ESG regulatory requirements are evolving fast. The UK and EU have made a particularly strong start, with many requirements due in 2023 and onwards. In this blog, we explore three key regulations: Sustainable Finance Disclosure Regulation (SFDR), The EU Taxonomy and the Taskforce on Climate Related Financial Disclosures (TCFD) and offer our analysis on what these developments mean for the industry.
SFDR seeks to eliminate greenwashing, improve transparency and create a standardised approach to sustainability disclosures within the EU financial services sector. It specifically applies to EU asset managers.
A product classification system is used to categorise funds according to sustainability characteristics: Article 9 funds must follow a sustainable investment strategy, Article 8 funds should promote environmental or social characteristics but do not need to formally target a sustainable outcome, and Article 6 funds do not promote ESG characteristics or have a sustainability scope.
On 1 January 2023, the Level 2 RTS went live, further enhancing transparency and disclosure requirements. The RTS set out low-level specifications for the content, methodology and presentation of disclosures outlined in SFDR.
However, in the lead up, there has been some confusion over the sustainability rules, with many asset managers arguing a lack of clarity on the requirements for Article 9 funds.
Under the climate of increasing regulatory scrutiny, and in preparation for the now live RTS, many asset managers also downgraded ESG funds from Article 9 to Article 8 during the final months of 2022. Among them were HSBC, Blackrock, Invesco and UBS Asset Management.
The EU Taxonomy was established as a tool to help investors make better informed decisions. Aimed at over 11,000 organisations, the system is focused on Financial Institutions and large companies with 500 + employees.
Eligibility reporting is a pre-requisite for a company to officially align. Alignment must be disclosed containing information on how the eligible activities align to one (or more) of the six environmental objectives as detailed below.
In 2022, large companies were mandated to report the first two objectives, and in 2023, these same companies must report on the remaining four. Secondly, the activities disclosed must ‘Do no significant harm’ (DNSH) to any of the other objectives, while respecting basic human rights and labour standards.
- Climate change mitigation
- Climate change adaptation
- Use and protection of water and marine resources
- Transition towards a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems
Given the threefold positive effects that the EU taxonomy will have for organisations themselves, investors and wider society, it is only a matter of time before other regions begin to adopt similar practices. Currently, the EU Taxonomy applies strictly to the EU.
As an example, we are already beginning to see the UK seeking to implement similar requirements. Despite the UK government pausing the exploratory phase due to the ‘complexity’ of implementation at the end of 2022, as we see the success of implementation of the EU taxonomy play out, it is to be predicted that expansion of a standardised Taxonomy system will be adopted soon.
TCFD is an international reporting framework, with the aim of ensuring consistency and comparability for climate-related financial disclosures. Companies who choose to report (or are mandated to) must align their disclosures with the four key areas: Governance, Strategy, Risk Management and Metrics & Targets.
The UK was the first to mandate TCFD disclosures and as of 2023, all UK companies that are currently required to produce a Non-Financial Information Statement must comply with TCFD.
Premium listed companies were initially mandated to disclose in 2022, and the FCA have since conducted a report to assess the extent to which regulatory intervention resulted in ‘material improvement’ in reporting. Following a review of the FCA’s analysis, we were able to interpret that the TCFD may be challenging for slightly smaller companies, and those that may not have adequate tools and systems to align to the quantitative features.
In addition, companies which are implementing or enhancing their net-zero strategies should be mindful of misleading statements, which could be called out or highlighted by TCFD’s guidance. However, the TCFD framework may provide a clear path to ensuring concise net-zero strategies, thus promoting a reduction in greenwashing.
From an international perspective, TCFD disclosures, or similar, are being considered in various jurisdictions, as outlined below. We can therefore expect TCFD to result in increased data quality around climate-related disclosures, and a more tangible path to achieving net-zero commitments.
- The US are considering the improvement of climate-related disclosures which follow a similar framework to TCFD
- Hong Kong has mandated TCFD for financial institutions and listed companies by 2025
- The Swiss financial regulator requires large banks and insurance companies to provide TCFD disclosures, as of 2021
- TCFD has been made mandatory by the G7, with most nations planning to implement these in the coming years
How can DC help?
Delta Capita offers Regulatory and ESG Consulting and Technology Services that provide insight, capacity and expertise to help companies maintain their commitment to global sustainability objectives and comply with regulatory requirements.
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This article was co-authored by Clementine Elcock, Consultant, Catrin Davies, Consultant and Amelia Wood, Analyst.