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The missing cornerstone in sustainable finance: investee company ESG reporting

The rush to regulate financial markets to produce ESG outcomes has brought focus to a problem: in the absence of good quality ESG data from investee companies, asset managers and investors are stumbling towards sustainability on a barely lit path. Greenwashing – false claims about the sustainability virtues of a product, strategy or company – could be rife, and it is difficult to fully demonstrate ESG credentials in any case.

So far, reliable and comparable ESG data has been lacking. However, a spate of recent announcements looks set to change this.

  1. The International Financial Reporting Standards (IFRS) Foundation, an accounting standards organisation, plans to publish a global ESG reporting standard in the latter part of 2022. The standard is to be overseen by a Sustainability Standards Board (mirroring the structure of the International Accounting Standards Board, the standard-setter for corporate financial reporting). Frankfurt, London and others are battling it out to host the new board and to be considered the global leader in sustainability. The big question for the global standard is whether it will primarily serve the needs of investors or whether it will seek to serve several stakeholders, including governments and NGOs. Asset management responses to a recent consultation on the topic argued that standard-setters should follow the money: investors should be prioritised as the primary drivers of ESG outcomes (see our blog about the IOSCO consultation). Ultimately the content of the global reporting standard will be a compromise between the various existing reporting standards, each with their own aims, and with a commitment to collaborate. The scope, format and content of the standard is forthcoming. Ultimately the standard will need to be adopted in law by jurisdictions or be a voluntary standard that companies adhere to alongside any mandatory reporting required by their local regulators.
  2. While the IFRS standard will seek to capture the breadth of environmental, social and governance factors, progress is already underway on climate-related disclosures. The G7 economies recently agreed to adopt the Taskforce on Climate-related Disclosures (TCFD) standard. Hong Kong and the UK have begun to mandate TCFD disclosures for listed companies. The FCA is currently also consulting on requiring asset managers and institutional investors to produce TCFD reports.
  3. The EU has been the first mover in ESG regulations but has so far largely focused on investors rather than investees (although the Taxonomy Regulation will require certain companies to produce environmental reports from 2023). However, the European Commission has announced that it will legislate for a Corporate Sustainability Reporting Directive (CSRD, not to be confused with the EU’s trade settlement regulation, CSDR). The regulations will mandate ESG reporting for around three-quarters of EU companies. The Commission’s intention is for the EU’s rules to be consistent with global reporting standards, although the details remain to be seen. Draft legislation is expected in 2022 and is planned to enter into force in 2024. In addition, the Commission intends to regulate ESG scores and data providers.
  4. Since Brexit, the industry has waited to see if the UK will adopt the EU’s approach to ESG matters. The Chancellor’s Mansion House announcements confirmed that UK policymakers are looking to EU regulations, such as the Taxonomy Regulation and wish to ensure broad consistency with EU rules but will adopt their own approach. Central to this will be Sustainability Disclosure Regulations. The standards will be integrated with an aim of ensuring consistency between investee company and asset manager and institutional investor disclosures. All eyes will be on the UK Budget on 27 October and the COP26 conference in Glasgow at the beginning of November for more announcements.
  5. The change in administration in the US has brought a change in tone towards sustainability, and a re-accession to the Paris Climate Accord. Although US regulators’ approach so far has been to enforce first and legislate later. The SEC has asked for public input on climate change reporting as part of its integrated disclosure system. It has also noted “the virtues of achieving a single global ESG reporting framework”. But legislative battles lie ahead with some in Congress arguing that the SEC must have a legislative mandate, particularly if it is to adopt an international ESG standard.

Overall, these developments are positive. If asset managers and others are to be required to produce ESG outputs, they will need ESG inputs to do this effectively. Increasing the quality and availability of ESG data should drive down the costs of buying ESG data (a current complaint for managers), help investors to make better decisions and reduce the risks of greenwashing.

Although it is evident that there remains a long way to go to achieving these aims. Consistency between ESG standards will be necessary to ensure that global capital flows can continue. The sheer number of political and regulatory actors, and the range of interested groups, makes this challenging. The verdict for now must be cautious optimism.

In the absence of good quality ESG data from investee companies, asset managers and investors are stumbling towards sustainability on a barely lit path.

Tags

investment management, financial services, esg, brexit, corporate, finance, regulated funds, private funds, credit funds, hedge funds, institutional asset managers, alternative afm

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