This article is sponsored by Bloomberg.
With sustainability in the spotlight ahead of COP28, the past year has seen myriad new sustainable finance-related regulations affecting investors globally. Bloomberg’s global product manager for sustainable finance regulation Rokhsana Saddighzadeh updates us on the most significant developments.
In the EU, sustainable finance regulation is evolving rapidly. What are the implications for investors?
Among the most significant is a review of the Sustainable Finance Disclosure Regulation. In September, the European Commission launched a consultation to comprehensively appraise the SFDR’s Level 1 text. It is seeking feedback on the implementation of the SFDR since its March 2021 inception and how any shortcomings might be addressed to ultimately improve investors’ decision-making capabilities.
The commission acknowledges that investors are experiencing some pain points, including on the availability of data to support Principal Adverse Impact indicators and the potential misalignment between other European sustainable finance legislation such as the EU Taxonomy’s concept of ‘significant harm’. One significant review is that of the categorisation system for financial products, with two distinct approaches proposed to supersede the existing and prevalently used Article 8 and 9 concepts.
The consultation is welcome. Investors should participate. The SFDR was the first of its kind and the commission is giving investors the opportunity to highlight the challenges of meeting its reporting requirements.
And are amendments to the EU Taxonomy itself on the horizon?
Yes. To date, the EU Taxonomy’s focus has been on climate. Going into 2024, its scope will extend to include almost 50 new eligible company activities across the four remaining environmental objectives that financial and non-financial companies should report. This will have a significant impact on investors exposed to these activities.
For example, investors exposed to biotech and pharma companies in their investment or lending practices may now have eligible activities under the taxonomy’s new requirements covering manufacturing of medicinal products. Investors therefore need to keep abreast of these changes and their compliance implications. To help them digest the new requirements, over the summer the commission released the EU Taxonomy Navigator, which aims to serve as a guide to those under the purview of the taxonomy.
What’s happening at the corporate level?
The EU’s Corporate Sustainability Reporting Directive, which came into force in early 2023, is one of the most significant regulatory developments. We expect it to meaningfully transform the scope of corporate reporting in terms of range and number of companies that need to report. This will increase from about 10,000 mainly large, European public interest enterprises to around 50,000 businesses, including small and medium-sized companies, and international businesses with European activities.
By generating more standardised and comparable data according to the European Sustainable Reporting Standards criteria, we expect the CSRD’s corporate reporting requirements to solve some key data scarcity and quality issues across E, S and G themes.
Crucially, in addition to disclosing information on policies and initiatives, the CSRD requires organisations to set targets (including absolute GHG emission reduction targets), select a baseline, and report progress towards these targets. Furthermore, the CSRD extends the reporting scope with reference to a company’s whole value chain within the EU and in third countries. By providing a much more comprehensive view of the sustainability profile of an investment universe, the new rules will ultimately improve transparency for the end investor.
How does the CSRD align with the International Sustainability Standards Board standards released in June?
The CSRD sets out mandatory requirements that are broad in scope and address both environmental and financial impacts – double materiality. The ISSB standards are voluntary, currently focused exclusively on climate, and address financial materiality only.
But there are overlaps. Critically, both draw heavily on the work of the Taskforce on Climate-related Financial Disclosures. They therefore have not been established in silos and ultimately converge around the same terminology.
We expect to see global uptake of the ISSB standards – this is already happening in countries like Brazil, the UK, Hong Kong and Japan, which are looking to integrate the standards into their corporate disclosure reporting requirements. However, each jurisdiction will differ in the way it incorporates local market considerations and nuances into its framework.
The US has been slow to develop sustainable finance regulation. Is it catching up?
We’re seeing some progress. While there are still no enhanced sustainability-related corporate reporting requirements at the federal level, California – the largest state economy in the US and the fifth-largest in the world – has introduced two climate-related disclosure bills, one focused on GHG emissions and the other on climate risk. This is significant. From 2026, more than 5,000 companies will have to report GHG emissions, and more than 10,000 companies will have to report climate risk. Improved disclosure will provide investors with much more information on which to base their investments.
Hopefully, more states will follow suit. The legislation, like the CSRD, the ISSB standards and new corporate disclosure rules proposed by the SEC, are based on TCFD requirements.
In the meantime, to combat greenwashing, the SEC has extended its ‘Names Rule’ to encompass ESG funds. ESG-labelled funds must now demonstrate that 80 percent of asset value is aligned with its stated strategy. Funds with $1 billion of net assets have 24 months from the effective date to comply. The adoption of this rule seeks to address the likelihood of fund names that may mislead investors about a fund’s investments and risks.
It’s an extremely complex regulatory landscape. How can investors navigate it?
There’s been a global proliferation of sustainability-related rules over the past year. While regulators are pursuing the same goal of advancing the sustainability agenda, there’s a risk they are working in silos. Global firms forced to consider separate requirements in each jurisdiction will face the heaviest reporting burden. The concept of equivalence – for example, that a business falling under the scope of the CSRD’s ESRS might meet equivalent US reporting requirements – could significantly ease this burden.
Firms with robust internal governance processes are best positioned to deal with fast-moving regulatory developments. These are managers with a strong definition of sustainability that already have information-gathering systems in place, and are confident in their approach. Firms that are simply trying to keep up with new regulations might struggle.
Lastly, being part of the conversation is crucial. For example, financial firms have been living with the SFDR for a couple of years now. They should have a lot of tangible feedback they can provide to the Commission. They shouldn’t miss this opportunity to have significant influence over how SFDR evolves.