FCA review into ESG benchmarks and noted that these benchmarks are poor, and do not provide sufficient information for users to understand the purpose, or indeed the underlying methodologies.
According to WTW, insurers are increasingly utilising such benchmarks to implement their own ESG investment strategy, and meet their required sustainability goals, which may include a tilted investment strategy.
FCA sees ESG benchmarks as integral in ensuring trust in the ESG product market and assisting the transition to net zero (see How Insurance Companies Are Preparing for a Net-Zero Future?).
As such, insurers will want to examine the findings of the review, to ensure that sufficient due diligence has been carried out on the benchmarks on which they rely to support their ESG decision-making processes.
Weaknesses in an important portfolio management tool
ESG benchmarks can be a valuable tool to facilitate portfolio management and performance attribution of ESG tilted investment strategies (see Role of Insurance in ESG).
These benchmarks assist insurers in providing ESG oriented products to consumers, and in providing assurance that their investment strategy is performing appropriately against relevant benchmarks, with similar ESG profiles.
Insurers therefore rely on benchmark administrators providing robust and reliable benchmarks, and weaknesses in those benchmarks may affect consumer outcomes.
Consumer impact of using weak benchmarks
Insurers should ensure they understand the benchmarks being used to manage their investments. The gaps highlighted by the FCA illustrate some of the weaknesses in approaches used to derive some ESG benchmarks.
What is particularly evident is the subjectivity of ESG factors and how ESG data and ratings are incorporated into benchmark methodologies.
Given the range of methodologies, and the inherent subjectivity incorporated in these assessments, building this understanding is key to ensure both that products offered are designed appropriately, and that consumers have sufficient information to understand the products they purchase.
Insurers should pay particular attention to these issues considering the new Consumer Duty.
Proactive approach to benchmark selection
Insurers should navigate away from benchmarks with poor disclosures or those that do not align with their expectations.
Insurers should regularly review their choice of benchmarks and ensure that those benchmarks remain aligned with consumer expectations where consumers rely on those benchmarks.
These reviews should ensure benchmark disclosures are appropriate and where this is not the case, consider whether the use of those benchmarks should be terminated.
Overview of the FCA’s ESG benchmarks review
The key areas summarised by the FCA which we consider relevant for insurers when assessing ESG benchmarks are as follows:
Benchmark statements should:
- contain essential information to enable users to understand what it measures, and its risks, so as to enable informed decision making;
- ensure that the methodology is easily accessible by users; and
- include sufficient explanation as to how ESG factors are reflected against each of the requirements referred to in Article 27 of the UK Benchmarks Regulation (UK BMR) (UK BMR providing governance and controls over the benchmark process).
Insurers rely on the robustness and quality of information provided in the benchmark statements for the benchmarks they use.
Given these findings, insurers must ensure that they have sufficient understanding of the benchmarks they rely on, and that this understanding is aligned with customer expectations, in particularly given new Consumer Duty requirements around consumer understanding.
Benchmark administrators have significant discretion in benchmark design and methodology, particularly with regards to use of ESG factors.
- provide good disclosures so that users and investors can assess the benchmark’s ESG claims;
- provide specific information on how key elements of methodology reflect ESG factors;
- meet the minimum content of explanations set out in the UK BMR; and
- ensure the underlying methodology for ESG data and rating products, whether provided by the benchmark administrator or a third party, is accessible, clearly presented and explained to users.
Insurers may rely on benchmarks from multiple administrators, who may use different methodologies and therefore leading to different, and potentially incompatible outcomes.
Insurers should ensure that where benchmarks from different administrators are used, the differences in methodology are understood, and that the resulting outcomes are in line with insurer and consumer expectations.
Low carbon benchmarks regulation
The FCA highlight the Low Carbon Benchmarks Regulation, which amended the UK BMR to introduce new categories of benchmarks and to provide for ESG-related disclosures for benchmarks, and the requirement for benchmark administrators to:
- provide specific information on how ESG factors are reflected in the benchmark;
- list ESG factors used as part of the index methodology
Insurers should familiarise themselves with the use of ESG factors in benchmarks they rely on, and that the choice and weighting of those factors is consistent with the information provided to consumers, as well as the insurer’s own expectations.
Robustness and reliability of ESG benchmarks
The FCA remind administrators that under Article 12 of the UK BMR, they are required to use robust and reliable methodology for determining a benchmark.
Given all the FCA’s concerns, insurers should regularly review their use of ESG benchmarks, and may choose to limit reliance on certain benchmarks where they do not have sufficient comfort on the robustness and reliability of those benchmarks.
As insurer’s approach implementing their ESG strategies, it’s important to ensure that any benchmarks selected to monitor performance are adequately validated and understood.
AUTHORS: Kartina Tahir Thomson – Experienced risk, capital and governance professional, IFoA Council, IFoA Foundation Chair, Non-Executive Director WTW, Michelle Radcliffe – Director, Climate Analytics & Exposure Management for WTW’s Insurance Consulting & Technology Business, Punil Chaubal – Associate Director in the Insurance Investment Team at WTW