Sustainability disclosures and enforcement risk: Reflections on COP

_{The FCA's focus on greenwashing and raising sustainability disclosure standards}

In 2019, the UK government made a commitment to reach a net zero economy by 2050. To support this aim, the FCA’s Business Plan for 2021/22 contains – for the first time – Environmental, Social and Governance (ESG) as one of its key priorities. COP26 spurred a flurry of FCA activity, particularly on sustainability disclosures and climate-related pledges. Rathi emphasised in his keynote speech that "greenwashing" (i.e. unsubstantiated or misleading claims about products' or activities' environmental performance) cannot be permitted to persist in the industry. 

This leads to an important question for firms: what are the FCA's plans from an enforcement perspective? We have already seen reports of regulatory investigations in other jurisdictions, including those by U.S. and German regulators in the asset management sphere. In the UK, press reports surrounding COP26 anticipated the FCA being granted powers to fine firms that fail to produce or deliver on pledges, but we should keep in mind that the FCA may not need new powers. Indeed, it can already bring enforcement action for breach of the FCA's Principles, for example, Principle 7 (communications with clients should be clear, fair and not misleading). The point is instead whether it wants to and, if so, when and how.

_{FCA supervision of firms' sustainability disclosure obligations}

The FCA clearly wants to raise "green" standards in the financial services industry. At COP26, Rathi introduced the FCA's strategy for positive change, which focuses on (amongst other things) building trust in the market for ESG products and ensuring transparency along the value chain. On the same day, the FCA released its Discussion Paper DP21/4 on Sustainability Disclosure Requirements and sustainable investment labels, which gives some insight into its intentions.

Historically, the FCA's climate-related work has been confined to its supervisory activities, which is echoed in recent publications. From a supervision perspective, it appears the FCA is not looking to catch firms out with the new and growing list of environmental-related rules, but instead is keen to encourage and support firms in raising standards and contributing to the government's net zero goals. 

The FCA's first focus is sustainability disclosures. Firms will be required to make sufficiently detailed disclosures and ensure that their pledges are substantiated by evidence. We can anticipate two forms of disclosure requirements: a concise and accessible consumer-facing summary, plus detailed reporting for institutional investors and other stakeholders. Firms should start preparing to make sustainability disclosures by: consulting the guidance issued by the taskforce on climate-related financial disclosures (TCFD); reviewing the firm’s existing documentation; and identifying the information that will need to be collated in order to make future disclosures. This is likely to be an important focus of the FCA's supervisory work. 

_{"Green" enforcement risks}

Firms should also note that, whilst the FCA is focusing on encouraging firms to take positive action, it is willing to take enforcement action against those who do not. 

The FCA has already suggested that it will move in this direction if deemed necessary. In Primary Market Bulletin 36, the FCA clarified that it is responsible for monitoring and "where necessary" enforcing compliance with the new listing rules that cover TCFD-aligned disclosures. Where a listed company's disclosures do not appear to meet the new requirements, the FCA expects engagement between the company and the Financial Reporting Council in the first instance. However, where issues (i) are not satisfactorily addressed, (ii) concern potentially false or misleading information likely to cause investor harm; or (iii) breach relevant FCA rules, they will be referred to the FCA to "take appropriate action".

_{Key risks for firms in relation to sustainability disclosures and pledges}

Some of the key risks firms should consider include:

• Failure to make a disclosure

Firms need to stay abreast of new disclosure requirements and plan ahead to ensure that policies, procedures and reporting frameworks are in place to accurately make the required disclosures. Firms should engage openly and co-operatively with the regulator to discuss issues and errors. 

• Disclosing incorrect information

Inadvertent inaccuracies are likely to be looked on more favourably if quickly identified and rectified.  We expect enforcement appetite to be low for isolated incidents. However, repeated incorrect disclosures could trigger an investigation into whether these are intentional or cause for wider concern. Accordingly, firms should ensure that they investigate the root causes and put in place further controls to mitigate the risk of reoccurrence.

• Intentionally false or misleading disclosures

A firm faces a much higher risk of FCA enforcement action if it is suspected of deliberately or repeatedly making inaccurate or misleading disclosures. The FCA's Dear Chair letter of July 2021 provides examples of poor practices identified in the asset management sector. Firms would be well advised to consider these and any further examples highlighted by the regulator. 

• Not delivering on pledges

The FCA has not yet set any particular standard for firms' net zero pledges, which are likely to depend on the outcome of the government's transition plan taskforce, but this could present a future enforcement risk – for example, if minimum standards are not met or firms intentionally set 'easy' targets (thereby increasing the risk of consumer harm). At this stage, it would be prudent for firms to assess how they can contribute to the government's net zero target and consider what pledges they can reasonably make.

_{What should firms expect from the FCA going forward?}

This year looks set to be particularly busy for the FCA, having publicly set itself milestones for its ESG work. The FCA intends to challenge greenwashing throughout 2022. We have listed below key disclosure-related milestones firms should be aware of.

• End of 2021 - FCA to publish final rules for TCFD aligned disclosures for a wider scope of listed issuers, asset managers, life insurers and certain pension providers. 
• Q1 2022 - TCFD-aligned rules begin phasing in.  FCA to publish feedback statement and consultation paper on sustainability disclosure regime and product labels.
• Q2 2022 - FCA to publish feedback statement on ESG issues in capital markets. First annual financial reports including disclosures subject to the new listing rules published. 
• Q3/Q4 2022 - FCA to publish consultation paper on prudential ESG disclosures.

Throughout this period, the FCA intends to engage with stakeholders, so firms should get up-to-speed and be prepared to discuss this significant issue with the regulator.

_{Is this an all-pervasive shift in the FCA's enforcement work?}

Whilst it is still uncertain how the FCA will regulate the industry in terms of being "green", Rathi emphasised at COP26 that it is working to embed climate and wider ESG considerations as a "golden thread" through everything that it does. The FCA is evidently keen to do so without enforcement at this stage, but if the industry does not fall into line, we can expect to see targeted enforcement activity. 

In addition, given the FCA's increasing appetite for considering broader ESG issues, such as culture and non-financial misconduct, in its more "traditional" investigations, we might start to also see firms’ conduct in relation to "green issues" creep in. For example, are poor systems and controls relating to climate-related issues reflective of broader weaknesses and misconduct?  

While further regulatory guidance is awaited with regard to the broader TCFD regime, firms should already be preparing to engage actively with the regulator on these issues.  Failure to do so could result in enforcement action in the worst cases.  Not only does an enforcement investigation carry the risk of sanction, but enforcement action relating to ESG issues risks significant reputational harm.