Legal development

Is this the start of a new FCA REM CODE for sustainability

Insight Hero Image

    The FCA has published a new discussion paper 'Finance for positive sustainable change: governance, incentives and competence in regulated firms (DP23/1)'. It’s a meandering exploration of ideas from the regulator (as well as a series of essays from third parties) on how firms could integrate ‘sustainability’ in their governance, executive accountability, and remuneration frameworks to encourage individuals’ and enterprise investment into supporting the wider transition to net zero.

    The problem slightly is that it is trying to be all things to all people without a clearly defined strategy direction that has been set by the regulator (or indeed the government). And so it comes across slightly as a student dissertation rather than a heavy policy discussion. But that’s not to say that it shouldn’t be read. The paper represents the point of germination of a number of ideas that we would expect will, at some point, make their way into the FCA’s Handbook so it is worth a look by all financial services firms, not least so that they can identify where they should help shape the policy direction of the FCA in this area. We summarise below some of the key issues in our briefing.


    The FCA kicks off this discussion commenting on the need for good governance and a healthy culture for financial services firms. It also highlights how it is widely acknowledged that the financial sector has ‘an important role to play in contributing to the transition to a net zero economy and a more sustainable long term future’.

    This brief discussion of why sustainability is important to firms is taken as a fait accompli for the industry, before highlighting the existing obligations in climate related reporting frameworks to incorporate sustainability into governance frameworks. These include:

    A. Taskforce on climate related financial disclosures (TCFD);
    B. International Sustainability Standards Board (ISSB); and
    C. Transition Planning Taskforce.

    The FCA rightly points out that all of these have obligations to set out various governance related disclosures around how boards and management focus on climate related issues.

    Against this backdrop, the FCA goes on to discuss how some of these themes could be more widely incorporated by all financial services firms.

    Culture as an enabler

    In this part of the discussion, the FCA seeks to link its previous sentiments on the expectations around culture to its discussion on sustainability. The FCA uses the same rhetoric that we have heard it speak about previously about the link between culture and executive-led engagement strategies to support the firm’s sustainability objective.

    It also brings in the discussion of Diversity and Inclusion into this debate, which as a reader feels slightly left field in the flow, but is clearly an important aspect of a just transition.

    Here the FCA considers whether, outside of its existing work on D&I and Consumer Duty, there should be regulatory expectations on how firms’ culture and behaviours should support sustainable change.

    Governance, responsibility and accountability

    Unsurprisingly, the FCA considers the role of the board and senior management in supporting a firm’s sustainability objectives. The composition of boards is an area of concern for the FCA. While an appropriate mix is required there is an acknowledgement that there is likely to be a lack of expertise in sustainability related matters at board level. The FCA considers how this gap can be filled, either through board members with appropriate skills sitting on the board or ensuring the board has appropriate access to that expertise either internally or externally. The FCA says it is ultimately the responsibility of the whole board to have the appropriate skills and knowledge to effectively lead and challenge the company on its wider sustainability related risks, opportunities, and ambitions.

    Some suggestions here include board sub-committees, and/or climate working groups or forums to focus on the strategic direction of the firm and overseeing the embedding of the firm’s ESG strategy and track progress. The paper goes on to discuss training and competence requirements more specifically, but the FCA questions what steps firms can take to ensure that they have the rights skills and knowledge relating to material climate and sustainability related risks, opportunities and impacts on their boards. The FCA also queries whether they should set regulatory expectations in this area.

    The FCA is looking for the most effective strategies in embedding climate and sustainability related considerations across a firm’s operations. This includes the management information needed by senior management to monitor and oversee climate and sustainability related developments and to monitor progress against public commitments.

    In this guise, the FCA seems to be considering further regulatory requirements, particularly for FCA solo authorised firms to enhance individual ownership and responsibility for sustainability related matters in firms. This is likely to look similar to the prescribed responsibility introduced by the PRA for identifying and managing financial risks from climate change to an appropriate senior manager.

    Product and service governance

    The FCA pulls no punches on its existing expectations around product governance for firms making sustainability related claims about their products or services. We expect, the FCA says, all firms making sustainability related claims about their products and services to maintain appropriate governance arrangements to deliver the product in line with these. The FCA goes on to say that it expects firms to have appropriate arrangements in place to ensure those claims reflect the sustainability profile of the product.

    The FCA recognises that there is currently no explicit reference to sustainability in relation to its product governance requirements in PROD. It is seeking feedback as to whether it should consider introducing specific regulatory expectations and/or guidance on the governance and oversight of products with sustainability characteristics or that make sustainability claims to clarify the roles and expectations of governing bodies.

    Integration, remuneration and incentives

    A firm’s approach to remunerating and incentivising staff can both enable and reinforce a firm’s culture according to the FCA. Existing rules around remuneration are intended to promote effective risk management. The FCA believes that where a firm has made climate or sustainability related commitments linking reward outcomes to these could - if appropriately designed - play a role in supporting delivery.

    The FCA’s rumination around linking remuneration and incentive plans to sustainability related metrics focus on the design of such structures and the measures put in place to support such a step change. The FCA emphasises the need for meaningful, stretching and transparent metrics and highlights that firms should not remunerate based on metrics that are easily achievable through normal business.

    Here, it is worth setting out what the FCA is asking for feedback on. THe FCA wants to know what matters should firms take into consideration when designing remuneration and incentive plans linked to their sustainability related objectives. In particular, the FCA is looking for views on:

    1. The case for linking pay to sustainability related objectives;
    2. Whether firms should break down their sustainability related commitments into different factors, allocating specific weights to each;
    3. Whether short-term or long-term measures are more appropriate, or a combination of both;
    4. Whether sustainability related incentives should be considered for senior management only, or a wider cohort of employees;
    5. How firms could consider remuneration and incentive plans in the design and delivery of their transition plans.
    6. How firms could consider remuneration adjustments where sustainability related targets at either the firm level or individual level have not been met.

    Of all the topics considered by the regulator this is the area that i consider will be most closely scrutinised. Depending on where the FCA lands, this could be a big step change for industry.

    Governance of investor stewardship to influence positive change

    The FCA has a useful discussion on the role of investor stewardship following on from previous publications from the regulator in this area. It is considering whether additional regulatory measures to encourage effective stewardship, particularly in relation to firms’ governance and resourcing of stewardship and associated incentive mechanisms and conflict of interest policies are required.

    Next steps and commentary

    The discussion paper is open for responses until 10 May 2023. Firms should be watching out carefully on where the FCA goes with this one. There is considerable scope for significant change to be required from the regulator and on a widespread basis.

    But in our view, the FCA needs to take a step back in some areas. The policy objective behind this discussion is unclear. Indeed, it is worth querying how these proposals fit in to the FCA’s existing objectives. This is a regulator who wants to do the right thing and encourage the same from industry. But it is not yet clear what it considers ‘sustainability’ to cover. Is this climate led or a wider ‘social purpose’ initiative. If it wants to take the industry with it on this journey it might want to be more specific about some of these questions before it goes hell for leather down this road.



    Stay ahead with our business insights, updates and podcasts

    Sign-up to select your areas of interest