By Paul Kelly
The ESG investment space continues to thrive, Bloomberg Intelligence forecasting global AUM could exceed $50 trillion by 2025 assuming 15% growth, half the rate of the last five years. Last November’s COP26 climate change conference further whetted market appetite for environmentally sustainable investment products, financing and corporate conduct. In a previous piece we highlighted the lack of internationally agreed definitions, assessment criteria and reporting protocols across all sectors which make it impossible to compare options. Here we take another look to establish whether stakeholders are any closer to achieving clarity about companies’ and their investments’ green credentials. Are we all now playing by the same rules?
In a word, no. Regional variations in standards and understanding persist and, according to Richard Stone, chief executive of the Association of Investment Companies, “Unfortunately, we are still in a situation where too many ESG claims do not stand up to scrutiny.”
There are three main sustainability-reporting areas where regulation could create global uniformity:
- Company disclosures to provide adequate information for investors intent on allocating capital
- Investment product disclosures so parties can simply compare the relative merits of separate options
- Agreed, international taxonomies or classifications to create transparency and ensure all actors are talking the same language
Tentative steps have been taken towards achieving reporting clarity but the journey will be long and complicated. “With the focus on greenwashing, asset managers… have a lot more to come in 2022.”
The EU leads the limited progress so far accomplished, the first phase of its Sustainable Finance Disclosure Regulations (SFDR) coming into force in March 2021. With a goal of imposing ESG disclosure obligations on financial advisers and market participants, its remit focuses on the investment space. The legislation requires companies to report on the sustainability of their activities using a specified taxonomy (the Corporate Sustainability Reporting Directive, CSRD) and, in accordance with the SFDR cited above, asset managers must employ the same classifications to disclose their products’ sustainability.
However, introduction of the taxonomy has been delayed, much debate surrounding the inclusion or not of nuclear and gas under an environmentally sustainable umbrella. Precise practices governing asset manager reporting won’t apply until 2023, though since January they’ve been required to prove their products’ conformity with a taxonomy not yet signed off. Further complications have been introduced by the addition of extra rules by some member states including Germany, France, Belgium and Spain.
The US and the UK are each pursuing regulatory reform, the SEC and the FCA formulating rules to prevent financial organisations making false representations about their portfolios’ sustainability. The FCA is currently consulting on potential classification protocols, labelling and reporting strategies for investment products, having published a discussion paper in 2021. Its prospective categories:
- Not promoted as sustainable
have caused critics to express concern that investments labelled with the less onerous ‘Responsible’ tag might mislead parties into believing they’re greener than they are. The UK Sustainable Investment and Finance Association says the term “could inappropriately raise expectations and over promise what it could deliver for clients and savers… implying higher sustainability attributes.”
Unlike the EU’s concentration on the investment arena currently, both the SEC and the FCA are concerned with governing corporate conduct more broadly to prove the validity of sustainability claims. “In 2022, this regulatory moment will jump from Wall Street to Main Street.” The UK’s Competition and Market’s Authority (CMA) has developed the Green Claims Code which specifies six key points people can use to check whether a company’s activities are genuinely green. In April, the UK will become the first G20 country to impose mandatory climate-related reporting requirements on 1,300 of its largest companies and financial institutions. It is following recommendations from the Task Force on Climate-Related Financial Disclosures.
The SEC has advised Congress it plans to finalise regulations in 2022 it hopes will overcome two primary issues:
- Improved data quality and consistency to enable meaningful comparison
- Better disclosure responsibilities for climate-related risks
ESG metrics are big business; the industry exceeded $1 billion in 2021 and the assortment of service providers and their output is confusing and growing. Evidently, reform will not be in its interests. A study by Massachusetts Institute of Technology (MIT’s) Sloane School of Management concluded the array of procedures used to rank company performance make results nonsensical. Liesel Pritzker Simmons comments, “Ratings are fine, it’s a place to start… But being an impact investor means you have to look under the hood of what these ratings mean.” As we’ve urged before, investors need to check the label carefully.
The more optimistic among us hope COP26 was a turning point. The Glasgow summit led to the formation of a global consortium of financial regulators that will investigate the issue of inconsistent ESG data standards: the International Sustainability Standards Board (ISSB). Its aim is to institute global benchmarks for data reporting to ensure uniform, accurate sustainability disclosures for the benefit of investors and financial markets. It’s imperfect; the US is keeping it at arm’s length and the timings are uncertain. But it’s a beginning. Unless impartial, accurate global standards for classification, data and reporting are adopted we’ll be reliant on a meaningless network of disjointed regulation within which comparisons and insightful rankings are impossible.