ESG: adapting to a changing world

2022 was expected to be a year for ‘heavy lifting’ in terms of ESG policy with multiple consultations and policy statements planned. The disruptions of H1 meant that many of these were inevitably pushed back into H2 so that the FCA could focus in on the immediate challenges of sanctions, side pockets and suspensions.

Unfinished business
This means that there is a lot of unfinished regulatory business, and it is likely that the latter half of this year will see a glut of set-piece engagement, particularly in the form of consultations on the Sustainability Disclosure Requirements (SDR) and the UK’s Green Taxonomy. Both of these have been summarised in previous editions of Depositary Insights but as a brief recap the SDR aims to introduce tiered fund labelling so that investors are better equipped to understand a fund’s sustainability characteristics. The Green Taxonomy will deliver consistent definitions of key terminology to ensure that participants in this market are all speaking the same language.

These build on the growing demands for more oversight, accountability and transparency when it comes to ESG. How do regulators help ensure that investors really are getting what they pay for when they invest in a ‘sustainable’, ‘green’, ‘responsible’ or ‘ESG’ product?

More demand, more products
The industry has undergone an exponential upskilling in this area as ever more products are launched to meet increasing consumer interest and demand. This makes core concepts such as accountability, oversight and common understanding particularly important. The landscape has shifted notably since the UN’s COP26 climate change conference last year: the cost of living, global energy crises and rising inflation have added to policymakers’ in trays and have meant that there is increased political scrutiny of concepts such as Net Zero. This means that the ESG movement, which has gone from niche to mainstream in a few short years, is now arguably in a more defensive position as it attracts deeper scrutiny from a regulatory and political perspective. Credible and auditable data and clear evidence of actual outcomes are more important than ever.

Big questions will be asked in terms of accountability and there may be a push for more formalisation in terms of executive responsibilities and incentives. Where Net Zero commitments are made with a long lead time what are the consequences for decision makers if these targets are not ultimately met? And how can the industry ensure that all three parts of the ESG acronym are given equal weighting? Arguably, there has been more focus on the ‘E’ so far with the ‘S’ and ‘G’ getting a lower billing. There are growing voices calling for a tightening up of the language the industry uses in this respect and the SDR and taxonomy regulations will be a timely attempt to address this challenge.

An evolving picture
While ESG has become relatively normalised across the industry there is still plenty of scope for evolution and debate. Reforms such as the development of the EU’s Social Taxonomy are examples of how policymakers are trying to address gaps that have been identified and it is likely the UK will follow suit given its stated commitment to becoming a leading jurisdiction for responsible investment.

The ESG movement does not exist in a vacuum and it is increasingly buffeted by macroeconomic and geopolitical headwinds. As regulators, policymakers and investors continue to raise expectations, and as new standards such as the SDR and Green Taxonomy are developed, firms will need to focus even more on the core themes of transparency, accountability and credibility. This applies across the piece: from reporting and communications, to prospectuses, strategy and executive responsibilities. There is plenty more ‘heavy lifting’ to come.