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Commentary

Take Five: Less is More

A selection of the major stories impacting ESG investors, in five easy pieces. 

Articles 8 and 9 may yet live on, but investors made a clear call to the European Commission for streamlining green fund regulation.

Rage against the (green) machine – It seems we’re little nearer to knowing the future of green fund regulation in Europe, after the European Commission released its synthesis of responses to proposals for reform of the Sustainable Finance Disclosure Regulation (SFDR). The commission admitted that “views are divided” on whether to ditch Article 8 and 9 fund designations or convert them into formal product categories. There were at least strong indications of support for creating a specific category for products with a transition focus, similar to the approach already being taken in the UK’s Sustainable Disclosure Requirements regime. But these exercises often tell us much else of interest beyond their core area of investigation. In this case, the consultation elicited a howl of frustration at the bureaucracy of Europe’s sustainable investment architecture, suggesting that efforts to streamline and simplify are due. Many respondents identified problems with interactions between SFDR, the EU Taxonomy, the Corporate Sustainability Reporting Directive and other finance rules; while many others questioned the usefulness of specific disclosure requirements – notably at entity level. No one expects it to be easy to be green, but easier should be possible.

Reform revived? – The Financial Reporting Council (FRC), the UK’s audit watchdog, took concluding steps on two high-profile corporate scandals this week. On Tuesday, the FRC wrapped up its investigation into the audits of mini-bond broker London & Capital Finance (LCF) by fining PwC and EY a combined £9.3 million (US$11.6 million) for audits that it said demonstrated a lack of understanding of the client’s business, risking “material misstatements” in its accounts. LCF went out of business in 2019, leaving 11,600 retail investors £237 million out of pocket. The FRC also published final notices relating to KPMG’s flawed audits for Carillion between 2014 and 2017, which contributed to the collapse of the construction and building services firm in 2018, having issued a record fine of £21 million to the Big Four firm last October. The fines were no doubt merited and will serve as a warning. But what of long-promised legislative measures to back up enforcement action? After all, investors rely heavily on audit quality to ensure their decisions are based on accurate and reliable information. Alongside the demise of Patisserie Valerie and BHS, Carillion’s fall was a key factor behind the government reform proposals published in 2021. But legislation – which included plans to replace the FRC with a more powerful regulator – was shelved in the run-up to last year’s King’s Speech, prompting the opposition Labour party to promise to revive it if it gained power. The Institute of Chartered Accountants in England and Wales recently called for the next government to hold a consultation on new primary legislation within its first 100 days. Labour, which has done a lot under incumbent leader Keir Starmer to boost its reputation among the business community, will want to stick to its commitment – but it may struggle given the likely size of its in-tray.

Anti-social networks – Social media firms will need to comply with new UK rules to prevent harm to children, which require them to stop their algorithms from recommending inappropriate content depicting suicide, self-harm or pornography. The draft Children’s Safety Codes of Practice, part of the UK’s new Online Safety Act, asks the companies to implement 40 practical measures – including carrying out age checks, reconfiguring algorithm recommendations and improving moderation of content deemed harmful to children. “Do not wait for enforcement and hefty fines – step up to meet your responsibilities and act now,” said UK Technology Secretary Michelle Donelan as the rules were unveiled. Some platform operators have already declared their commitment to child safely – including Meta, although the company reportedly plans to cut staff at its oversight board. Investors have long engaged with major social networks on their record of limiting harms to users, and recent developments may stiffen resolve ahead of this year’s AGMs. In 2023, a request for a report on child harm reduction at Meta received 16.3% support, considered equivalent to 54% at a firm without a dual class share structure. A similar resolution has been lodged for Meta’s 2024 AGM, on 29 May, and for the first time – at Alphabet’s.

Blended boost – Blended finance gained a further boost, with the European Commission mulling lower capital charges to encourage more institutional investors to allocate funds to public/private transactions that support sustainable development in emerging markets and developing economies. In its final recommendations, the High-level Expert Group on Scaling up Sustainable Finance in Low- and Middle-income Countries said blended finance vehicles should no longer be placed in the same risk category as structured products, which typically attract high charges due to their complexity and opacity – not to mention their associations with the Global Financial Crisis. Instead, the commission recommended a “dedicated EU legal framework” be established, with prudential treatments taking account of de-risking mechanisms and underlying asset quality. Following on from news of a rebound in transaction levels and signs of increased attention and innovation by multilateral development banks, continued momentum could see blended finance establish itself as a standard constituent of the asset owner’s portfolio.

Head above water – Among a number of grim reports released this week on rising carbon emissions and their likely impacts, analysis of data from the EU’s Copernicus Climate Service outlined record-breaking rises in sea temperatures throughout 2023, caused both by climate change and El Niño. Our oceans’ capacity to soak up heat appears to be reaching its limit, with dire consequences for marine species – let alone those of us living on land. Many actions are required to mitigate these, but this week the World Wide Fund for Nature made the case for improved maritime special planning, notably in Europe, which already allocates space to ocean and coastal activities and communities to ensure a sustainable long-term balance between people and nature.

 

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