Just as financial services firms get used to the likes of AML Regulations, Market Abuse, Anti-Bribery & Corruption, and Brexit…..there’s a raft of new legislation that centres around what is known as ESG. E for Environmental, S for Social, and G for Governance.
What is ESG?
ESG itself is a mindset. A core set of values that firms need to consider and implement.
The initiative stems from the Paris Agreement on Climate Change that was entered into in 2015 by several countries. More recently, COP26 has further enhanced and raised the worlds awareness of the impact of climate change driven by our everyday demands upon the environment and the way that we live. It is clear that the decisions we make can drive environmental change.
Under this heading, there have been two key pieces of legislation that have been implemented in Europe. The Sustainable Finance Disclosure Regulation (SFDR) and The Taxonomy Regulation. In the UK, due to Brexit the EU Regulations no longer apply. However, Rishi Sunak, Chancellor of the Exchequer unveiled the UK’s equivalent of the SFDR – The Green Finance Roadmap. These measures are outlined further below.
This is about firms demonstrating that they have the interests of the community and people at the heart of their policies and culture. For example, do they have a Diversity and Inclusion policy? Is the Board made up of an equal number of men and women from diverse backgrounds?
Do firms have an effective framework in place to achieve the targets that governments are setting on climate change? Does the board have a culture in place at the firm that ensures that the policies are effectively rolled out and are working?
The Sustainable Finance Disclosure Regulation (SFDR)
This legislation sets out the requirements for those firms that both make and advise on financial products. For example, Fund Managers must disclose how they have considered sustainability risks during the investment process. In addition, they must also disclose how they have considered any negative factors with regards to sustainability.
This piece of EU legislation amends the SFDR. It is essentially a classification system that has six environmental objectives:
1. Climate Change Mitigation
2. Climate Change adaptation
3. Sustainable use and protection of marine and water resources
4. Transitioning to a circular economy
5. Pollution control and prevention
6. Protection and restoration of ecosystems and biodiversity
Firms must contribute to at least one of the above objectives and ensure that they “Do no significant harm” to the other objectives.
A further aim of the measures is to prevent Greenwashing.
What is Greenwashing?
This is where products of services are falsely advertised as “green” and environmentally friendly/sustainable when in fact they are not. The false marketing can dupe consumers into believing that they are helping the environment in some way by purchasing the products/services.
It can be difficult for consumers to navigate their way around the false claims. Generally speaking, genuine claims are the ones that provide clarity and detail about how the products is made. False claims are usually vague and unsubstantiated.
The EU’s SFDR and Taxonomy legislation along with the UK’s Green Finance Roadmap aim to reduce Greenwashing by ensuring that firms provide bona fide disclosures and information to substantiate why and how they are meeting the objectives of the Paris Agreement and Cop26.
The Taxonomy measures above need to be in place by 1 January 2022 for certain parts of the legislation and 1 January 2023 for the remaining measures.
According to Rishi Sunak, “Investors and businesses must have the information they need to understand the full range of environmental risks they face and create. That information should be a key component of every investment decision and the strategy of every business. Climate and environmental considerations should be central to the decision-making process of every UK board and every investor’s risk and return calculations.”
Is your firm ready for the above measures?
Principal Consultant, Lysis Financial