ESG Regulatory Essentials

This is a regular publication from KPMG's EMA Financial Services Regulatory Insight Centre, providing key updates on the latest ESG regulatory developments impacting financial services firms in the UK and the EU.

This is a slightly shorter issue than our last update but there is still plenty for financial services (FS) firms to focus on in the ESG regulatory space.

June is expected to be a very significant month, with final publication of the International Sustainability Standards Board's (ISSB's) first two standards — on general sustainability and climate-related disclosures — and completion of the first 12 European Sustainability Reporting Standards — spanning the E, the S and the G. These publications will pave the way for authorities to consider whether and how they wish to adopt and apply the ISSB standards, and will clarify for corporates (including certain FS firms) the disclosures that will be expected of them under the EU Corporate Sustainability Reporting Directive (CSRD). 

Meanwhile, the ISSB is consulting on its agenda priorities for the next two years (i.e. what the next iteration of standards should target) and on a methodology to integrate the Sustainability Accounting Standards Board (SASB) standards into its wider reporting framework. 

The Basel Committee for Banking Supervision (BCBS) has announced that it will consult in the autumn on integrating climate-related financial risks into the Pillar III disclosure framework in a way that is compatible with ISSB initiatives. 

The Sustainable Finance Disclosure Regulation (SFDR) continues to evolve, with the European Commission responding to questions received back in September 2022, and the European Supervisory Authorities (ESAs) — the EBA, EIOPA and ESMA — publishing a consultation on amendments to the SFDR Delegated Regulation. There is potential for significant changes, ahead of a wider review by the European Commission later this year. 

The European Central Bank (ECB) has published an assessment of banks' climate-related and environmental disclosures, and the ECB and EIOPA have both called for increased update of climate catastrophe insurance. 

ESG ratings, and the challenges they pose for transparency and governance, remain in the spotlight. HM Treasury (HMT) has issued a consultation on a potential new regulatory regime for ESG ratings providers, which would bring them within the regulatory perimeter of the Financial Conduct Authority (FCA).  

Diversity, equity and inclusion (DEI) is also a running theme. While the industry awaits the joint BoE/PRA/FCA consultation on DEI, the FCA has reminded firms of the diversity disclosure requirements in its listing rules. In the EU, the EBA is consulting on guidelines on the benchmarking of diversity practices. 

For more information, read on.

• Reporting and disclosures
• Data and ratings 
• Climate-related financial risk
• Diversity, equity and inclusion 
• Other standard-setter updates 

ISSB consults on agenda priorities for the next two years

The ISSB is consulting on its workplan for the next two years, asking stakeholders to comment on its foundational priorities as well as four possible areas for new research and standard setting. 

The foundational priorities are:

• Supporting implementation of ISSB standards
• Researching targeted enhancements to ISSB standards
• Enhancing Sustainability Accounting Standards Board (SASB) standards (see below)
• Ensuring connectivity between the ISSB and IASB's respective requirements
• Ensuring interoperability of the ISSB standards with other sustainability standards

The proposed new research and standard-setting activities are:

• Biodiversity, ecosystems and ecosystem services (BEES)
• Human capital
• Human rights
• Integration in reporting

The consultation deadline is 1 September 2023. Firms with interests in any of the above research areas may wish to respond given that the outcomes will likely be reflected in future standard-setting.

ISSB consults on integrating SASB standards into its overall reporting framework  

The ISSB is consulting until 9 August on a proposed methodology for enhancing the international applicability of the SASB's standards. 

Under the proposals, the SASB standards are expected to form the framework for sector-specific disclosures under the application of IFRS S1 (the first ISSB standard). The proposed changes aim to ensure that entities can apply the SASB standards regardless of the jurisdiction in which they operate or the accounting principles they apply for financial reporting. 

European Commission responds to ESAs' questions on SFDR 

The European Commission has responded to the latest questions from the ESAs on the Sustainable Finance Disclosure Regulation (SFDR). For more information, see our article above. 

ESAs consult on amendments to the SFDR

The ESAs have published a joint consultation paper proposing amendments to the Delegated Regulation of the SFDR. For more information, see our article above. 

ECB supervisory assessment of institutions' climate-related and environmental risks disclosures 

The ECB has published the results of its supervisory assessment of banks' disclosures of climate-related and environmental (C&E) risks. The review covered 131 banks based in the EU (103 significant institutions and 28 less significant institutions). These were benchmarked against 12 global systematically important banks (G-SIBs) based outside the EU. The ECB's assessment, in line with 'expectation 13' of its Guide on Climate-Related and Environmental Risks, looked at how firms disclosed materiality assessments, business model and strategy, governance, risk management, and metrics and targets.

The ECB found that most banks have expanded their climate and environmental disclosures compared with the previous year, but that the quality of information remains too low. It expects firms to continue to address their disclosure shortcomings, particularly ahead of the Pillar 3 requirements that will come into force in June 2023, and has sent individual feedback letters to banks informing them of their disclosure shortcomings. 

