Reviewing the continued evolution of the regulatory landscape and the role of the regulator

Arthur Carabia, Director of ESG Policy Research, Morningstar Sustainalytics

Below is an insight into what was spoken about in Arthur’s session at ESG Europe 2024.

The views and opinions expressed in this article are those of the thought leader as an individual, and are not attributed to CeFPro or any particular organization.

How has the regulatory landscape and role of the regulator evolved?

Over the past five years, policymakers globally have initiated regulatory measures pertaining to sustainable finance, aiming to achieve two complementary objectives: supporting net-zero ambitions and mitigating the risk of greenwashing. Initially, the focus was on financial market participants, mandating ESG disclosures (e.g., SFDR, SDR) and integrating ESG into risk management. The expectation was that the influx of ‘sustainable’ capital would prompt issuers to adopt similar disclosures and transition towards more sustainable business models. However, this anticipation has not fully materialized. Consequently, policymakers are now concentrating on issuers by standardizing sustainability disclosure (e.g., CSRD, ISSB standards) and mandating due diligence in value chains and transition plans (e.g., CSDDD). Simultaneously, rules for investors are being expanded and refined (e.g., ESMA guidelines on the use of ESG terms in fund names).

What are the key takeaways from the FCA’s updated sustainability disclosure regime?

SDR shares a similar objective with SFDR, aiming to mitigate the risk of greenwashing and protect retail investors, but it takes a different approach. SDR is less prescriptive in terms of data but paradoxically more holistic than SFDR, incorporating elements such as stewardship requirements, naming rules, and an explicit transition label. While SFDR relies mainly on newly created data points (Taxonomy, PAI, Sustainable Investment) and a dual fund classification regime (Article 8 and 9), SDR’s strength lies in its naming rule, establishing minimum standards for using sustainable/impact-related terms in fund names through four nuanced labels (focus, improver, impact, mixed).

How can institutions ensure they effectively work towards implementation requirements of CSRD standard in January 2024?

Companies issuing their first CSRD report in 2025 should be relatively well-equipped, having been subject to NFRD reporting and gaining several years of experience in double materiality reporting. However, it won’t be without challenges, as they now need to navigate extensive and granular standards covering a broad range of ESG topics and data points. This is likely to increase the volume of sustainability information disclosed by issuers, necessitating additional resources to meet the new reporting obligations.

In what ways has the delayed implementation of current regulations effected ESG related risk on financial institutions?

The sequential implementation of reporting obligations (financial institutions first, followed by non-financial companies) has posed a significant challenge for financial market participants. They have sought assistance from data providers to fill gaps. For certain ESG topics estimation models can be credibly leveraged (e.g. GHG), while others face challenges due to data gaps that credible proxies cannot alleviate (e.g. gender pay gap). This is one reason why SDR, learning from SFDR, adopts a less data-prescriptive approach, contributing to a global push to enhance corporate disclosure.

 Why is excessive regulation a challenge in the UK and Europe and how can financial institutions effectively mitigate this?

The primary challenge appears to be the lack of clarity and legal certainty around rules. Regulating of the ESG space is an iterative process. Policy makers are continuously refining and sometimes changing positions. Given the non-trivial nature and cost of adapting the classification or terminology of a fund, a conservative approach to claims is often preferred in this context.  Another challenge is the multiplication of rules across jurisdictions, leading to risk of fragmentation. While there is optimism that rules will converge due to the global nature of financial products and sustainability as a theme, the current reality often requires institutions to consider rules cumulatively.