Legal development

Benchmark administrators warned to improve ESG disclosure

Insight Hero Image

    On 20 March 2023, the UK's Financial Conduct Authority (FCA) published a Dear CEO letter to benchmark administrators, entitled "ESG Benchmarks Review". In the letter, the FCA describes the current quality of ESG disclosure as "poor" and highlights widespread failings in ESG-based disclosure by administrators. 

    In a clear warning shot, the FCA advises administrators that it will continue to monitor ESG-based disclosure and will use supervisory tools and enforcement action in the future if its expectations are not met.

    FCA expectations for ESG benchmarks

    The FCA had previously set out its expectations for ESG benchmark disclosure in a letter dated 8 September 2022. These included:

    • good quality disclosure in benchmark statements and methodologies;
    • benchmark names that fairly reflect the methodology and content of the benchmark such that users’ reasonable expectations are met; and
    • where ESG ratings are provided by an ESG ratings agency, clear presentation of the underlying rating methodology.

    The letter drew particular attention to the subjective nature of ESG factors and the fact that this can increase the risk of poor disclosure in ESG benchmark statements. It also noted that poor quality ESG benchmarks could negatively impact the transition to a net zero economy. 

    In the letter, the FCA said that administrators should improve disclosures where necessary and ensure that they are understandable to users and end investors. It also said that it would continue to monitor the quality of disclosure in relation to ESG benchmarks, and would scrutinise their construction and labelling.

    Slow progress

    Fast forward to March 2023 and the FCA's Dear CEO letter. This gives a scathing view of the progress made by administrators since September, explaining that a preliminary review of ESG benchmarks indicated that the quality of disclosure was generally poor. It also pointed out that many benchmark methodologies contained insufficient detail of ESG factors and that some firms had failed to fully implement the disclosure requirements incorporated into the UK Benchmarks Regulation1  by the Low Carbon Benchmarks Regulation2, which has been in force since December 2019.

    The FCA attaches to the letter a list of risks and issues identified during its review. These are summarised below.

    Generic descriptions and unclear cross-referencing

    The FCA's review found that some descriptions of the market or economic reality measured by benchmarks were generic, particularly in benchmark statements for families covering a broad range of benchmarks. The FCA has indicated that, where additional information is made available in other documents, administrators must clearly signpost such documents and make sure that they are easily accessible.

    Key requirements of benchmark statements not met

    According to the review, administrators failed to provide sufficient explanations in their benchmark statements as to how ESG factors are reflected against certain requirements of the UK Benchmarks Regulation. In this section, the FCA reminds administrators to ensure compliance with all of their regulatory obligations, not just the requirement to use the prescribed disclosure templates. 

    Lack of detail in benchmark methodologies

    The FCA found a general lack of detail in benchmark methodologies, including in relation to the ESG factors used and the thresholds selected to measure these. The FCA's concern is that this could lead to greenwashing, particularly where benchmarks purporting to pursue ESG objectives apply ESG factors such that the constituents are not materially different from those of a similar non-ESG benchmark. Benchmark administrators need to ensure that the underlying methodology for these products is accessible, well described, and clearly presented.

    The FCA also notes that ESG data and ratings services are increasingly embedded within investment processes, directly influencing capital allocation. According to the FCA, ESG data and ratings services should be transparent, well-governed, independent, objective, and based on reliable and systematic methodologies and processes. The FCA notes that the UK government is expected to consult in due course on extending the FCA's perimeter to include ESG ratings providers.

    Incomplete templates

    Under the UK Benchmarks Regulation, administrators must provide specific information on how ESG factors are reflected in each benchmark or family of benchmarks. The minimum disclosure requirements are established by statute and prescribed templates must be used.

    According to the FCA, many administrators do not include key information in the templates. In some cases, the required information is provided in other documents, but this is not always clearly signposted in the templates. The FCA says that, if administrators cannot obtain relevant data for a particular benchmark, they should consider whether they are able to continue to offer it for use in the UK. 

    Incorrect application of ESG factors

    During its review, the FCA noted cases where benchmarks had been miscalculated due to the incorrect application of ESG factors: for example, in some cases, constituents had been assessed against outdated ESG ratings and data and ESG exclusion criteria had not been applied. 

    The FCA also noted that some administrators do not have adequate controls in place to verify that ESG factors have been correctly applied. In this regard, the FCA states that benchmark administrators are expected to have sufficient systems and controls in place to ensure compliance with the methodology requirements each time the methodology is implemented and the benchmark is determined. 

    Future anti-greenwashing rule

    In the Dear CEO letter, the FCA takes the opportunity to draw administrators' attention to the FCA's proposed anti-greenwashing rules, which, when in force, will require all sustainability-related claims by administrators to be clear, fair and not misleading. The rule is expected to come into force by the end of June 2023. 

    Given the FCA's clear focus on ESG ("ESG matters are high on our agenda"), and this explicit warning of potential regulatory action in the future, administrators may wish to review their sustainability-related claims and ESG-based disclosure as a matter of urgency, and before the end of June at the latest.

    Authors: Mike Logie and Kirsty-McAllister Jones

    1. The onshored version of EU Regulation 2016/1011.
    2. The onshored version of EU Regulation 2019/2089.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.


    Stay ahead with our business insights, updates and podcasts

    Sign-up to select your areas of interest