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March 21, 2023

UK financial regulator demands improvements on ESG benchmarks

Financial Conduct Authority head office and logo.
The FCA says a number of benchmarks have been miscalculated by administrators after some ESG factors had been applied incorrectly. (Photo: Toby Melville:Reuters)

The FCA has told benchmark administrators that they are failing to correctly implement ESG benchmarks’ methodologies.

The Financial Conduct Authority has written to ESG benchmark administrators about the lack of detail on the environmental, social and governance factors used in their methodologies, and warned about intervention should the situation not improve.

It follows a letter sent in September 2022 to administrators that set out its concerns over lack of sufficient disclosures. “We believe that the subjective nature of ESG factors, and how ESG data and ratings are incorporated into benchmark methodologies, give rise to an increased risk of poor disclosures in ESG benchmark statements,” it said at the time, warning that this could affect the transition to a net zero economy.

After reviewing the quality of disclosures made by a sample of UK administrators, the FCA has now written: “In general, this was poor”.

“There were often instances where benchmark administrators did not provide sufficient detail and description of the ESG factors considered in their benchmark methodologies,” wrote FCA director of infrastructure and exchanges Jon Relleen in the letter.

Within their benchmark statements, all administrators within the sample failed to set out adequate explanations on how ESG factors were reflected against requirements set out in the UK Benchmarks Regulation. None referred to ESG factors when explaining the rationale for adopting their benchmarks’ methodology.

Some administrators had not fully implemented disclosure requirements set out by the Low Carbon Benchmarks Regulation, which originated from EU regulation. Most disclosures left out key details set out by templates for the regulations.

“All benchmark administrators in our sample failed to provide sufficient information on the data and standards used to calculate the weighted average scores for their ESG factors,” the FCA said. “Descriptions of the data sources and the extent to which they are estimated or reported were particularly poor.”

“We will be doing more work in this area to address the potential failings, and expect firms to be able to explain these strategies on request,” said the regulator. “We will use the full range of our tools where this does not happen.” 

Regulating ESG

There is growing momentum behind improving the quality of ESG benchmarks. Last year, the European Securities and Markets Authority backed creating an EU ESG benchmark, adding that this would need to align with the green taxonomy and the Sustainable Finance Disclosures Regulation.

The FCA, meanwhile, closed its consultation on its Sustainability Disclosure Requirements and sustainable investment labels in January.

In its latest communication, the UK regulator repeated its support for regulating ESG ratings, noting that the government is expected to consult soon on whether and how to include ESG ratings providers within the FCA’s regulatory perimeter.

It also noted that a number of benchmarks had been miscalculated after ESG factors were applied incorrectly, with administrators having measured their constituents against outdated ratings. 

“We observed that some administrators did not have adequate controls in place to verify that ESG factors had been correctly applied in their ESG benchmarks,” said the letter.

The FCA found that administrators were failing to make sure that the methodologies for ESG data and ratings products used in benchmarks were “accessible, clearly presented and explained to users”. 

One cryptocurrency index provider told Sustainable Views that it does not provide ESG benchmarks altogether, partly because “some of the shortcomings that the FCA highlighted are very difficult to surmount” in order to “ensure the provision of a high-quality benchmark to users and investors”.

“In my experience and evaluating benchmarks offered by other providers, obtaining consistent and timely ESG data is very challenging,” CF Benchmarks chief executive Sui Chung said. 


A service from the Financial Times