Ben Gillespie (pictured), Partner at law firm Seddons examines the FCA’s proposals to introduce standardised rules that set out how much asset managers must disclose about their impact on climate change and the ‘practical concerns’ raised by the BVCA…
Consultation paper CP21/17 was issued by the Financial Conduct Authority (FCA) in June 2021 with comments requested by 10 September 2021 and is part of the UK Government’s green commitment of achieving a low-carbon economy and net-zero by 2050.
The purpose of the proposed rules and guidance (Rules) is to place mandatory climate related disclosures on assets managers, life insurers and FCA-regulated pension providers, based on the recommendations of the Financial Stability Board (FSB)’s “Taskforce on Climate-related Financial Disclosures” (TCFD). The British Venture Capital Association (BVCA) responded to the consultation paper in a letter dated 10 September 2021, which was supportive “We welcome the FCA’s proposal…” and “welcome a common regulatory framework…” however the BVCA did raise some practical concerns.
Increased regulation on private companies
The Rules are a continuation of a theme of increasing social regulation on UK companies to counterbalance the traditional modus operandi of making maximum profit for shareholders. They also represent an extension of regulatory accountability beyond listed companies to the private sector – particularly relevant to the private equity industry.
The 2006 Companies Act (CA 2006) saw the beginnings of a socially more accountable company regime applicable to all English companies, with directors needing to have regard to (amongst other things) “the impact of the company’s operations on the community and the environment” – section 172(i) CA 2006. In the last few years, the movement has gathered momentum with the passing of the Companies (Miscellaneous Reporting) Regulations 2018 giving more weight to section 172 with various reporting obligations placed on larger private companies, and for the first time, the development of a set of proposed governance principles for large private companies (the Wates Principles).
The Rules will apply to asset managers/owners whose portfolio has a value of £5 billion or more, but the nature of the reporting obligations means that they will have a knock-on effect on the underlying private equity portfolio businesses, which are often SMEs not previously subject to climate related regulation.
All benefit?
Whilst classical good corporate governance (the “G” of ESG) can be sold on the premise of reducing operational risk and liabilities within a business and thereby supporting long term prosperity and longevity, the “E” (and to an extent the “S”) part of the initialism can sometimes be harder to reconcile with profit, at least in the short/medium term.
Meanwhile, more onerous reporting responsibilities are placed on company officers, internal systems of reporting climate-related metrics need to be developed, data limitations and gaps managed, and expensive consultants and experts engaged – all increasing a company’s running costs to the detriment of competitiveness in a not altogether even playing field. Although investors may increasingly be keen to invest in ESG sound businesses from a moral and reputational perspective, it cannot be assumed that all consumers will exercise the same discretion when faced with higher prices. Less green focused companies providing a cheaper offering and not subject to the Rules, or similar obligations, may be in for a bonanza – at least in the short/medium term.
CP21/17 estimates implementation costs at GBP231.4 million and annual ongoing costs at GBP125.4 million, but there is no attempt at setting out the actual financial benefits to the market. “We do not consider that it is reasonably practicable to quantify the benefits of our Proposals.” The statement that: “only a small improvement in investment decision-making as a result of these proposals would be sufficient to outweigh the costs and produce a net benefit” is somewhat vague.
There are non-financial benefits referred to, but little specifically directed at the persons to whom the Rules would chiefly apply (and who will bear the cost of compliance). Reducing global carbon emissions must be a good thing, as is more accountability on such matters and (as noted by the BCVA) creating a consistent approach to reporting and “fostering comparability for investors”, and the Rules may allow some asset managers to shine, however others may (quietly) see this as reporting for reporting sake, and unlikely to be a catalyst for the adoption of wholesale greener practices at the expense of profitability. Such a sea change would require more drastic government intervention, for example creating direct financial incentive on all businesses to reduce their carbon footprints through the medium of direct carbon taxes.
CP21/17 presupposes that the Rules will lead to a preference by asset managers and owners to favour investments into greener projects: “Our proposals aim to increase transparency and competition, thus encouraging capital flows towards firms that better manage climate risks”. This is a reasonable conclusion, but might it deter investment into ‘red’ businesses that need capital investment most in order to put them onto a greener business trajectory? Should there be some additional prominent metric that looks at a portfolio’s percentage reduction of climate impact year on year, perhaps disregarding newer assets which have not yet had the opportunity of benefiting from a greener focused stewardship?
Another area of potential concern is increased liability on directors, both as a collective body and at the individual level in terms of who signs-off on the relevant disclosure statement and is thereby potentially holding themselves out for additional scrutiny. Concern possibly compounded by some of the more onerous future looking reporting obligations within the Rules, such as scenario testing (essentially forecasting based on different climate scenarios) and a preference for setting emission targets. Both more challenging in the private equity arena when assets are typically held for a limited duration.
