Five policy and regulatory trends shaping the sustainable investment landscape

HSBC Global Asset Management's Stephanie Maier identifies sustainable trends that are critical in post Covid-19 world

The global response to Covid-19 has not held back the rapid evolution of the sustainable finance policy landscape. These policy shifts are set to change the way capital is channelled, and will be critical as we consider what our economic recovery may look like.

We look at five policy and regulatory trends shaping the investment landscape:

  1. Policy ambitions are high and moving to the centre stage … at least in some jurisdictions

Regulations are commonly reactive: responding to, rather than driving the agenda. However, the European Commission was an early and committed actor in developing a regulatory approach to build a financial system that supports sustainable growth. The recent Sustainable Finance Strategy consultation outlines further areas where policy can intervene. This includes increasing investment in sustainable projects, further integration of climate and environmental risks into the financial system and supporting both the European Green Deal and European Sustainable Investment Plan. EU Member States have positioned the European Green Deal as an important element in medium to long-term recovery planning post Covid-19. For the world’s second largest economy, the role of sustainable finance policy is firmly established; and we think others will follow suit as markets across Asia look to the opportunities of unlocking sustainable finance.   

See also: – How regulation can level the ESG playing field

  1. Sustainable finance regulation is accelerating

The pace of regulation focused on corporate disclosure of environmental, social and governance (ESG) and in particular climate-related factors, stewardship and institutional investor duties is accelerating. According to the Principles for Responsible Investment (PRI), policy measures now number over 730 hard and soft-law policy revisions, across 500 policy instruments that support, encourage or require investors to consider long-term value drivers, including ESG factors.

These developments are increasingly catalysed or supported by detailed national sustainable finance strategies as governments recognise not just the climate and environmental risks embedded in the current system, but also the advantages of attracting long term capital to support the transition to a more sustainable economy. Many financial centres are also vying to become sustainable finance hubs as the need and market for innovative finance and investment solutions grows.

Given this inevitable trend towards further policymaking, it is no surprise that we are seeing an increase in investors engaging with policymakers, regulators and standard-setters with multiple open consultations currently taking place across the EU.

  1. Next generation stewardship

Investors are set to play a central role not just in their allocation of capital, but importantly as stewards of the investments they own or manage.

Following the first UK Stewardship Code in 2010, the 2020 code establishes a new benchmark for stewardship and the role of investors in the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries. This is important and needed because it outlines the potential for this activity to lead to sustainable benefits for the economy, the environment and society. The revised principles include a renewed focus on purpose and outcomes, and an expanded scope to include systemic risks and activities across all asset classes.

These changes in voluntary codes plus an increase in regulatory requirements, are set to change the nature, emphasis and reporting expectations of stewardship activities over the next few years. The current crisis has also brought renewed scrutiny on the role of investors in supporting companies for long-term value preservation and creation. We are likely to see an increase in focus on the ‘S’ in ESG, with issues such as the treatment of employees, inclusion and broader societal purpose, coming to the fore.

  1. Disclosure moving from voluntary to mandatory … and expectations are ratcheting

We are likely to see an increase in jurisdictions with mandatory disclosure requirements by 2022. Previously, ESG disclosure frameworks tended to be voluntary and principles-based, but the new requirements are more technical and implementation-focussed. Additionally, central bank supervisors are already making plans for climate-related stress testing. This should be a key priority for convergence between the members of the Network for Greening the Financial System who recently published their first set of climate scenarios.

The new EU Sustainability‐Related Disclosures Regulation outlines further requirements, including a policy on the integration of sustainability risks, due diligence process, and aligned remuneration. The recently finalised EU taxonomy, which identifies technical screening criteria for economic activities which can substantially contribute to climate change mitigation or adaptation, provides the foundation for a number of legal obligations. This includes requirements for financial market participants offering financial products in the EU. It will also provide the foundation for further regulations, standards or labels for green financial products or green bonds.

The first requirements are currently due to come into place in December 2022 and its influence is likely to expand as work continues to develop criteria for the remaining four environmental objectives.

  1. Focus on real economy impact

The driver for many of the policy and regulatory changes we are seeing is the recognition that financial flows are not currently aligned to support a sustainable and resilient economy. Sustainable finance policy plays an important role in addressing both financial and investment risks associated with unsustainable practices and transition risks, as well as the role of the financial system in the real economy.

However, the finance system cannot deliver a sustainable transition alone. Governments are now making ‘net-zero’ commitments, which will need to be supported by legal and policy frameworks. The EU Green Deal sets out such an ambition with associated strategies which imply further real economy policy in areas such as the circular economy, building efficiency and vehicle emissions. The importance of policy in influencing the investment implications of a transition to a low carbon economy is starting to be explored more routinely in climate-related scenario analysis These policies will have implications for company’s shareholders and bondholders, and their preparedness for these changes will determine whether they will be winners or losers in the low carbon transition.

The transformative role of the financial system in shaping and financing the real economy is likely to remain a key area of focus in the post-Covid-19 recovery phase and one investors would do well to prioritise.

Where do we go from here?

As economies begin to open up and move into the post-Covid 19 world, a proactive approach to engaging with policy makers is both sensible and potentially beneficial to the private and the official sector. As investors we understand the long term benefits that investing in higher rated ESG companies can have, not only on client’s portfolios but also the planet overall. It is important that regulators are starting to harness this influence too.

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Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity and has been an investment journalist for 16 years. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021, and was Winner...