LPP Response to FCA Discussion Paper – Climate Change and Green Finance
Q1: What, if any, difficulties do issuers face in determining materiality? We are also interested in exploring how investors consider materiality in this context.
Individual issuers must determine locally what material financial risks their businesses face from physical climate change, adaptation and regulation and from broader trends associated with the global transition to a low carbon economy.
Climate change poses challenges in relation to the timing, scale and form of future impacts and their outcomes (quantification). It is for this reason that TCFD has recommended the use of scenario analysis to encourage the consideration of a range of potential influences (and policy environments) and recognition of the short, medium and long-term business consequences potentially to be managed.
For investors, the severity of the impact on operating results and financial position (in the short, medium and long term) is the basis of materiality judgements, which will be contextualised by information from broader disclosure on the arrangements in place for anticipating, planning for and delivering an effective mitigation strategy which will protect value and seek to take advantage of appropriate opportunities.
Investors are also interested in how materiality determinations are being made by companies and want insights into the governance and risk management context in which business strategy and operational planning are being undertaken.
Q2: We are interested in understanding whether greater comparability of disclosures would help investors in their decision-making more generally. If so, what framework would be most useful?
Yes, greater comparability of disclosures would considerably assist investors. The TCFD disclosure framework should be the preferred model. It is already in the process of incorporation by early adopters and has been designed to be applicable to multiple sectors and jurisdictions.
Q3: Would exploring a ‘comply or explain’ approach, or other avenues to encourage more consistent disclosures, be an effective way of facilitating more effective markets?
Facilitating more effective markets is more likely to follow from there being meaningful consequences for non-disclosure than from an option to explain noncompliance. Page 2 of 6
Some of the challenges of TCFD (in seeking disclosure through the annual financial statements, but currently being voluntary) are the need for support and status from regulators and greater certainty around the role and abilities of external auditors to review and give shareholders assurance on the quality and accuracy of reported information.
The TCFD disclosure framework is sufficiently broad and inclusive to accommodate the reporting arrangements of a diversity of companies across multiple sectors and jurisdictions. There should ideally be a universal requirement to comply with TCFD and also to explain whatever local circumstances and context are relevant.
A broad scale of TCFD adoption is critical to providing the coverage needed to facilitate capital allocation decisions which can differentiate between companies on the basis of the quality and breadth of information being disclosed on climate change risks and their management and mitigation.
Q4: Do you think that a requirement for firms to report on climate risks would be a valuable measure?
Yes – adequate disclosure by firms is the foundation of effective risk assessment by the entire investment chain. An absence of issuer information through poor or partial disclosure prevents informed decision-making by all other parties which impacts on effective capital allocation decisions and hinders market pricing adjustments.
Q5: Do you have any suggestions for what information could be included in a climate risks report?
The TCFD disclosure framework is the appropriate pattern and standard – it sets out minimum reporting requirements across easy to understand categories but also encourages evolution over time as familiarity and confidence build. (See TCFD final report Figure 4).
Q6: Do you have any views on which regulated firms should be required to compile a climate risks report?
The final TCFD report and recommendations confirm the financial sector participants who should be required to report on climate risks (banks, insurance companies, asset managers and asset owners) and the justification for this (a requirement for the financial sector to report will foster earlier adoption of the assessment of climate-related risks and opportunities, improve the pricing of climate-related risks, and lead to more informed capital allocation decisions). These conclusions were reached after considerable research and reflection.
The dependency of the finance sector on the scope and quality of information disclosure by underlying companies should not be under estimated. TCFD recommendations recognise that the finance sector can create a strong demand Page 3 of 6 impetus for better reporting on climate change risk, and this will ratchet up more quickly through a requirement to report on their own activities.
Q7: How can authorities, including the FCA, most effectively work with industry to meet investor demand for green investment opportunities and encourage those raising capital and investing in it to pursue sustainable outcomes?
Work should be in close collaboration with other major initiatives underway on this topic - the European Commission’s Action Plan on Sustainable Finance and the UK Green Finance Taskforce and follow-on activities being key. A consistent taxonomy and agreed set of universally adopted minimum standards and expectations are a desirable outcome for all market participants and will provide the most effective impetus for positive change.
