Regulating ESG: What is the world doing about it?

Regulating ESG

A broad range of factors, including investor demands, are leading more capital to flow towards companies that are better equipped in terms of environmental, social and governance (ESG) factors. Governments worldwide are also incentivising ESG-focused activities, meaning more companies are expected to either move in this direction or emerge in the space.

The accelerated rise of ESG arguably began in 2005 when, on the initiative of the then UN Secretary General Kofi Annan, the world’s largest institutional investors developed the Principles of Responsible Investment (PRI). The PRI comprises six principles, directly relating to ESG issues, which signatories voluntarily agreed to adopt. There are now more than 3000 signatories contributing to the growth of the PRI.

In 2015, the UN General Assembly adopted the Sustainable Development Agenda, which has 17 interlinked Sustainable Development Goals (SDGs), including eradication of poverty, provision of education, clean energy, and climate action. The Paris Agreement, signed by various UN countries in 2016, increased focus on climate change and sought to channel finance towards achieving these goals.

But, in the journey towards cementing ESG as key investment criteria, what is being done about ESG regulation? In this article, we outline the regulatory initiatives currently underway within key geographic regions and look at the progress made to date in setting universal standards for ESG.

What is Europe doing about ESG?

As an overarching set of policy initiatives, the European Union has adopted the European Green Deal, which aims to make Europe climate neutral by 2050. Many initiatives are underway to achieve the 2050 goal.

The most relevant policies for financial institutions include:

  • A Disclosure Regulation requiring various financial institutions, including asset managers, to disclose at entity and product level how they build sustainability into the products they provide and how products branded as sustainable achieve their objectives. Most of the requirements will apply from 10 March 2021, however this date may be subject to change
  • A Taxonomy Regulation establishing the criteria to determine if an activity is sustainable or not. This is to stop ‘greenwashing’ of investment products by preventing them from being labelled as sustainable when they are not. Most of the provisions will apply from 1 January 2022. This regulation also imposes some entity level disclosures on listed entities
  • Other regulations including UCITS, AIFMD and MiFIDII are being updated to take into account sustainability measures, such as a requirement for asset managers to build sustainability related practices in their due diligence processes
  • Regulatory Technical Standards are also being finalised and are expected to be published in the coming months. These will include more details about some of the disclosure requirements mentioned above
  • A Green Bonds Regulation is expected to be released in the coming months.

What is the US doing about ESG?

Currently there is no major regulation in the US that oversees the implementation of ESG-related practices. However, the US Securities and Exchange Commission (SEC) has noted in its priorities its interest in determining the adequacy and accuracy of any ESG-related disclosures made by asset managers.

The Department of Labour (DOL), which is the regulator of Employee Retirement Income Security Act (ERISA) employment plans and also major contributors to alternative investments, has finalised a rule that requires ERISA plan managers to make investments based on their financial performance and not based on other factors.

Is there a universal set of standards for ESG?

There isn’t yet a suitable industry body to provide a universal set of standards that could harmonise ESG reporting. The main standard setters include:

  • Global Reporting Initiative
  • Sustainability Accounting Standards Board (SASB)
  • Task Force on Climate Related Financial Disclosures (TCFD)
  • IFRS Foundation (also considering launching its own ESG standard)

In September 2020, the World Economic Forum and International Business Council announced another set of standards, which have the backing from the ‘Big Four’ accounting firms. These standards look to create a list of standardised “Core” and “Expanded” metrics, aligned with the SDGs and principal ESG domains, with “the aim of amplifying the rigorous work already done by standard-setters instead of reinventing the wheel”.

Most recently, in October 2020, the United Nations Development Programme released its own set of voluntary standards as well, which are aimed at private equity, venture capital and debt funds and how they can contribute to the SDGs.

Staying up to date

As the ESG-related regulatory environment continues to evolve at a pace, and new policies and initiatives emerge from countries across the globe, we will look to issue further updates to keep our clients and industry partners updated.

In the meantime, if you or your clients need ESG-related support or if you wish to discuss your current ESG approach with us, please feel free to contact me or reach out to your usual IQ-EQ relationship manager.

Tom Miller
T: +44 20 7397 5529