Key developments in 2021 are going to drastically impact the ESG investing space.
While factoring ESG considerations into investment processes and strategies has become more of a priority for asset owners, managers and corporates, policymakers around the world are making sustainability a legislative priority, both to direct capital flows to green investment opportunities and to secure a sustainable future for all.
From the proposed EU Taxonomy to the Task Force on Climate-related Financial Disclosures (TCFD) mandate, “the EU and UK are dictating and setting the pace,” says Jihan Diolosa, Head of Responsible Investing EMEA at Russell Investments. But the pace of change in the US and Asia will be no less brisk in 2021.
Moves toward a global sustainability corporate reporting standard are gathering pace. And the late-2020 rush of recent net-zero emissions pledges from the likes of China, Japan and the Republic of Korea suggest sustainability will continue to be a priority in 2021. Ahead of COP26 in November, we will see a plethora of regulatory and legislative changes, as well as industry-level initiatives.
In this article, ESG Investor summarises some of the main expected developments.
Growing support for TCFD guidelines
Since the Financial Stability Board established the TCFD, global support has grown for its disclosure guidelines, which centre around four pillars: governance, strategy, risk management and metrics and targets. This is expected to continue this year, as more countries declare their support for the suggested disclosure guidelines.
“The TCFD reporting guidelines are some of the most widely adopted and accepted of the existing frameworks,” says Adam Gillett, Head of Sustainable Investment at Willis Tower Watson. “Everyone looks to it as a strong foundation.”
More recently, TCFD has responded to industry feedback which highlighted the need for further clarity when sourcing and analysing future-focused climate metrics. In October 2020, TCFD released its ‘Forward-looking Financial Sector Metrics Consultation’, providing more context around future-focused climate-related metrics for the financial sector. The consultation closes January 27.
From Q1, commercial companies with a UK premium listing – including FCA-regulated pension providers and building societies and insurance companies – will be among the first subjected to mandatory reporting in line with TCFD guidelines, following Chancellor of the Exchequer Rishi Sunak’s announcement that TCFD reporting for UK entities will be phased in up to 2025. To soften the transition, the Financial Conduct Authority (FCA) has inserted an interim step for asset managers to “comply or explain” with TCFD reporting guidelines.
“Many countries already have voluntary disclosure requirements,” says Michelle T Davies, International Head of Clean Energy and Sustainability at Eversheds Sutherland. “But the UK’s decision to making reporting requirements mandatory is really going to change the face of this whole agenda.”
It is therefore expected that more countries will follow the UK’s example in 2021 and make TCFD-aligned disclosures mandatory.
IFRS and ‘the group of five’
Partly building on TCFD guidelines, the International Financial Reporting Standards (IFRS) Foundation’s consultation paper on sustainability reporting has proposed the implementation of the Sustainability Standards Board (SSB). The consultation closed December 31 2020. The IFRS has said it will address feedback and identify “whether and to what extent the Foundation might contribute to the development of [sustainability reporting] standards” in Q1 2021.
In a related development, the ‘group of five’ sustainable reporting bodies – CDP, Climate Disclosure Standards Board (CDSB), Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI) and International Integrated Reporting Council (IIRC) – published a prototype global standard for sustainability-related financial disclosures, which supported the IFRS Foundation’s proposed SSB and the inclusion of TCFD standards.
Facilitated by the Impact Management Project (IMP), World Economic Forum (WEF) and Big Four accountancy firm Deloitte, the five organisations will be releasing an update paper in January 2021 to further outline the concepts and motivations behind the prototype.
Europe: SFDR Level 1, NFRD update and the EU Taxonomy
From March 10 Level 1 of the Sustainable Finance Disclosure Regulation (SFDR) will come into effect. SFDR aims to reorient capital flows towards a more sustainable economy by imposing new transparency obligations and periodic reporting requirements on EU investment management firms. Level 2 has been delayed until 2022.
The Non-Financial Reporting Directive (NFRD), which ensures large companies of more than 500 employees disclose non-financial information on their social and environmental impact, is expected to be updated during Q1 of this year. Amendments have been made to further ensure that “investors, civil society and other interested parties have access to the information they need, while not imposing excessive reporting obligations on companies,” the European Commission (EC) has said.
The EC will adopt the delegated act on NFRD entity reporting under Article 8 of the impending Taxonomy Regulation by June 1 2021.
Two of the EU Taxonomy Regulation’s delegated acts – climate change adaptation and climate change mitigation – are due to be adopted by December 31. This means that any disclosures made by EU companies relating to climate must be in line with the taxonomy from this date, by referring to the technical screening criteria (TSC). The rest of the taxonomy will be adopted from January 2022.
“Following the launch of SFDR Level 1 in March, more detailed requirements around Level 2 look likely later this year,” says Phil Spyropoulos, Principal Associate in Financial Services at Eversheds Sutherland. “I expect this will focus on additional transparency in order to mitigate the perceived risk of greenwashing.”
UK Stewardship Code, climate stress tests and pensions
In January 2020, the UK introduced Stewardship Code, which outlined a set of 12 principles for asset owners and managers to help ensure they are meeting expectations on managing money sustainably for savers and pensioners. Signatories to the Code must produce an annual stewardship report outlining how they applied the 12 principles over a 12-month period.
