The Financial Services and Markets Act must deliver for climate and nature

This June, the Financial Services and Markets (FSM) Bill received Royal Assent, entering the statute books after 18-months of review and consultation. The Act rewires the regulatory architecture of the UK financial services sector by repealing retained EU law and transferring new powers to UK financial regulators – whilst also introducing measures to improve accountability.

In 2021, then-Chancellor Rishi Sunak announced an ambition for the UK to become the ‘world’s first net zero-aligned financial centre’. In line with this goal, there’s a good deal in the Act on climate and nature, from regulator’s mandates and sustainability-related disclosure to forest risk commodities. This represents a considerable upgrade to the existing FSM Act 2000, which only makes reference to the “desirability of sustainable growth”.

But with warnings that global temperatures are likely to breach 1.5C for the time (albeit temporarily) within the next five years, modest changes within the Act still do not go far enough. It’s crucial that the regulatory framework ensures the UK financial services sector is facilitating – and not obstructing – the transition to a net zero and nature positive economy.

As introduced in July 2022, the aim of the FSM Bill is to drive growth and competitiveness in the UK financial sector. To achieve this, the Act repeals retained EU rules, enabling the government to deliver its Edinburgh Reforms, and gives financial regulators a new objective to advance international competitiveness and economic growth, amongst other reforms.

The Act also includes three important changes that will help to align the financial sector with the UK’s environmental goals, but more must be done to accelerate progress.

A new net zero and nature remit for financial regulators

Alongside the new statutory objective, the Act gives the FCA and PRA a new regulatory principle to consider the UK’s net zero emissions target and environmental targets.

Whilst this change is a good first step, regulators are not required to act to advance regulatory principles and only need to consider them.

The government should provide regulators with a stronger legal requirement to enable them to more comprehensively address climate and nature-related risks and to facilitate the net zero transition. This should happen when more progress has been made against the Net Zero Strategy and regulatory barriers, such as skills and capacity constraints.

A legislative footing for the Sustainability Disclosures Requirement (SDR) regime

The Act includes important developments for this regime, a new requirement for businesses and financial products to disclose sustainability information to provide investors and consumers with decision-useful information.

Under the Act, the Treasury is given new powers to prepare a SDR policy statement and to require the FCA and PRA to incorporate it within future rules and guidance relating to sustainability.

Further details on its implementation, first announced in July 2021, are expected this summer. As part of this the Government must clarify its vision of what reporting against the framework will look like, including guidance, rollout timelines and how it will streamline existing climate reporting requirements, so businesses can begin to prepare.

A review to assess the adequacy of regulation in eliminating deforestation financing

The Act requires the Treasury to carry out a review and report to Parliament within nine-months on the effectiveness of UK financial services regulation in eliminating the financing of illegal forest risk commodities – that is, goods and raw materials such as palm oil, cattle, and rubber whose processing contributes to tropical deforestation and degradation.

While better than nothing, campaigners have pointed out that the Global Resource Initiative Taskforce – an expert cross-sector body set up by the government – has already recommended that government introduce a mandatory due diligence obligation on business and finance when investing in or lending to businesses producing forest risk commodities. Considering this, it’s hard to understand the rationale for another review.

Whilst the Act is a significant upgrade compared on its 2000 predecessor, further action is needed to embed climate and nature comprehensively within financial regulation. We cannot wait another 23 years for a ‘once-in-a-lifetime’ opportunity to do so, though.

The government must build on the Act by setting out further details on the SDR regime, acting swifty on the findings of the review into deforestation financing, in the near term, and giving financial regulators a stronger mandate on climate and nature in the medium term.

James Fotherby is Policy Officer and green finance lead at the Aldersgate Group.