FCA publishes new Discussion Paper in a bid to promote financial sustainability in firms

In a nutshell

The Financial Conduct Authority (FCA) has published their Discussion Paper 23/1 on firms' sustainability-related governance, incentives and competencies (the "paper"). The paper has a number of articles from experts and commentators appended, to which the FCA makes reference throughout.

The paper does not make any concrete proposals in terms of new regulatory rules, but it does refer to expectations from a variety of currently applicable and upcoming sources (such as TCFD disclosures, TPT draft Transition Plan recommendations, SDR, the FRC Corporate Governance Code, Consumer Duty, MiFIDPRU, UK Stewardship Code, etc) and poses a number of questions for debate.

The key purpose for the paper is, as part of the government's wider commitment to a net zero economy by 2050, to:

• encourage an industry-wide dialogue on how to best integrate sustainability in governance, remuneration, training and investor stewardship frameworks; and
• encourage firms to reflect on the matters discussed in the paper and, where appropriate, incorporate them as they review and refine their current approaches to governance, remuneration, incentives and training.

Much of the regulatory and firms' policies' focus so far has been on climate-related matters. This paper reminds firms to consider and take action on the whole range of sustainability topics, such as human rights, diversity and inclusion, nature and biodiversity. By seeking views on how firms should develop their arrangements for governance, incentives and competence in sustainability, the paper also signals the FCA's readiness to move beyond disclosure-based initiatives.

Responses to the paper are requested by 10 May 2023.

In a bit more detail:

Strategy and Culture

• The paper highlights the importance having a well-articulated and credible sustainability-related strategy:

"Where a firm has made public sustainability-related commitments, it is reasonable to expect that it will develop and articulate a credible strategy to deliver on those commitments. A credible strategy would typically include a suitable timeframe and milestones, detail the interaction with other parts of the business plan, identify roles, responsibilities and accountability, and link with incentive structures – potentially including remuneration."

• In terms of culture, familiar themes (e.g. from DP18/2 and DP20/1) emerge but now with a sustainability-related perspective:

• • senior leaders leading by example;
  • the importance of middle management and frontline staff taking ownership of their roles;
  • an environment that encourages a safe speak-up culture;
  • individual purposes of employees who have a meaningful connection and sense of fulfilment to their work;
  • disclosure and improvement of D&I practices; etc.

The paper seeks feedback on whether additional guidance on regulatory expectations in respect of sustainability and culture (beyond the Consumer Duty and the ongoing work on D&I) would be helpful.

Governance and personal accountability

• From a governance perspective, the FCA focuses on the importance of the board being skilled and knowledgeable on sustainability-related matters and board vacancies being filled by people with the right range of sustainability-related skills. The paper recognises that board members are not typically sustainability experts and there may be gaps in expertise on many boards. However, board members do need to gain an understanding of sustainability matters and seek guidance from experts as needed.
• In terms of organisational models, the FCA mentions sustainability committees (that would typically be chaired by the CEO or CRO), climate working groups and sustainability "champions" across the organisation as relevant organisational approaches.
• The paper also considers the role of senior managers under the SMCR in promoting sustainability within firms. For dual-regulated firms, the FCA cross-refers to PRA's SS3/19 and the expectation to allocate responsibility for identifying and managing financial risks from climate change to an appropriate existing senior manager. For solo firms, the FCA notes that, whilst there is currently no prescribed responsibility for sustainability, in respect of climate specifically, they expect that the CEO, CRO and other senior managers should be able to credibly articulate how climate related risks and opportunities are managed within the firm. The FCA is seeking feedback on whether additional guidance on sustainability expectations of senior managers would be helpful and which SMFs would be most suitable to assume responsibility for the sustainability strategy and climate transition plan of the firm.

Product governance and services

• The paper notes that firms making sustainability-related claims about products or services need to maintain appropriate governance arrangements to ensure that the claims reflect the sustainability profile of the product.
• The FCA recognises that the current product governance rules do not expressly refer to sustainability requirements (unlike the approach in the EU, where the product governance rules under MiFID have been amended to include sustainability considerations). However, the paper reminds firms that under the new SDR rules (which come into force later this year), new requirements will apply in respect of disclosures and labelling, including a new greenwashing rule.
• The FCA seeks feedback on whether there is a need for additional guidance on embedding sustainability within product governance.

Remuneration and incentive plans

• The FCA recognises that firms can incentivise their workforce to achieve corporate sustainability goals in a variety of ways, such as offering participation in share ownership schemes (which include sustainability/ESG metrics) and/or providing non-financial incentives, which can also be effective in fostering behaviours and decision-making that ultimately align with a firm's commitments to sustainability.
• The FCA is therefore seeking feedback on what firms should consider when designing remuneration and incentive plans linked to their sustainability-related objectives.

Investor stewardship

• The FCA zooms in on the role that asset managers and asset owners play to support the adoption of sustainability through their stewardship activities.
• The paper emphasises the importance of adopting robust governance arrangements for oversight and accountability for stewardship.
• The FCA seeks feedback on whether additional measures (beyond the UK Stewardship Code and the implementation of the second Shareholder Rights Directive in COBS 2 andDP19/1) is necessary to encourage effective stewardship.

Training and competence

• The paper notes the growing consensus that training and upskilling at all levels within firms is needed and emphasises that the FCA is keen to avoid "competence washing" in firms.
• The key challenges noted for sustainability-related training and competence are the gaps in ESG data and metrics, the lack of both key definitions and expertise that cuts across sustainability topics.
• The FCA is working with the five Accredited Bodies (who provide qualifications for regulated activities) as well as other stakeholders to discuss sustainable finance skills and training.
• In the meantime, the FCA is seeking feedback on what firms perceive as the main sustainability-related knowledge gaps and whether additional guidance on sustainability training within existing rules is necessary.