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ESG standards: From mainstream to mandatory

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Earlier this month, two ESG experts sat down to discuss the rapidly evolving ESG landscape as part of the Sustainability and Impact Investor Forum (SIIF). In conversation were Vanessa Barnett, FactSet’s Global Head of ESG, and Marye Cherry, EU Regulatory Counsel with Compliance Solutions Strategies. This blog follows up that conversation and considers the impact of the developing body of ESG regulation.

In recent years, there has been a huge shift in ESG. Following the mainstreaming of voluntary ESG standards—SASB (Sustainability Accounting Standards Board), the Principles for Responsible Investment, and the Global Reporting Initiative—we are now in a season of rapid changes within the ESG space. ESG regulation has begun to supplant voluntary initiatives.

The European Landscape

Spurred on by the EU’s Sustainable Finance Action Plan, the first wide-ranging ESG regulations have been implemented within the EU. These regulations include the Sustainable Finance Disclosure Regulation (the SFDR) whose initial rules came into force in March 2021. The most visible outcome of the legislation was the product-classification exercise made on 10 March. Approximately 30% of EU funds were classified as ESG products (as either Article 8 or Article 9) and that number is steadily increasing. The next step under SFDR is the upcoming Level 2 regulatory technical standard, which will resolve the final form of the entity-level and product-level disclosures for ESG products. The Level 2 should also provide more clarity around product classification, as well as the timing for Article 8/9 product disclosures.

In addition to the SFDR, the EU has progressed its EU Taxonomy, with the development of the first two sets of six detailed technical screening criteria under the EU Taxonomy. These first sets focus on climate change adaptation and mitigation and raise a number of practical issues around implementation. When seeking to operationalize the EU Taxonomy, one is confronted with the challenges relating to: lack of available data at the issuer level, lack of relevant granularity in the available data, and potential inconsistencies in methodology when attempting to map a company’s activities to the EU Taxonomy’s classification system. Currently, there is no direct corporate disclosures that provide this information and the proposed Corporate Sustainability Reporting Directive (CSRD) is expected to fill this data gap with amendments to the Non-Financial Reporting Directive. In the meantime, data providers like FactSet are working closely with the European Commission to map existing industry classifications to the EU Taxonomy activities.

The UK Path to ESG

With the advent of Brexit, and the now-separate region of the UK, there is already divergence in ESG regulation. The UK has elected not to adopt the EU’s suite of ESG regulations; instead, the UK has set out a roadmap towards mandated disclosures per the standards of the Task Force on Climate-Related Financial Disclosures (TCFD). The roadmap envisions TCFD disclosures across the UK economy within the next five years. This marks the first time a voluntary ESG standard is adopted as a mandatory standard. And the UK’s approach may well set a trend for other regions.

ESG Trends in the US

The Biden administration brought an immediate focus on ESG in its first six months. First, it has moved to reverse the anti-ESG policy of the previous administration—by re-signing the United States to the Paris Accord and by reviewing controversial Department of Labor rulemaking widely viewed as discouraging of ESG investments in retirement plans. The SEC, under President Biden, has signaled both its intention to monitor ESG marketing as part of its examination process as well as its increasing readiness to mandate disclosures in the context of environment or climate change. Regarding the latter, the SEC has sought public comment on potential climate-related financial disclosures, aimed at “facilitating the disclosure of consistent, comparable, and reliable information on climate change.” More than 5,500 individuals and entities submitted comments.

Where to Focus

For firms with global reach, one way to address the growing body of ESG regulation, and the accompanying divergence, is to focus first on the impact of, and potential compliance with, the EU’s SFDR and Taxonomy. The UK is committed to disclosures under the TCFD, a less-detailed standard than the EU suite of legislation. While the US is still exploring to what extent to impose ESG disclosures, it appears to be honing in on climate-related issues. For the foreseeable future, therefore, the EU will have the most comprehensive and detailed set of ESG regulation with increasing detail coming under, among other developments, the SFDR Level 2 standards and further sets of technical screening criteria pursuant to the EU Taxonomy.

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