The Financial Conduct Authority (FCA) has warned compilers of benchmarks used to measure companies’ environmental, social and governance (ESG) performance that they will be penalised if they do not improve their ESG disclosures.

Following a review of ESG benchmarks, the FCA found the quality of disclosures to be “poor”, and lacking in “sufficient details and description of ESG factors considered in their benchmark methodologies”.

The regulator’s review found that some descriptions of the market or economic reality measured by benchmarks were “generic”. It also urged ESG compilers to provide clearly signposted links to supporting materials, and to ensure information was easily accessible to users. 

A lack of detail in benchmark methodologies also alarmed the FCA. “We are concerned that this can contribute towards or lead to greenwashing. This is particularly concerning where benchmarks that purport to pursue ESG objectives apply ESG factors in such a way that the constituents are not materially different to a similar non-ESG benchmark,” it said in its letter to CEOs.

Peter van Veen, Director, Corporate Governance and Stewardship, ICAEW, says: “Companies need to make sure they do not fall into the trap of treating the compilation of ESG metrics as a tick-box exercise or, worse, as a PR exercise. It is important that companies’ boards assure themselves that the compilation of ESG metrics follows the same rigour as the compilation of financial data to ensure investors can trust the data.” 

The FCA’s caution comes as the watchdog steps up efforts to clamp down on greenwashing – when companies make exaggerated or misleading sustainability-related claims about their products that don’t stand up to scrutiny. This, the FCA says, erodes trust in the market for sustainable investment products.

Its proposals contain an anti-greenwashing rule which restates the requirements that all regulated companies making sustainability-related claims must ensure these are “clear, fair and not misleading”. 

The warning should come as no surprise to companies, given that last September the financial watchdog issued a clear warning about the “subjective nature of ESG factors and how ESG data and ratings are incorporated” could increase the risk of poor disclosures. 

The FCA said in its letter: “Given the importance of ESG benchmarks and our initial supervisory findings, which indicate the potential for widespread failings, we will be doing more work in this area across the portfolio. We will holistically consider the risks of harm related to ESG benchmarks across the value chain.”