This article is sponsored by SIX.
Adhering to standards on emissions and ESG was once voluntary for investors. Recently, however, climate and transition risk management – as well as ESG disclosure frameworks – have moved to the top of the global regulatory agenda. ESG compliance has therefore increasingly become subject to rules-based approaches.
However, the specifications for climate risk management differ between jurisdictions, presenting challenges for investors looking to navigate global markets. Martina Macpherson, head of ESG product management at SIX, explains how understanding, interpreting and mapping key ESG regulatory risk requirements is becoming a prerequisite for data and services management.
How is ESG regulatory risk management changing?
We’ve identified regulatory risk management as one of the key market drivers for ESG because regulatory data and services are becoming a prerequisite for investor clients. We have just finished a strategic survey and it’s clear that investors face new regulatory reporting challenges. But there is still a lack of understanding of the relevant ESG reporting infrastructure and operational systems, especially on the asset management side. According to our survey, the biggest gaps remaining are in automated, end-to-end regulatory risk management solutions.
Regulatory risk challenges are ever-changing, so it’s a very fragmented landscape. At SIX, we take an aggregated approach by looking at all types of frameworks within the regulatory environment. We see clear developments around ESG regulation and there’s a trajectory for normative frameworks, such as the Task Force on Climate-related Financial Disclosures, to move into the regulatory sphere, becoming mandatory standards.
Consequently, there are potentially areas where investors need to disclose information and align with specific taxonomies or thematics. Relevant thematic regulatory areas for ESG include climate risk, and an increasing focus on human rights and labour rights, in the context of modern slavery regulation and supply chain management oversight. There’s also increasingly a focus on sustainable finance in capital markets, and prudential climate risk regulation, which will have major implications for investors and the broader capital markets.
How do jurisdictions differ in their approach and what are the implications?
“Tech is becoming indispensable for ESG”
Climate risk regulation, based on the TCFD, is being rolled out around the world and climate risk management is aligning to a large extent across jurisdictions. The overarching, TCFD-aligned ambitions of, for instance, carbon emission reduction, and risk and opportunities management for climate change mitigation and adaptation, are fundamentally the same. However, each jurisdiction has certain nuances where climate risk assessment criteria, scenarios and time horizons for Paris and/or net-zero alignments are concerned. Hence, understanding and mapping portfolios to ensure compliance with local regulation – for example in the climate risk management domain – is becoming a key
investment management challenge.
The need for further alignment, especially around something as important as TCFD and climate risk and opportunities management, is becoming increasingly clear. In the UK, the Financial Conduct Authority (FCA) is focused on staying as close as possible to international developments in its work around TCFD disclosures for large-cap listed companies, public-interest companies and public pension funds. There has been close collaboration with the International Platform for Sustainable Finance, as well as with International Organization of Securities Commissions (IOSCO), around ESG and climate risk disclosures, metrics and frameworks. And the FCA is trying to align with the major trajectories coming out of the US, where we see the Securities and Exchange Commission’s (SEC) proposal for major public-interest companies to disclose climate-related risks.
Despite global standard setters focusing on harmonising global ESG reporting frameworks, we still see a lot of pluralism. There’s a need for mapping to bring more clarity, comparability and consistency of ESG and climate risk information.
How is the market adapting to these changes?
Investors are increasingly looking for end-to-end solutions, covering ESG data management, analysis and reporting, as well as portfolio exposures. Technology can play a big part in this.
When it comes to ESG, you see technology enabled solutions for analysis, attribution analysis and analytics. Tech is used throughout the whole value chain from data collection to data triaging, management, monitoring and reporting for regulatory purposes. On the other side of the equation, there are alternative data sets, digital data catalogues and geospatial data, as well as AI, machine learning. There are also efforts such as the green wallet initiative to utilise blockchain for green bond verification systems. Tech is becoming indispensable for ESG.
We’re moving away from traditional rating data sets towards more specialist ESG data, across different asset classes and thematics. Technology underpins the triaging and mapping of data sets and enables an end-to-end workflow. It also helps by providing underlying analytics to support investment at a corporate and, increasingly, at a capital markets level.
What does it look like in the markets? We’re seeing accelerated growth in ESG technology through targeted acquisitions, strategic partnerships and marketplace models in line with these changes. There are end-to-end capabilities and models that are driving the analytics in this market. We’re focusing heavily on this area to identify solution providers we can partner with to define and calculate green revenue streams and ratios.
How do you see ESG regulatory risk management developing?
Alignment, standardisation and harmonisation between materiality approaches and the underpinning frameworks and taxonomies must continue. There’s significant alignment around the EU Sustainable Finance Action Plan, because to distribute and sell a fund product in Europe you have to comply with the plan’s regulations. So, I think global managers are moving towards the scenario where this will become a baseline.
Then there is the International Sustainability Standards Board (IFRS/ISSB), which is working to develop a global baseline for disclosure in sustainable finance. These requirements will also have implications and will require some type of alignment further downstream regarding investor reporting and disclosures. And finally, IOSCO is developing a global standard for sustainable finance due out at the end of this year. This will have a particularly strong trajectory in emerging markets.
These are the frameworks that might be most relevant in some shape or form for investors, as well as potentially capital markets. Alignment with these frameworks should happen within the next 10 years or so. But on this journey, we now need the right type of platforms for engagement and interaction. This has to happen at a supranational level, and I think that is the main challenge at this time. It’s an interesting space to watch – and it is very exciting to be part of some of these developments from ESG to RegRisk to RegTech.