The UK needs a much tougher system of financial regulation to meet the Paris climate goals with revised fund labels, full Financial Conduct Authority (FCA) regulation of rating agencies and a climate-data based system for companies, markets and funds, as part of a comprehensive change in approach.
At the Financial Inclusion Centre we recently published a report, Time for action: the Devil is in the policy detail – Will financial regulation support a move to a net zero financial system?, which concludes that existing and planned regulations won’t be enough to align financial market behaviours with the UK’s statutory climate goals.
It argues that current regulatory plans could leave investors confused with a risk of greenwashing and ‘impact-washing’, while stymying ambitions for the UK to become a leading green finance centre.
Therefore, the FCA should carry out a review of current sustainability and ESG marketing to understand where asset managers are complying with or breaching existing requirements to be clear, fair and not misleading.
As part of this review, the FCA needs to understand why there is so much divergence between rating agencies when it comes to rating ESG and sustainable funds and securities.
More broadly, UK financial institutions continue to finance, at scale, corporate and sovereign entities that cause serious harm to the environment and voluntary disclosure will not drive sufficient changes.
Disclosure
In terms of disclosure, the Task Force on Climate-related Financial Disclosures, the Sustainability Disclosure Requirements, and the FCA’s sustainable investment labels are too reliant on narrative-based reporting. Investors need independently verified hard data, overseen by regulators, to measure the climate harm caused by economic entities and financial institutions, and to measure progress against agreed climate goals.
The UK remains a long way from having comprehensive, trustworthy data or a rating system that would allow investors and advisers to fully scrutinise asset managers’ assertions and actions while delay to the UK green taxonomy adds to retail and institutional investor confusion.
The report argues the FCA’s sustainable label proposals are flawed and won’t prevent green or social impact-washing.
The planned regime conflates green and social impact goals and does not create a robust rating system, which would expose the degree to which funds invest in climate damaging economic activities. Fund firms will be able to ‘mark their own homework’ on compliance while the social impact label is too vague and the usual return seeking investments could easily be rebranded as social impact.
The labels should clearly differentiate between funds with green and social impact goals and require independently verified green ratings based on degrees of compliance with climate goals. Funds with poor green ratings should carry a clear environment health warning while any social impact label should be reserved for funds that forgo market returns.
Without firmer rules, asset managers have an incentive to select the least onerous ratings providers, which will be unfair on their more rigorous peers, financial advisers and end investors.
The government should give the FCA the power to regulate ratings providers as swiftly as possible while the planned voluntary code, devised by an industry-dominated working group, will not build sufficient investor confidence.
Equal footing
The report also demands a radical change in mindset and approach: protecting the environment should be given equal status with other financial regulatory objectives.
Other significant measures include the creation of an Environmental Harm Register with details on emissions generated by publicly listed and larger private companies, and sovereign state agencies.
Financial regulators should also produce a baseline audit of the environmental harm caused by the major financial sectors and establish a public register of environment-critical financial institutions with agreed and published de-risking plans.
Prudential regulators should deploy tools to deter banks, shadow banks, insurers, and defined benefit pension schemes from financing climate harm while defined contribution pensions should publish and seek member approval for climate derisking plans.
In time, sanctions should be applied to firms that continue to finance economic entities on an Environment Sanctions List.
Finally, to address the quality of data provided by listed companies, the Financial Reporting Council should require corporates to produce audited data on emissions generated and alignment with the UK green taxonomy when finalised. Auditors should qualify company reports if they are unable to support conclusions on environmental risks.