Climate risk management constantly undergoes regulatory change. So, how do compliance teams keep up and ensure they meet ethical expectations?
With climate risk being a substantial area of ongoing regulatory change, compliance teams will need to work with others to implement new rules, guidance and standards.
The UK Financial Conduct Authority (FCA) and other regulators are working to ensure financial services firms in the jurisdiction meet both international obligations and the ethical expectations of the domestic electorate.
The FCA, working closely with the Bank of England's Prudential Regulatory Authority (PRA) and the industry through the Climate Risk Forum, has produced a considerable amount of new regulations and guidance around climate risk management over the past two years or so.
Compliance teams need to work with their risk management teams and others across the business to implement this considerable volume of regulatory change.
“Climate change is a core focus of environmental work, which is itself one pillar of ESG. And ESG captures the key dimensions of wider sustainability; that is, how people, planet, prosperity and purpose come together to help enable ‘the needs of the present [to be met] without compromising the ability of future generations to meet their own needs’”.
- The FCA
Also, more regulatory change is in the works. For example, in its annual plan for the fiscal year 2022-2023, the FCA has committed to developing metrics designed to increase the quantity and quality of climate risk-related disclosures. It singles out greenwashing as an area where it will take proactive enforcement action.
So, compliance teams will need a strategy to manage the substantial amount of work required today and over the next few years to implement climate risk-related regulatory change.
One substantial area of the new regulation is to do with climate risk disclosures. The UK is adopting the Task Force on Climate-Related Financial Disclosures (TCFD) framework – launched in 2017 – as the basis for developing its rules in this area. The TCFD framework contains 11 recommendations built around four themes:
This document extended the new disclosure requirements beyond premium-listed companies to most standard-listed public companies, asset managers, life insurers, and pension providers from 1 January 2022.
The FCA shares responsibility for monitoring and enforcing compliance with the Financial Reporting Council (FRC).
Compliance teams will need to perform a gap analysis of these new requirements against the data their firm currently produces and discloses. Then they will have to work with the business to produce the required information, keeping in mind existing requirements around data disclosure for listed companies and other FCA and FRC requirements.
The disclosure work required for financial firms is substantial and will demand a considerable amount of work from the compliance team. Key disclosure requirements include:
In addition to the disclosure requirements above, financial firms will need to enhance their risk management programmes to take climate-related risks onboard.
The FCA published Supervisory Statement SS3/19 – Enhancing banks' and insurers' approaches to managing the financial risks from climate change in 2019 to help firms develop their framework.
In addition, the Climate Risk Forum has published extensive guidance on topics such as climate risk appetites, climate risk training, and managing legal risk. The authors of these materials are four working groups on climate risk that convene under the auspices of the FCA and the PRA.
The Bank of England is also running a series of exploratory scenario exercises on climate risk involving the largest UK banks and insurers. These use scenarios to try and better understand how different kinds of climate risks will impact these areas of the financial services industry.
Compliance teams should partner with the risk management teams in both the first and second lines of defence to meet these obligations, continually improve their firm's climate risk management programme, and meet climate risk management-related regulatory obligations.
The FCA fosters active investor stewardship among asset management firms, including insurers and pension funds. This way, the companies they invest in are influenced to implement sustainability strategies.
So, compliance teams should train their firms' asset managers in this more proactive approach and support those teams in documenting these activities.
There are more disclosures, too. In addition to the TCFD-related disclosures that these asset management firms will need to make, they will also need to undertake product- and portfolio-level disclosures.
The PS21/24 states: Enhancing climate-related disclosures by asset managers, life insurers and FCA-regulated pension providers, published in December 2021.
This fundamental set of consistent, comparable product- and portfolio-level disclosures include metrics designed to meet users' needs across the investment value chain. These disclosures need to be in regular reporting or on the firm's website.
Firms must make the first public disclosures, according to these rules, by 30 June 2023. Compliance teams will need to support the business in creating this data and then disclosing it to meet this regulatory obligation – and pre-existing ones around information disclosure.
The FCA has said it would like to see improvements in the overall quality of product labelling for climate risk and the environmental space in general. To that end, it published DP21/4: Sustainability Disclosure Requirements and Investment Labels in November 2021.
This set of rules seeks to improve the quality of:
Implementing this will require extensive changes to many firms' product governance and marketing development, and approval processes. Compliance teams will need to help ensure that all of these changes are implemented correctly and that the outcome meets their firm's regulatory obligations.
Although high quality and comparable climate-related data and consistent metrics are essential for the financial markets to price and manage climate-related risks properly, today's reality is that the data is often a metaphorical Tower of Babel both within firms and among them.
To help combat this, in October 2021, the Climate Financial Risk Forum published the Climate Financial Risk Forum Guide 2021 – Climate Data and Metrics. The report provides an overview of the state-of-play of climate risk metrics at the time, noting the recognition of data gaps in the industry. It also provides some suggested solutions.
Climate risk data is a work in progress today. So firms need to be sure they understand the quality and use of their data at a granular level and that they are aware of any issues around the use of the data or its comparability.
Compliance should engage with other teams across the business, including data governance, risk management, IT and investor relations, to work through climate risk data issues internally. Given the overall challenges highlighted in the report, they should also be alert to potential legal risks around using and publishing data.
The FCA has publicly stated that it is actively looking for evidence of greenwashing among the financial services firms it regulates. The regulator uses its existing rules around misleading communications and treating customers fairly to punish firms.
Asset management firms should read the regulator's open letter to AFM chairs, Authorised ESG & Sustainable Investment Funds: improving quality and clarity, for guidance.
The UK's Advertising Standards Authority (ASA) is also cracking down on financial firms for greenwashing. For example, in April 2022, newspapers reported that the ASA was preparing to sanction a large UK-based multinational bank for ads that selectively promoted green initiatives because the ads did not accurately reflect the broader context of the bank's climate risk activities.
Compliance teams should enhance their marketing review processes to consider climate risk regulatory issues. This is likely to be a space where best practice evolves as regulators sanction firms.
These are just a few areas touched by this enormous FCA project. The core of this is having a robust approach to training across the organisation – from helping individuals understand the nature of new rules and how they impact their role to enhancing its overall ethical approach to climate risk issues.
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