The first round of Code-aligned annual stewardship reports by asset managers and service providers should be submitted by March 31. Asset owners have until April 30. The submitted reports will be evaluated by the Financial Reporting Council (FRC), with those successfully fulfilling all reporting expectations being listed as signatories to the Code.
In June 2021, the Bank of England will run its pandemic-delayed climate risk tests. The tests aim to accurately forecast the potential costs to UK businesses of three possible climate scenarios spanning 30-year periods.
Throughout 2021, UK Minister of Pensions Guy Opperman will be overseeing the Taskforce on Pension Scheme Voting Implementation – an initiative proposed by the Association of Member Nominated Trustees (AMNT) in its ‘Bringing Shareholder Voting into the 21st Century’ report. This is in response to concerns that asset managers of pooled pension funds are not voting in line with asset owner policies.
China prioritises ESG
To meet its net-zero emissions by 2060 target, China will be launching a national carbon emissions trading scheme on February 1. This is according to the trial rules for the scheme which were published by the Ministry of Ecology and Environment (MEE) on January 5.
The new rules will require all enterprises in sectors with more than 26,000 mt/year of CO2 emissions to be included in the scheme. The ministry will act as the national regulator and supervisor of China’s carbon trade.
In China’s latest five-year plan, spanning 2021 to 2025, the country has pledged to actively implement the 2030 Agenda for Sustainable Development, with authorities prioritising green development in the coming years.
APAC accelerates ESG action
The wider Asia Pacific region is also beginning to accelerate its ESG integration into regulation and product trends.
On October 29 last year, Hong Kong’s Securities and Futures Commission (SFC) issued a consultation paper which outlined sustainability-focused changes to the Fund Manager Code of Conduct (FMCC). The changes would require fund managers to consider climate-related risks in their investment and risk management processes. The consultation period ends January 15.
“Taking into account the respondents’ comments, a conclusions paper will be issued together with the final form of the proposed requirements,” the paper noted. This is expected later this year.
New Zealand Minister for Climate Change James Shaw recently announced that the country aims to make TCFD-aligned reporting mandatory by 2023. Starting from this year, registered banks, credit unions and building societies with total assets of more than US$1 billion will need to comply on a ‘comply or explain basis’.
Australia’s Modern Slavery Act, which was first introduced in 2018, requires corporates, trusts and superannuation funds with a consolidated revenue of AUS$100 million or more to issue annual statements disclosing the risks of modern slavery occurring in operations and supply chains. Following the impact of Covid-19, the latest annual report submission date was extended until March 31.
The Monetary Authority of Singapore (MAS) published its ‘Guidelines on Environmental Risk Management for Asset Managers’ report in December 2020, which outlined how the regulator expects asset managers in the region to approach managing and disclosing environmental risk.
“There will be a transition period of 18 months for asset managers to assess and implement the guidelines as appropriate,” MAS said in its response to industry feedback.
Singapore’s central bank and financial regulatory authority will start engaging with asset managers from Q2 2021 on the implementation of the new environmental-risk management process.
Task Force on Nature-related Financial Disclosures
From Q1 2021, the Global Canopy, United Nations Development Programme (UNDP), United Nations Environment Programme Finance Initiative (UNEP FI) and the Worldwide Fund for Nature (WWF) will be researching and developing a new taskforce – the Task Force on Nature-related Financial Disclosures (TNFD). It was first suggested back in 2019.
“The new TNFD will help financial institutions to shift finance from destructive activities and toward nature-based solutions,” said António Guterres, United Nations Secretary-General.
The taskforce is due to be fully established by Q3 to Q4 and will provide a framework for corporates and financial institutions to assess, manage and report their dependencies and impacts on nature.
In May 2021, the Convention on Biodiversity will take place in Kunming, China, and will feature the TNFD.
Back to Europe: MiFID II, AIFMD and UCITS directives
With the focus on the EU Taxonomy and Disclosure Regulations and TCFD, Russell Investment’s Diolosa points out that new regulations coming into force under the Markets in Financial Instruments Directive II (MiFID II), the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings for the Collective Investment in Transferable Securities (UCITS) “have taken a backseat”.
The consultation originally closed on July 6 2020. The legislative timetable remains unclear, but it is possible proposed changes across the directives could apply from Q4 2021.
The EC is currently considering advice submitted by the European Securities and Markets Authority (ESMA), which outlined the importance of ensuring sustainability risks and factors are integrated into all directives. This is to make sure that investment firms providing financial advice and portfolio management are taking clients’ ESG considerations and preferences into account and are further providing clients with information on ESG-related products.
“These consultations are currently taking place in the background, due to the deadlines not being finalised, but I look forward to seeing what these changes entail,” Diolosa says.
Industry waits for ESG action from the US
Finally, investors will be looking for ESG-related legislation from the US under a new, more environmentally-minded President. While specific approaches have yet to be made official, President-elect Joe Biden has pledged to re-join the Paris Agreement, made ESG-focused key appointments and further plans to funnel US$2 trillion of federal government spending to the climate budget.
On December 1 2020, the Asset Management Advisory Committee (AMAC) of the US Securities and Exchange Commission (SEC) gathered to discuss draft recommendations proposed by its ESG Subcommittee. The subcommittee’s guidelines will inform the direction of future SEC rulemaking. The draft includes recommendations such as the SEC mandating the adoption of standards by which issuers disclose material ESG risks and further suggesting ‘best practices’ to enhance ESG product disclosure.
The ESG Subcommittee’s final recommendations are expected in early 2021.