Basel Committee to consult on Pillar 3 climate disclosures

The Basel Committee on Banking Supervision (BCBS) has announced that it will issue a consultation paper by the end of 2023 on integrating climate-related financial risks into the Pillar III disclosure framework. Disclosures will be designed to be interoperable with International Sustainability Standards Board (ISSB) disclosure initiatives. 

HMT consultation on the future regulatory regime for ESG ratings providers

HMT is consulting on a potential new regulatory regime for ESG ratings providers. For more information, see our article above.

ECB and EIOPA call for increased update of climate catastrophe insurance

The ECB and EIOPA have published a joint discussion paper on how to insure households and businesses in the EU against climate-related natural catastrophes (nat cat). The paper documents the significant, and increasing, scale of the problem, noting that only one quarter of EU climate-related catastrophe losses are currently insured, and that this insurance gap poses a risk to financial stability as the fiscal burden on governments increases. 

The paper tentatively proposes a 'ladder approach' to address the protection gap, with actions ranging across private insurance, capital instruments, private-public partnerships (PPP) and EU-level measures. It also suggests that targeted prudential/macroprudential regulation may be needed to enhance the banking sector's resilience to the persistent climate insurance protection gap. This is consistent with the UK CBES findings on the interlinkages between insurance and banking climate-related vulnerabilities.

Stakeholders can provide feedback until 15 June 2023. 

FSB analysis of climate-related financial risk in compensation frameworks

The Financial Stability Board (FSB) has published its analysis of how financial institutions are reflecting climate-related financial risk in their remuneration frameworks. The analysis does not intend to compare practices across jurisdictions, but it does aim to present the challenges firms face in this area. 

The FSB found that climate-related metrics are usually included in remuneration frameworks as non-financial rather than financial measures, and that they are often part of wider ESG metrics that cover several other issues, such as diversity and inclusion. Specific climate-related metrics include: the reduction of a firm's carbon footprint, provision of sustainable finance and products, and overall leadership when it comes to climate-related risks.

Challenges faced by firms when incorporating climate-related financial risk metrics into their remuneration frameworks include:

• Developing meaningful metrics that are relevant to a firm's strategy and are objectively quantifiable and measurable
• Deciding on an appropriate time horizon to measure such metrics, as climate-related goals will take a long time to achieve and performance evaluation periods are based on relatively short timeframes
• Gaps in data availability and reliability

The FSB urges regulators to continue sharing insights on this matter both with each other and with industry. 

EBA consultation on draft guidelines on benchmarking of diversity practices  

The European Banking Authority (EBA) has launched a consultation on guidelines on the benchmarking of diversity practices, including diversity policies and the gender pay gap. The consultation reflects benchmarking requirements under the Capital Requirements Directive (CRD) and the Investment Firms Directive (IFD). Proposed data to be collected include: 

• The age and gender identity of executive directors and non-executive directors
• The 'geographical provenance' of executive directors, non-executive directors and employee representatives. 'Geographical provenance' is defined as a cultural, educational or professional tie of at least 3 years to a region
• The educational background of executive directors, non-executive directors and employee representatives
• The firm's nomination committee and its diversity policy, including whether any targets for representation have been determined
• Gender pay gap data for executive directors, non-executive directors and employee representatives

The EBA will collect this data from a sample of firms, with the first round proposed for 2025 (based on FY2024). The consultation closes on 24 July 2023.

Diversity disclosure reminder in FCA market bulletin

The FCA published `Primary Market Bulletin 44', reiterating the diversity-related targets introduced to the Listing Rules under PS22/3: 

• At least 40% of the individuals on its board of directors to be women
• At least one of the following senior positions on its board of directors to be held by a woman: the Chair, Chief Executive, Senior Independent Director or Chief Financial Officer
• At least one individual on the board of directors to be from a minority ethnic background

UK and overseas standard and premium listed firms must make `comply or explain' disclosures reflecting their progress towards these targets. The first disclosures will be made in annual reports in 2023, covering accounting periods beginning on or after 1 April 2022.  

FRC consults on Corporate Governance Code amendments

The Financial Reporting Council (FRC) is consulting on amendments to its Corporate Governance Code. The ESG-specific revisions include:

• Expanding the scope of audit committees to include narrative reporting, including sustainability reporting, and where appropriate ESG metrics
• Amending remuneration principles to strengthen the link between companies’ remuneration policies and their corporate performance in the wider sense — including ESG objectives. This also includes specific references to workforce pay and conditions when determining executive pay
• Taking a more direct approach in asking how companies’ executive remuneration policies, structures and performance metrics support company strategy, including ESG objectives

The consultation is open until 13 September 2023, and the FRC intends to apply the revised code to accounting years commencing on or after 1 January 2025.