ESG regulation widens and deepens

As asset and fund managers continue to implement the requirements of the Sustainable Finance Disclosure Regulation (SFDR), ESG regulation is expanding in both scope and detail, within Europe and beyond. Many more firms will be brought into corporate reporting requirements, which will both improve data on investee companies and increase managers' own reporting obligations. Scrutiny and challenge of fund disclosures will increase as supervisors develop their understanding of new rules and market trends, and as concerns about greenwashing are articulated.

IOSCO has committed (PDF 235 KB) to issue reports on disclosures by issuers in mid-2021 and on disclosures by asset managers by end-2021. Meanwhile, the European Commission's latest package of final ESG rules and new proposals includes:

• Detailed rules under the Taxonomy Regulation relating to climate change mitigation and adaptation
• New rules under MiFID II, the UCITS Directive and AIFMD, requiring firms to incorporate sustainability considerations across their operations
• A draft Corporate Sustainability Reporting Directive (CSRD), which will expand current corporate reporting requirements and bring many more companies into scope

In the UK, the government is proposing to require a large number of companies to disclose climate-related financial information by April 2022, and the FCA will issue:

• Final rules on climate-related disclosures by asset managers by end-2021
• Guiding principles for the design, delivery and disclosure of ESG/sustainable funds to help ensure firms are clear about, and understand, their existing obligations, including their responsibility to provide information to investors that is fair, clear and not misleading
• Technical screening criteria to define what economic activities are environmentally sustainable, to be finalised by end-2022

Further detail is provided below. For further thoughts on this topic, see our new reality paper, Delivering sustainable finance, and look out for our annual flagship report on Evolving Asset Management Regulation.

A series of “delegated acts” amend existing rules under MiFID II, UCITS and AIFMD, with similar amendments for insurers and insurance intermediaries. The rules require the integration of sustainability risks or factors:

• For portfolio managers and financial advisers, in risk management policies and suitability assessments (including potential conflicts of interest)
• For MiFID product manufacturers and distributors, in the target market determinations of products and product information
• For fund managers, in the management of UCITS and AIFs, risk management, due diligence on investments and conflicts of interest policy; and they should assign senior management responsibility and have sufficient resources and expertise

In relation to suitability assessments, the Commission notes that there may not be a direct read-across to the product categories under SFDR. This will add to operational complexities for firms.

The implementation date for all these amendments will be 12 months after their publication in the Official Journal. This would point to a deadline of early summer 2022, but the Commission indicates that the deadline may be later, in October 2022.

The detailed annexes to the “delegated act” under the Taxonomy Regulation are long - at nearly 500 pages in total - and set out the technical screening criteria for economic activities that can make a “substantial contribution” to climate change mitigation and climate change adaptation. In order to gain political agreement at this stage — described as a “delicate compromise” — texts relating to crops and livestock production were deleted, and those relating to electricity generation from gaseous and liquid fuels now relate only to renewable, non-fossil sources. On the other hand, texts on the manufacture of batteries and plastics in primary form have been added, and the sections on information and communications technology, and professional, scientific and technical activities have been augmented.

The Commission estimates that these delegated acts cover the economic activities of about 40% of EU-domiciled listed companies, in sectors which are responsible for almost 80% of direct greenhouse gas emissions in Europe. A complementary delegated act, expected later this year, will include criteria for the agricultural and energy sector activities that were excluded this time around. The four remaining environmental objectives — sustainable use of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems — will be addressed in a further delegated act scheduled for the end of this year.

CSRD will amend existing accounting, auditing and transparency requirements, including the Non-Financial Reporting Directive (NFRD). CSRD adds to the new NFRD requirement, introduced via Article 8 of the Taxonomy Regulation, which the Commission says requires around 11,700 large companies to disclose proportions of turnover and expenses relating to environmentally sustainable activities. CSRD will:

• Extend the scope of NFRD to all large companies and all companies listed on regulated markets (except listed micro-enterprises), bringing many more asset and fund management companies into scope
• Require the audit (assurance) of reported information
• Introduce more detailed reporting requirements and a requirement to report according to mandatory EU sustainability reporting standards
• Require companies to add a digital tag to the reported information, so it is machine-readable and feeds into the European “single access point” envisaged in the Capital Markets Union action plan

The Commission estimates that around 49,000 large companies will have to comply with sustainability reporting requirements for financial years beginning on or after 1 January 2023, and medium- and small-sized companies will have to report for financial years beginning on or after 1 January 2026.

CSRD also includes a broader definition of social and governance factors.