ESG Regulation: What Next?

At this year's Regulatory Horizon 2022: Preparing for the Challenges of Tomorrow conference, we examined key governance, risk and compliance challenges that firms face in 2022, and beyond. A whitepaper has now been developed, capturing key takeaways and benchmarking polls from the event.

This blog features one of the nine chapters in the paper. Click here to view the full paper and access on demand recordings of panel sessions embedded throughout.

Overview

• Regulatory bodies are taking an increasingly active role in setting standards and requirements for environmental, social and governance (ESG) topics.
• With increases in investor demand for ESG information expected to increase, regulators across the globe are likely to continue their recent rulemaking push.
• Companies can best prepare for this more aggressive regulatory posture by working to take a more holistic view of ESG and moving the issue out of its common siloed location within assurance functions.

ESG regulation: What next?

An Increasing Regulatory Focus on ESG

With a surge in investor interest in ESG topics, as well as numerous firms attempting to set themselves apart from their peers through their commitments to issues like climate and sustainability, regulators have been busy working to establish consistency and transparency around ESG claims.

Firms with operations in the UK will be aware of the increased activity from the FCA on ESG issues. During the past year, Taskforce on Climate-Related Financial Disclosures (TCFD) has come into effect, the FCA has created an entirely new division to oversee ESG-related issues, and it has also clarified its strategic direction and focus areas for ESG issues. At the time of the conference, the FCA’s official strategy statement had not yet been released. However, the Business  Plan 2022/23 was subsequently published on 7 April 2022.

Tim Rowe, Manager in the FCA’s Sustainable Finance Hub, noted that the FCA is really focused on five “Ts” for its ESG strategy. These include:

• Transparency – Working to provide the public with greater visibility into climate and sustainability related issues.
• Trust – Building trust in the broader ESG ecosystem.
• Tools – Partnering with external experts to develop the resources firms need to be able to maximize their positive impact on the climate.
• Transition – Supporting broader Net Zero goals by working to move firms away from fossil fuels.
• Targets – Establishing metrics and outcomes that firms can work towards to help them understand their impact on climate and ESG topics.

For firms with a presence across the EU, the regulatory environment is changing just as rapidly. As Ruth Knox, Partner of ESG & Impact at Kirkland & Ellis International, highlighted that the Sustainable Finance Disclosure Regulation’s (SFDR) first phase of implementation took effect in March of 2021. And, with its implementation, there has been a bit of a shock to many European firms that were used to disclosure requirements that were voluntary and could be completed using more generic disclosure or tools. With Phase 2 of SFDR less than a year away, firms are working to try to keep pace with the rapid pace of regulatory expansion in the ESG space.

Challenges of Existing ESG Regulations

As the regulatory landscape has solidified across the UK and Europe, there has been progress made by many firms to raise the profile of ESG concerns within their firms, and to provide investors with greater clarity and transparency into the impact they have on the environment and their communities. However, the recent regulatory focus on

ESG matters has also created challenges for firms and learning opportunities for regulators.

For most firms, the struggle has typically centred around unclear interpretations of regulatory guidance, and/or difficulty in gathering the data necessary to complete the required disclosures. As Ruth noted, at times understanding aspects of regulations like SFDR’s Articles 8 and 9* has been extremely difficult for firms, and the guidance provided by regulators has, at times, added to the confusion of how regulations should be understood. Even when firms do have  a clear sense of what is expected of them from certain regulations, gathering data in areas such as Scope 3 emissions is often very challenging for firms.

Regulators understand these challenges, Tim explained, there are several lessons the FCA has learned in its experience rolling out recent rulemaking in the UK. For example, he noted that the FCA is working to create greater clarity around the objectives of it’s regulations.

While the UK’s rulemaking is often similar the EU’s, the FCA’s goal is to make sure that UK firms clearly understand how the objectives may differ between different regulations, as that can help ensure greater clarity in understanding how to interpret new regulations.

Additionally, the FCA is committed to increasing the communication flow between firms and the regulatory, working to be as transparent as possible about its expectations and guidance around this new rulemaking. Given the technical nature of some of the recent climate- related regulations, this increased communication and goal clarity will be essential in creating regulatory regimes that are not burdensome for firms.

What’s Next for ESG Regulations

Since it is likely that investors and civil society more broadly will continue to be interested in ESG related issues, regulators will likely continue to push firms for greater clarity and comparability in their ESG claims and disclosures. This will likely include greater efforts by regulators to address more advanced issues within the environmental space (e.g., unintended “greenwashing”). There will also likely be a greater focus on regulation related to other categories of ESG outside of the “E”, with new rulemaking likely in the social and governance areas as well.

For firms, these issues are sufficiently broad and complex that there will need to be an intentional effort to hire staff with specific ESG skills and/or upskill existing staff to make sure that they are able to respond to new requirements. However, the most important steps for firms will need to be involved in the discussion around new regulations. Regulatory bodies like the FCA are interested in direct input from practitioners, and feedback on how proposed rules or disclosures would impact day-to-day operations. So, firms should take a proactive approach towards potential rulemaking and regulations, being involved in the conversation early to help regulators understand their position and their concern.

About the articles

• Article 6, firms that do not promote sustainability,
• Article 8, firms that promote sustainability and have ‘E’ and/or ‘S’ characteristics; or
• Article 9, products which have sustainable investment objectives at its core.

On Demand Webcast

Click here to watch a recording of the panel discussion on which this article is based. 

Questions?

Our specialists are on hand to help you to navigate these challenges while considering the complexity of your firm’s unique compliance, managed services, and ESG requirements.

In addition, our ESG advisory team are on hand to help you gain clarity on your ESG requirements and build a strong ESG program that meets incoming regulatory needs. This practice helps firms of all sizes develop and monitor ESG programs to mitigate risk, make informed choices, grow profitably and sustainably, and combat greenwashing in the process. 

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