (TCFD) reporting regime, with reports required to be published by 30th June 2023. Firms with less than £50bn but over £5bn AUM are second, and are required to publish their TCFD reports by 30th June 2024. In addition to this, the FCA’s recent Policy Statement PS23/16: Sustainability Disclosure Requirements (SDR) and investment labels, was published on the 28th November 2023, requiring the same firms to implement; an anti-greenwashing rule, sustainability related product labels, and some amendments to specific naming and marketing requirements.
It is clear that, as a regulator with a consumer protection mandate, emphasising trust and transparency between firms and consumers is vital. It was a key driver behind the Consumer Duty, and it is also a key driver behind the SDR and investment labels regime. Financial products that are marketed as sustainable in some way need to deliver what they claim, and firms must have the evidence to back up those claims.
A package of measures
The ESG agenda includes a package of measures, and the proposed rules within the Policy Statement is a crucial cornerstone of the FCA’s ESG strategy.
The Policy Statement clearly outlines the FCA’s view on the relationship between good consumer outcomes and enabling consumers to make informed decisions about sustainable investing – 81% of whom would like the way their money is invested to do some good as well as provide a financial return.
With the consumer at the forefront of our minds, here are some key parallels between the Consumer Duty and ESG.
- Higher standards – As with the Consumer Duty, there are explicit references to cross cutting rules which set out how firms must act (proactively and reactively) to deliver good outcomes for customers. This means firms must:
- Act in good faith to deliver sustainability-related products and services, taking into account the expectations of retail customers.
- Avoid causing foreseeable harm, including harm caused through greenwashing, or a lack of consumer understanding; and
- Enable and support retail customers to pursue their financial objectives, including where customers have sustainability-related needs and preferences.
- Higher standards – As with the Consumer Duty, there are explicit references to cross cutting rules which set out how firms must act (proactively and reactively) to deliver good outcomes for customers. This means firms must:
- Governance, MI and reporting – Governance will play a critical role in shaping the success of any ESG programme. The recent report from The Sustainability Board in its 2023 Annual ESG Preparedness Report highlighted that, despite previous progress, there’s been a stagnation in Director involvement in ESG issues. It is imperative that Boards and Senior Management are upskilled to ensure effective oversight of their ESG obligations and also establish appropriate reporting and assurance activity to ensure the ‘higher standards’ are being delivered.
- People – Relevant staff will need to enhance their skills and competency so that they understand the firm’s ESG strategy and can explain a product’s ESG credentials. Remuneration structures will need to be reviewed to ensure they don’t create any conflicts or bias across the distribution of different products.
- Ensuring consumers are informed with information they can rely on – It is vital that distributors understand the ESG profile of products so that they can relay information and disclosures effectively, educating the end customer and supporting their understanding. Recent ESG work from the FCA highlighted product inconsistencies and confusing language in firms. Firms will need to be content that any disclosures made are accurate.
What firms need to do now?
We learnt from Consumer Duty that the time needed to implement large scale regulatory change is often underestimated, and the strain on BAU is significant, so delay is not recommended. A comprehensive programme of activity is required, inclusive of robust governance and programme management disciplines.
Below we outline twelve critical steps to effectively develop and deliver your programme:
Final thoughts
Whilst we have all known ESG regulations would be broadening, the FCA has clearly indicated there is more work to be done. In particular, as with Consumer Duty, we all need to think hard about consumer outcomes. We believe that firms can leverage their work and the mindset shift created under Consumer Duty, and in a similar vein, ESG adoption should be thought of an evolution rather than a revolution of business practices. It is another step in the direction towards the future shape of financial services that the UK government and regulators are striving towards. The regulator expects to see a material culture shift towards a focus on the consumer through the implementation of both the Consumer Duty and ESG rules.
Engraining ESG into your business practices means that good customer outcomes will support good sustainability outcomes. Whilst the proposed implementation timeline for the SDR should be manageable, it requires critical changes to be embedded within firms, with some key challenges expected. This will be a material change to firm business models, so focus will be a key to success.
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