What might global ESG regulation look like in 2025?
Following COP26 and the broader discourse around green finance, there is increasing pressure on governments and financial organisations to introduce regulation on Environmental, Social and Governance (ESG) issues.
In fact, in 2021 alone, at least 34 regulatory bodies across 12 markets undertook official consultations on ESG (MSCI 2021).
This flurry of interest compliments current guidelines on ESG disclosure and investing practices.
Moreover, guidelines and proposed regulations are crucial for the financial sector. In fact, over 60% of initiatives planned globally before 2025 chose 'financial entities' as the holders of reporting responsibility (MSCI 2021).
Initiatives like the Taskforce on Climate-related Financial Disclosures have also improved the availability and quality of climate-related financial information.
Understanding the trajectory of global ESG regulation is crucial for forward-looking asset managers.
This article will consider three examples of current and upcoming regulations or guidance that will likely be active by 2025.
The SFDR is the European Union's (EU's) pioneering mandatory regulation for asset managers and other financial market participants on Environmental, Social and Governance (ESG) disclosure.
It is the first step in the EU's standardisation of environmental disclosure frameworks for asset managers.
The first level of the SFDR came into place in March 2021 as part of the European Commission's (EC) Sustainable Finance Action Plan.
Level 1 considers entity level disclosures of sustainability consideration.
This level means financial market participants will provide information on their methods for identifying and managing adverse sustainability impacts. It includes both impact measurements (known as principle adverse impact indicators) and risk considerations.
As opposed to simply considering a fund 'sustainable' or not, the SFDR divides funds into three categories:
'Dark Green' Article 9 funds: direct positive sustainability impact.
'Light Green' Article 8 funds: promote environmental or social efforts.
'Grey' Article 6 funds: Consider risks as part of the investment process or are non-sustainable funds.
Level 2 will include product level disclosures.
FMP's will need to provide annual reports via detailed and standardised templates on the sustainability criteria of their financial products.
Level 2 of the SFDR will come into force in July 2022.
Regulator: European Commission
Reporting entity: Financial Market Participants (this includes institutional investors and asset managers).
Who's affected: Financial market participants operating in the European Union.
USA: Climate-related financial risks and insurers (planned)
MSCI's report on ESG trends for 2022 included the expectation that the Federal Insurance Organisation (FIO) are planning regulatory measures to ensure the inclusion of climate-related risks.
Initiated by two executive orders (14,800 & 14,030 - 2021), the FIO is tasked with assessing climate-related gaps in the insurance market and their impact on financial stability in America (FIO 2021).
These orders expect a current risk-assessment gap for environmental issues that undermine economic resilience.
The FIO has identified three priorities for tackling climate risk (FIO 2021):
Supervision and regulation: Assess the climate-related regulatory gaps on insurers and their potential to impact US financial stability.
Markets and mitigation: Assess where climate issues will impact insurance coverage most and how the FIO can create resilience.
Insurance sector engagement: How can the insurance sector help to achieve climate-related goals.
A request for public information with significant contributions from asset managers and investors solidified these goals and the FIO's role as a leader in achieving them.
Further details of the regulation are yet to be announced.
Regulator: Federal Insurance Organisation.
Reporting entity: Financial entities.
Stringency: To be confirmed.
Who's affected: To be confirmed.
Singapore: Environmental Risk Management Guidelines for Asset Managers
In 2020 the Monetary Authority of Singapore (MAS) introduced environmental risk management guidelines for asset managers with discretionary authority over the investment of funds.
These guidelines aimed to encourage the management of environmental risks for a resilient portfolio.
They highlight the importance of considering climate change and biodiversity loss in risk management (MAS 2020).
Moreover, the guidelines focus on these themes in three categories:
Physical risk (the impact of resulting events, e.g. extreme weather).
Transitional risk (the effect of economic change towards a more sustainable economy).
Reputational risk (the negative associations with an asset manager choosing unsustainable investments).
MAS' suggestions include a framework for governance and strategy, research and portfolio construction and analysis for accurate risk management.
They also touch on asset managers' stewardship role (guiding investee companies towards more sustainable business practices) and duty to disclose environmental risk management to stakeholders.
Overall the guidelines urge asset managers to consider environmental risks as 'crucial' (MAS 2020).
The MAS started engaging with financial institutions on their implementation progress in 2021.
The MAS has since launched key green finance initiatives. These include the Green Finance Industry Taskforce (2021), which will likely provide further guidance on environmental disclosure for the financial sector.
Regulator: Monetary Authority of Singapore.
Reporting entity: Product. Financial Entity.
Stringency: Guidance (not mandatory).
Who's affected: Asset managers.
These three examples illustrate the global breadth of the development of ESG finance regulation.
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Please note: this article does not constitute financial advice. Policy guidance was accurate at time of writing but may be out of date.