What is happening with ESG?

Amid COP27, it seems timely to share the latest developments in Environmental, Social and Governance (ESG) regulations. Mandatory ESG reporting is continuously on the rise, even at a more product level. From the likes of climate-related concepts, disclosures, SFDR and TCFD – the sheer volume of ESG regulations is expansive and sustainable investing is the new Holy Grail.

Financial Conduct Authority vs greenwashing

On 25 October, as part of the Financial Conduct Authority’s (FCA) ESG strategy and Business Plan, new frameworks are introduced to crack down on greenwashing. Greenwashing refers to a false environmental claim by a company which suggests that they are sustainable.

Increasingly more investment products have been marketed as ‘green’ and ‘sustainable,’ and some of which the FCA have found to be “exaggerated, misleading or unsubstantiated,” damaging confidence in these products.

In a bid to “protect consumers” and “improve trust in sustainable investment products,” the new measures include restrictions on how terms like ‘ESG,’ ‘green,’ and ‘sustainable’ are used by firms and investment product sustainability labels are announced.

Sacha Sadan, the FCA’s Director of Environment Social and Governance, said: “Greenwashing misleads consumers and erodes trust in all ESG products. Consumers must be confident when products claim to be sustainable that they actually are. Our proposed rules will help consumers and firms build trust in this sector. This supports investment in solutions to some of the world’s biggest ESG challenges. This places the UK at the forefront of sustainable investment internationally. We are raising the bar by setting robust regulatory standards to protect consumers in line with our wider FCA strategy.”

The FCA’s proposal includes the following measures:

• Sustainable investment labels – these will have three categories, one of which will be for products looking to improve sustainability over a longer period. The labels aim to increase consumer trust in choosing the right products.

• Restrictions on terms such as ‘ESG,’ ‘green,’ or ‘sustainable’ – limiting how these terms can be used in product names and marketing purposes and tackling greenwashing covering all regulated companies.

• Consumer-facing disclosures – guidance to aid consumers in their understanding of the sustainability features of a product.

• Detailed disclosures – for institutional investors or retail investors that would like to find out more.

• Requirements for distributors of products – this includes ensuring that labels and disclosures are accessible and clear for consumers on investment platforms.

The FCA is also transforming its enforcement strategy – including evaluating if firms have made changes according to the expectations in the July 2021 Dear Chair letter.

The EBA investigates ESG risks on investment firms

On 24 October 2022, the European Banking Authority (EBA) publishes a report on the integration of ESG risks in the supervision of investment firms including existing risks to capital or liquidity.

It aims to assess the resilience of firms to potential financial effects from ESG risks such as climate change risk. The EBA recommends how to embed ESG in strategies and governance structures and how to manage these risks.

The report outlines three key points:

1. How ESG risks should be incorporated
2. Definition of ESG risks
3. The management of ESG risks building on the 2021 report

The conclusions of the report findings are:

• Existing assessments don’t capture vulnerability to long-term ESG risks, and the time span will be extended to at least 10 years.

• ESG factors and risks should be embedded in supervisory reviews in a proportionate manner. Consideration should be given to the investment firm’s size, business model, internal organisation, the materiality of its exposure to ESG risks and the nature, scale and complexity of its services.

• Integration of ESG risks should be completed progressively, beginning with a short-term implementation that concentrates on strategy, business model analysis and internal governance arrangements – in the future, assessing ESG risks on capital and liquidity.

• NCAs will be evaluating how investment firms identify, assess and manage their exposure to ESG risk as well as monitoring attempts in implementing processes to collect ESG data more effectively. 

The report outlines “the criteria, parameters and metrics by means of which supervisors and investment firms can assess the impact of short‐, medium‐ and long‐term ESG risks for the purposes of the supervisory review and evaluation process.” – EBA report.

For full details, please refer to the EBA report.

Review of Corporate Governance Reporting in the UK

The Financial Reporting Council (FRC) has completed its annual governance reporting review. It found that UK firms continue to improve reporting requirements as per the UK’s Corporate Governance Code.

Whilst reporting has improved year on year, there are “few companies whose disclosures meet the highest of standards.”

Key report findings

• There has been an increased level of transparency and disclosures – however, there was too much explaining and not enough complying – only 27/100 sample companies were fully compliant.

• There was little disclosure to report how company policies have changed to prove governance has improved.

• Firms would confirm risk management systems were effective or that there were no gaps in the system but did not explain how the effectiveness has been measured.

• Most firms explained their processes to mitigate risks but did not provide insight into the frequency of actions such as how often risks were reviewed.

• 43 out of 100 firms detected a risk but only 25 explained what the risk was.

• There is still further room for reporting improvements in areas such as substantive disclosures on Board appointments, succession planning and diversity.

During a time of financial uncertainty, the CEO of the Financial Reporting Council (FRC), Sir Jonathan Thompson believes “how companies govern themselves through these difficulties is more important than ever, and the UK Corporate Governance Code provides a clear and flexible basis to address governance policy and practice.”

This year, we have continued to see a good standard of reporting, but companies still need to go further in reporting how they apply the Code’s principles and comply with the provisions, describing the actions and outcomes that come from them to improve market confidence and facilitate better stewardship.”

The Code is not a “set of hard rules,” but a “guiding principle from the original Cadbury Report.” The Code consists of “principles which must be applied and provisions which allow companies to report on their governance on a ‘comply or explain’ basis, which enables investors to engage more effectively on material governance issues relating to individual companies.”

CUBE comment

The developments in ESG showcase a country’s determination in achieving consumer protection, reducing environmental damage, and sustaining a financial system that is fair, transparent and operably excellent.

But new reporting measures could create a lot of additional work for compliance teams. There is a need to automate this reporting process to decrease the burden for firms and reduce the chance of falling behind.

RegTech provides the opportunity to automate regulation and take over basic-level regulatory processes, allowing compliance officers to focus on higher-value activities. Humans and AI can work collectively to improve a business’ compliance and reduce the risk of non-compliance.

Want to hear more? Contact us below.