Not a week goes by in the world of sustainable investing without a new development in regulation, but the picture from one global region to another can differ vastly.
Europe is leading the way by putting a regime for sustainable finance at the forefront of its agenda, while the US begins to take it’s own steps to legislate directing investments towards more ESG-friendly projects. Meanwhile, ESG regulatory regimes in Asia Pacific are diverse, but the overall picture shows moves towards improved data and disclosures.
ESG Clarity asked three commentators to outline the key developments in ESG regulation over the past few months, and where it is headed in their respective regions this year.
Europe and UK: Taxonomies taking shape for E and S
UK Sustainable Investment and Finance Association (UKSIF)
“One of the biggest regulatory developments spurring momentum in our industry recently was the latest report on a social taxonomy published by the EU Platform on Sustainable Finance.
“While discussions on taxonomies in recent years have focused overwhelmingly on defining what is environmentally sustainable, this report looks at how we can address serious social issues more meaningfully in investments. It covers the areas including modern day slavery, labour rights, diversity, and employees’ mental health.
“Taking its thinking quite a distance away from its initial report last summer, the platform outlines three broad objectives for a social taxonomy to pursue:
- decent work (including for value-chain workers);
- adequate living standards and well-being for consumers of products and services;
- and inclusive communities.
“Each objective will include more specific sub-objectives.
“The proposals align closely with the structure the EU’s green taxonomy. For example, investors’ alignment with a social taxonomy would be based on delivering a “substantial contribution” to one of these three objectives, while avoiding significant harm to the others.
“These efforts at alignment are very welcome – they could ensure the two taxonomies, in future, do not pursue conflicting end-objectives. And it could allow investors to compare the degree to which funds are aligned with either taxonomy.”
Learning from EU
“UKSIF strongly supports continued exploration of a social taxonomy in the UK too. This could drive a positive focus among investors and companies in addressing the pressing social challenges we face that will be vital to delivering a net-zero future.
“The European Commission may be reluctant to step up this work, as the green taxonomy is yet to be implemented. The EU Council and European Parliament are continuing to scrutinise the complementary delegated act which provides for the inclusion of certain nuclear energy and natural gas activities in the taxonomy. We expect this debate to begin shortly in the UK. Our position remains strongly opposed to the inclusion of these energy sources within a green taxonomy.
“The inclusion of gas and nuclear would have critical implications for the UK’s new initiative on an investment labels system, which aims to help consumers compare the range of sustainable funds in the market. The UK’s taxonomy is likely to underpin the labelling system, with funds categorised under different labels depending on the taxonomy-alignment of a fund’s underlying investments. Should nuclear and gas form part of the taxonomy, this could lead to savers raising questions over their funds’ sustainability approach.
“In the months ahead, more attention should be paid to links between the taxonomy and investment labels in the UK. It will also be interesting to see how Europe makes inroads into new areas of sustainable finance and see how the UK can continue to learn from the Europe’s approach.”
US: The SEC’s forthcoming climate risk disclosures
Brandon Cooperman, senior manager at Mazars
“There is increasing interest in ESG across all stakeholders over the past several years in the US. Recent analyses of fund flows in asset management highlighted the increase in ESG-directed investments in 2020 and 2021. As investment dollars have followed the interest in ESG, there is increased regulatory focus, especially from the Securities Exchange Commission (SEC).
“While ESG is a broad topic, the focus of the SEC, consistent with its mandate of protecting the interest of investors, includes monitoring advertised claims on ESG approaches and investing guidelines, and measurement and climate change risk.
“Based on recent regulatory statements and positions, it is expected the SEC’s first ESG regulation will focus on climate change and disclosures surrounding climate-related risks.
- “In early 2021, then-acting SEC chair Allison Herren Lee directed the Division of Corporate Finance to enhance its focus on climate-related disclosures in public filings. The SEC received more than 600 responses from market participants. The sentiment among market participants overwhelming supported disclosures that would provide more transparency on greenwashing in an effort to strengthen public trust.
- “In 2021, the SEC also created a Climate and ESG Task Force in the Division of Enforcement to identify gaps in public company disclosures of climate risk under current rules.
- “In November 2021, SEC chair, Gary Gensler, mentioned before the Asset Management Advisory Committee that he had “directed staff to review current practices and consider recommendations about whether fund managers should disclose the criteria and underlying data they use to [market themselves as green, sustainable, low carbon, etc.]”
Time to prepare
“While currently no specific new regulations have been put in place, the asset management industry must act now and be prepared to meet the volume of information on climate risk that it will receive for all assets under management and increasing demands for climate-related disclosures.
“In order to tackle the task, asset managers should consider a broader ESG strategy by:
- Implementing an operating model with governance and oversight at its core
- Embedding appropriate ESG-related monitoring and surveillance controls and processes
- Using standardised, comparable and reliable data that measures the return to shareholders
“Expect the SEC’s forthcoming climate-related disclosure rules to be comprehensive, industry-specific, likely mandatory, and primarily based around the Task Force on Climate-Related Financial Disclosures (TCFD) framework. Asset managers should take proactive measures to ensure regulatory preparedness and ease the transition to the coming wave of regulation.”
APAC: Transitioning ‘factory Asia’ to clean, green and inclusive growth
Gabriel Wilson-Otto, director, sustainable investing at Fidelity International (based in Hong Kong)
“Over the past five years, mindsets in the APAC region have shifted towards recognising the need of sustainable and equitable growth, as opposed to growth at any cost.
“Since 2016, the number of new ESG regulations or amendments in the region has doubled. Keeping up with the news flow often feels like trying to drink from a firehose. To aid digestion, it can be helpful to group regulations into three broad categories:
- Enhancing corporate disclosure
- Taxonomies or classifying the activities that are green or sustainable
- Labels or minimum criteria for sustainable investments
“Mandatory, or “comply or explain”, ESG disclosure requirements have been adopted by many regulators in the region. As a result, corporate disclosure of common ESG data has improved significantly in the APAC region and is now roughly on par with the United States.”
“More recently, regulators have shifted their focus to the quality of ESG data provided and effective risk management.
“To help prevent boilerplate policies and a compliance mindset – as opposed to a strategic approach – to ESG data disclosure, there has been a shift towards regulating disclosure of the governance framework and strategies that underpin ESG disclosure. An example of this is the adoption of climate-related risk disclosures in line with, or at least strongly influenced by, the recommendations of the TCFD.
“High-quality information is a cornerstone of effective decision-making and capital allocation, so it is no surprise that regulation has focused on establishing critical building blocks to differentiate between sustainability leaders and laggards.
“In this regard, APAC appears to be following in Europe’s footsteps. In Europe, corporate disclosure, taxonomies and fund disclosure requirements have helped facilitate strong inflows into sustainable investing products. In the fourth quarter of 2021, Article 8 and Article 9 products captured over 60% of all inflows in Europe.
“The current trend in the Asia Pacific region looks set to continue and could result in reshaping not only capital flows, but the valuations of issuers that make balance growth with positive environmental and social outcomes.”