Work should be through and in partnership with organisations which are already bringing engaged investors together to discuss and take action on climate change (IIGCC and Climate Action 100+ for example) in order to learn from the most advanced and encourage an up to date two-way dialogue. The FCA should utilise existing knowledge and feedback networks and avoid taking a solitary stance which involves duplication or results in the re-asking of essentially similar questions.
Q8: Do you agree with the extent of the FCA’s proposed interventions on climate change-related financial disclosures? Is there a specific need for us to intervene further in the interests of market integrity or consumer interests?
The proposal (per para 5) is to review the disclosures required by issuers admitted to trading on a regulated market and to explore whether issuers require further clarity over what is expected of them and greater encouragement to give investors appropriate information. It is also proposed to seek views on introducing a new requirement for financial services firms to report publicly on how they manage climate risks to their customers and operations. The proposals therefore cover investee companies as the providers of information and financial managers as the users of company information for decision-making on behalf investment clients.
The question of whether the proposed intervention goes far enough rather depends on the final proposals and the approach to ensuring (or enforcing) compliance.
The TCFD recommendations already provide for reporting by issuers and financial services companies, but they are a voluntary framework. A broad adoption requires a regulatory impetus and consequences (beyond peer pressure) for failing to take steps to improve disclosure and meet the needs of investors and consumers for current and forward-looking information. Page 4 of 6 Updated listings rules represent an obvious lever for positive change, but equally important is greater clarity around (and meaningful enforcement of) existing requirements to disclose financially material risks and to understand the implications of climate change. Physical, transitional and regulatory risks are already part of the business environment companies face and they should be evaluating, quantifying, planning for and reporting upon these (where material). For example, section 172 of the Companies Act 2006 requires “companies in their annual reports to report on the principal risks and uncertainties to their business, and long-term factors and trends that affect their businesses, where they are material.”
Existing reporting requirements are not being complied with or enforced and an evaluation of the reasons why should inform the FCA’s development of proposals for new and additional measures designed at improvement.
Q9: In light of the EU work on taxonomy, what are your views on the form common standards and metrics for measuring and reporting against green financial services products should take?
The need for simplicity combined with adequate rigour is key given the outcome aimed at is for the market to generate more investable products and for consumers (and their investment service providers) to be able to understand, evaluate and usefully compare them as part of informed capital allocation decisions.
Measuring and reporting metrics will need to be unequivocal (and accompanied by detailed guidance on components and calculation method) in order to ensure standardisation and comparability.
Q10: How could regulators and industry best work together as part of the Climate Financial Risk Forum?
Collaboratively, based on a shared commitment to clear and agreed common goals and outcomes.
Clarity is needed on what the forum is intended to achieve and how it fits within the broader landscape of positive action (complementing and helping to facilitate progress on climate change risk mitigation by the financial sector).
The objectives and interactions agreed upon will determine which participants need to be around the table or consulted with in order for knowledge, influence and resourcing to be brought together effectively.
Q11: What are your biggest concerns and commercial priorities regarding climate change?
As an asset manager for public sector pension funds our biggest concern is the availability of decision-useful forward-looking information from which to Page 5 of 6 understand and analyse the nature and scale of material financial risks faced from climate change at both a granular and aggregate level (short, medium, and long-term).
Our priority (set out within our Responsible Investment Policy) is to be able to identify, quantify, measure, act, monitor and report to clients on our management of climate change risk on their behalf as part of actively protecting the long-term value of client portfolios through sustainable investments which safeguard asset backed retirement savings.
Q12: What are the biggest barriers to the growth of green financial services in the UK?
A demand for green investment products which is immature.
Limited understanding of the risks investment portfolios face from climate change and uncertainty about the timing of market adjustments, regulatory interventions and demand shifts related to the low carbon transition. Inadequate insight dulls the impetus for attributing risk and transitioning capital to appropriate products with relatively lower exposure.
The poor performance record of many early investments in renewables.
Unproven performance (lack of track record) for new and more innovative products.
The lack of a universal taxonomy and agreed standards for green investment products.
The lack of a predictable and supportive policy context to actively incentivise the emergence of investable opportunities across different asset classes and create viable options which match the performance and other requirements of investors whatever their type, scale and investment strategy.
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