Integrating ESG into UK capital markets

Wednesday 21 September 2022

Green Bonds

Author: Natalie Gregoire-Skeete 

The Professionalism Committee reviewed the FCA Feedback to CP21/18, which looked at ESG integration in UK Capital Markets. There were three significant discussions that were sparked from its release. First, the use of Proceeds bonds, secondly whether SPO providers should be regulated and finally, the mixed response to a Green Bond Standard.

Use of Proceeds bonds – make them a binding commitment?

In our letter, CFA UK stated that they would prefer for Use of Proceeds (“UoP”) bond terms to be made binding in the prospectus providing lenders/noteholders with the option to put bonds back to the issuer at par, in the event that the use of proceeds were not as defined in the prospectus.

However, the FCA explained that stricter regulation around UoP could drive issuances towards Sustainability Linked (“SLB”) bonds, where no restrictions on use of proceeds are required.  The FCA observed that UK prospectus content rules already require specific disclosures including use of proceeds and risk factors, that the UK does not have a compulsory bond standard for ESG-labelled bonds and that it is common for an issuer to make it clear that the use of the proceeds of an issuance is not binding.  Binding contractual terms therefore tend to be determined by market practice and market forces.

The FCA reflected that insisting on including the UoP as a binding provision in contractual agreements could increase liability risks for issuers, particularly in situations where issuers do not have full visibility on future capital expenditure plans and opportunities. The FCA therefore resolved not to propose any changes to its rules framework at this time. That said, any changes are dependent on the outcome of HM Treasury proposals to revise the UK regime for public offers of securities and admissions to trading on capital markets.

In our response, CFA UK also stated that, YES, it would be beneficial if the FCA explored supporting the UoP bond market by recognising existing standards such as ICMA’s Principles and Guidelines for UoP Bonds. In turn, the FCA state they encourage UoP issuers to coalesce around emerging good practice, as reflected in industry standards such as the ICMA Green Bond Standards which the feedback notes is referenced in more than 98% of ESG-labelled bond issuance globally. The FCA also noted that the Climate Bonds Initiative’s Climate Bonds Standard & Certification Regime builds on ICMA’s Principles & Guidance to include a taxonomy to support certification.

The FCA also cautioned that, whilst a number of sampled green bond issuers stated in their prospectuses that the issuer was not obligated to use the bond proceeds in a specific manner, the UoP bond framework document does imply a strong commitment to do so. The FCA reminded all relevant persons of their existing obligations regarding advertisements under PRR3.3.1. In particular, Article 22(3) of the UK Prospectus Regulation provides that information in an advertisement must not be inaccurate or misleading and should be consistent with information contained in the prospectus.  In other words, if a bond issuer ends up using UoP bond proceeds for purposes other than those specified in the UoP prospectus then they should have a clear reason why they were not used for their originally stated intention.

Alongside PS22/04, the FCA issued FS – PMB 41 to remind issuers of their obligations in this area under existing rules; where advertisements fall short of FCA requirements, the FCA can consider taking additional actions through Market Oversight and Enforcement powers.

Second Party Opinion (“SPO”) Providers – should they be regulated?

CFA UK suggested that in the UK, ARGA (the successor entity to the FRC) should be given regulatory oversight responsibilities for third party firms that provide assurance for a company’s businesses such as climate change and data checks. The FCA’s feedback agrees with the principle of regulating SPOs and identifies the FRC as a candidate for this role.  The FCA went on to underline the international context and how IOSCO had already set out a series of recommendations for SPOs to be governing their businesses under.

In our response letter, we encouraged the FCA and HM Treasury to use their influence to ensure that ESG ratings were fit for purpose and that they keep pace with new developments. The FCA acknowledged the similar clear feedback received from most respondents regarding the role of SPOs and the clear consensus for regulatory oversight.

However, the FCA emphasised that SPOs are currently outside their own regulatory perimeter and that for regulatory oversight to be implemented it would need to be authorised by HM Treasury. In the meantime, the FCA encourages issuers to consider relevant industry standards such as the ICMA’s Guidelines for Green Social, Sustainability and Sustainability-Linked Bonds External Reviews and to observe codes of conduct standards. Within the UK, the relevant standard is the FRC’s: “ISAE UK 3000, Assurance Engagements and Other than Audits or Reviews of Historical Financial Information”.

CFA UK agreed with how the FCA had previously characterised some of the challenges and potential harms arising from ESG data and rating providers. In its Feedback Statement, the FCA highlighted some additional points raised, which included the high cost of ESG ratings as providers use “product bundling”, thereby preventing asset managers from being able to only purchase the “specific ESG data they are interested in”. In its Feedback, the FCA also agreed with our letter on the need for investors, in particular, to be aware of the limitation of ESG-ratings. The FCA used almost the exact CFA UK wording in their feedback (para 3.38) stating that whilst “some ESG services tasks can be outsourced, the user’s ultimate responsibility cannot be”.

Given the current absence of applicable regulation of SPOs, 39 of the 44 respondents (to Q19) supported the FCA to either encourage SPOs to adopt a voluntary best practice code and/or engage with HM Treasury to bring their activities into the “regulatory perimeter”.

A new UK Green Bond Standard?

The FCA received a mixed response on the development of a new UK Green Bond Standard with exactly half of respondents, like ourselves, wanting international co-operation and not another set of duplicative and/or overlapping standards. Nevertheless, the FCA cited other feedback which argued that the development of a UK Green Taxonomy could enable a more targeted disclosure standard for UoP bonds to be developed in due course.

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