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Emerging regulations for ESG disclosure
Environmental, Social and Governance investments are the talk of the market. More than 8 out of 10 investors have expressed interest in participating in ESG-focused investment opportunities.
So why not give the people what they want?
As is often the case with compliance, it’s not quite as simple as supply and demand.
Without the introduction of regulatory measures around ESG investments, the sector is exposed to fraudulent behaviour and financial risk-taking.
Therefore, governments and organisations around the globe are responding to this increased interest in ESG disclosure rules and creating robust regulatory frameworks to facilitate knowledgeable and safe investment decisions. In this piece, we’re going to discuss some of the most prominent emerging regulations for ESG disclosure.
Green Finance Roadmap: United Kingdom
The UK’s Green Finance Roadmap was introduced by Chancellor of the Exchequer, Rishi Sunak in November 2020. Its purpose was to outline the future environmental schemes and regulations in anticipation of meeting COP26 goals and the Paris Agreement.
The major features of the green finance roadmap included:
- Sustainability disclosure requirements
- Green gilt funding opportunities
- ESG investment into large-scale pension operations
- Reduction of greenwashing
Sustainability disclosure requirements
The Green Finance Roadmap has been formed in conjunction with the Task Force on Climate-Related Financial Disclosures (TCFD). This organisation is the first of its kind among G20 nations, and continually releases new best practices for UK companies who facilitate investment opportunities in the green space.
The TCFD has three major benefits:
- A more accurate and effective risk assessment of climate hazards on your company or organization (and therefore the proposed effects)
- More thorough and detailed capital allocation plans
- Better strategic planning for the long term effects of climate change
We expect to see more recommendations around transparency and disclosure requirements moving closer towards the 2050 Paris Agreement goals. Since 2016, these aims have been to help reduce climate change by 2 degrees celsius.
The Green Gilt is a funding opportunity for companies in the UK to make positive progress towards environmental goals. The companies who qualify will be classified into the UK’s Green Savings Bond, which will have an obligation to report on the socio-environmental impact of its projects.
The Green Gilt is facilitated by the TCFD, and the framework includes specific justification for budget allocations on a Green Register. The projects will be reviewed on an annual basis to audit their positive environmental effects.
This fits into the larger Green Claims Code, which has been published to help businesses and retailers comply with regulations. This manifesto aims to improve transparency across the entire supply chain to better inform consumers when they make purchasing decisions. The full scale of green impact will likely be clearer, as an impact of this code.
In the UK, 70% of the workforce expressed an interest in having their investments make a positive difference. This has been reflected in the Green Finance Roadmap, with specific provisions enabling pension providers to embed ESG into the overall investment strategy.
By 2023, the majority of trustee scheme managers will be subject to ESG related requirements for their pension strategies. The regulation will outline that climate change is the number one risk to financial investments and that actions must be taken to truly make a change, instead of just to comply with the regulation.
Disclosures and standards: European Union
The EU commissions have been leading global standards in ESG risk, disclosure and management for a long time. Alongside Asian markets, processes and systems for companies located in this region are required to comply with some of the most thorough and technical standards across the globe.
In an investigation by the European Commission, it was found that 42% of companies exaggerate their green claims. At the same time, 78% of consumers’ purchasing decisions were impacted by environmental impact.
The New Consumer Agenda has recently been amended to empower consumers with more transparency on green product purchases. As part of this, the “Green Transition” aims to furnish consumers with more reliable information, as well as standardising the environmental claims that companies are allowed to make. This should make comparisons of the environmental impacts of competing businesses much easier.
Sustainable Finance Disclosure Regulation (SFDR)
The SFDR was introduced by the European Commission in order to increase the number of sustainable investment products available, and provide more transparency around their impacts. We are expecting another significant update to this legislation around July 2022, after a six month deferral period from the original January timeline.
The update is likely to include amendments to mandatory ESG disclosure templates, whereby companies are required to declare the adverse environmental impacts of their projects. This gives investors advanced notice and security around the consequences of their investment decisions, which would previously have been kept as private information by the business.
In the update, we expect to see additional details around the standard disclosures and taxonomy regulation.
Markets in Financial Instruments Directive (MiFID)
The second iteration of the European Markets in Financial Instruments Directive was proposed in December 2021 and will introduce a number of climate-related measures. It is likely that we see will institutions become compliant gradually over time, as they continue to line up systems and processes with their regulatory obligations.
Unlike the SFDR changes above, the sustainability updates within MiFID apply more broadly to the market. They aim to push the popularity of ESG risk considerations and declarations for banks and financial institutions.
The change require firms to conduct suitability assessments for new ESG investing products, alongside risk management and preparations for governance.
Firms should note that, as well as this, MiFID fines for non-compliance are common and substantial, with over €8 million worth of fines issued in 2020.
Federal and government pressures: North America
As we’ve written about previously, the United States has been slow to follow the rest of the world with regards to ESG reporting. But change is coming to North America, with a renewed focus from the SEC and the all-round tightening up of security on ESG issues across regulators and issuing bodies.
The Securities and Exchange Commission (SEC) updates
It’s no secret that the SEC has focused largely on investigation into climate risk factors in recent years, though little action has followed and we are yet to see ESG disclosure rules.
In fact, reports over the last decade highlighted the lack of guidance around climate risks, including that 90% of the largest 500 companies used third party standards to quantify their assets. This led to the inaccurate categorisation of investments by asset managers and misled public investors.
In July 2021, it was announced that the SEC would produce a proposal for mandatory sustainability risk disclosures, coming into effect within one year.
The aim of this regulation is to ensure that information is “consistent and comparable”. For example, updates will include ensuring that a fund name accurately reflects its focus, given the significant growth in sustainable options, for example.
Special Purpose Acquisition Companies (SPACs)
Traditionally, SPACs are subject to far less regulation than other publicly traded companies, while not operating all that differently. Even without a focus on sustainability, the SEC has identified issues in the way that SPACs are able to advertise in order to condition the market.
Now, positive ESG performance has meant that SPACs with a highly prominent ESG factor are out-performing other investments on the market. As such, SPACs are gaining more attention from regulators.
In 2022, we’re expecting the introduction of more regulation forecasted around diligence and transparency for ESG metrics in SPACs. These standards are likely to increase in an ongoing manner as regulation grows and stakeholder expectations also evolve.
Fund managers will have a new responsibility to keep up with the disclosure requirement in order to meet these demands.
Office of the Superintendent of Financial Institutions (OSFI)
In Canada, there is a significant lack of current regulation around ES disclosure and transparency in financial services. However, a letter from Prime Minister, Justin Trudeau, prompted discussion into regulatory change as the effects of climate change grow as a threat.
OSFI announced that it would release a summary of comments in early 2022 in response to its recent consultations. The newly published blueprint report suggests that OFSI will introduce clearer rules around ESG regulation (particularly governance, with its Enterprise and Risk Strategy). Alongside this, they will launch climate panels and forums.
We’re moving in a good direction and we’re moving fast. Right now, much new legislation remains a pipe dream. We expect to see challenges arise throughout their implementation process. As with any industry-wide change, it’s up to the institutions and organisations leading the pack to be at the forefront of those changes, as well as highlight any teething problems. To get ahead of the pack, speak to a member of CUBE’s team.