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.

As we write this edition of ESG Regulatory Essentials, the UK’s 2023 Green Finance Strategy is hot off the press, including updates on the timing and scope of the UK Green Taxonomy, the Sustainability Disclosure Requirements (SDR) and transition plans. It also addresses alignment with international standards and developments in nature and carbon markets. Critically, after some uncertainty, the Government’s commitments to all of these appear intact.

The revised UK strategy rounds out a busy quarter for ESG regulation. Ahead of the UK Taxonomy consultation, the Green Technical Advisory Group (GTAG) has made ten recommendations, focusing on harmonisation, where possible, with the EU Taxonomy to avoid both regulatory difficulties and significant costs for cross-border firms. Continuing with the taxonomy theme, the European Commission has just published draft technical screening criteria for the remaining four objectives of the EU Taxonomy.

There have been other developments relating to reporting and disclosure requirements, with the spotlight firmly on sustainability standards and interoperability. The International Sustainability Standards Board (ISSB) has delayed publication of its first two disclosure standards until the end of June 2023 to align with the European Sustainability Reporting Standards (ESRS). IOSCO has proposed a global assurance framework for sustainability-related corporate reporting. And the Basel Committee plans to consult on a Pillar 3 disclosure framework by the end of the year, noting that this should complement the ISSB's work. 

For asset managers, amendments to the SFDR level 2 Regulatory Technical Standards (RTS) came into effect at the end of February. The FCA announced a delay to the publication of its SDR Policy Statement until Q3 2023, and its latest portfolio letter and supervisory strategy for mainstream asset managers highlighted its disclosure priorities and signposted publication of a review of firms' ESG oversight practices. It also provided further information on its recently formed Vote Reporting Group (VRG), which aims to enhance shareholder vote reporting by asset managers via a standardised framework and template.

Pension trustees should note the new climate disclosure campaign from The Pensions Regulator, which will run through spring and summer. The European Supervisory Authorities (ESAs — EBA, ESMA and EIOPA) have joined forces with the European Central Bank (ECB) to call for enhanced climate disclosure requirements for structured finance products. And the EU Parliament and Council have reached political agreement on a Regulation to implement the European Green Bond Standard (EUGBS), laying down uniform requirements for issuers of bonds that wish to use this designation. 

The focus on nature is gaining momentum, with publication of the last instalment of the Taskforce for Nature-related Financial Disclosures (TNFD) framework ahead of its finalisation in September. Meanwhile, thinking and best practice around climate-related risks and the regulatory capital framework are evolving, with a report from the Bank of England and the release of session 3 guidance from the Climate Financial Risk Forum (CFRF). The European Commission has asked the ESAs to conduct a one-off climate scenario analysis exercise, focusing not only on capital losses within firms but also on contagion and second order effects — a marked shift in focus compared with previous exercises. EIOPA has published a report on climate adaptation measures for insurers, and the IAIS is consulting on amending its Insurance Core Principles (ICP) framework to explicitly highlight climate as an interconnected risk. 

In February, the FCA published a Discussion Paper on finance for positive sustainable change, exploring how sustainability-related considerations should be embedded in firms’ objectives, strategies, culture and decision-making processes. This may pave the way for future regulation. 

Other developments include a report on diversity practices across nearly 800 banks, which concluded that further improvements are required to address gender balance and diversity in general, and the UK Pensions Regulator published guidance on improving equality, diversity, and inclusion in pension schemes. We await the joint BoE/PRA/FCA consultation for financial services.

For more information, read on.

• Regulatory policy agenda
• Taxonomy developments
• Reporting and disclosures 
• Nature and biodiversity 
• Climate-related financial risk 
• Capital markets and asset management 
• Diversity, equity and inclusion

Updated UK Green Finance Strategy

On 30 March, the UK Government published (PDF 27.0 MB) its much-awaited 2023 Green Finance Strategy — ‘Mobilising Green Investment’. For more information, see the article above.

FCA paper on finance for positive change

The FCA has published a discussion paper (PDF 1.90 MB) on finance for positive sustainable change. For further analysis, see the article above.

European Commission consults on further technical screening criteria for EU Taxonomy  

After some delay, the European Commission is consulting on technical screening criteria (TSC) for the remaining four environmental objectives of the EU Taxonomy:

• Sustainable use and protection of water and marine resources.
• Transition to a circular economy.
• Pollution prevention and control.
• Protection and restoration of biodiversity and ecosystems.

The Commission is also proposing targeted amendments to the Taxonomy Climate Delegated Act and to the Taxonomy Disclosures Delegated Act. The consultation will run for four weeks only, until 3 May.

Latest GTAG report on the UK Green Taxonomy 

The Green Technical Advisory Group's (GTAG) latest report (PDF 7.6 MB) on the UK's proposed Green Taxonomy focuses on interoperability to avoid multiple regulatory difficulties and significant extra costs for cross-border firms. It notes that interoperability can be pursued at three levels: via the design of the technical screening criteria, the disclosure regime, and through advocacy and international cooperation. 

GTAG has made ten recommendations to the UK Government, including to: 

• Adopt the same broad concepts, methodologies and metrics as the EU taxonomy.
• Streamline language and requirements to maximise interoperability with non-EU jurisdictions.
• Provide guidance on how key performance indicators should be applied to activities abroad under the UK reporting regime. 
  

The recommendations are not binding but will be considered by the Government as it decides how to approach the UK Green Taxonomy. 

FCA SDR Policy Statement delayed

The FCA has announced a delay to its planned Policy Statement on Sustainability Disclosure Requirements (SDR) and investment labels, from 30 June 2023 to Q3 2023. The effective dates of the new requirements will be adjusted accordingly. The FCA notes that it received a "significant response" to the consultation, which closed in January (see our analysis of the proposals here), and that it will carefully consider the feedback and firms' practical challenges.

ISSB final standards confirmed for end Q2 2023 

At its 16 February meeting in Montreal, the International Sustainability Standards Board (ISSB) made final decisions on the content for the first two ISSB standards — S1 on general sustainability-related disclosures, and S2 on climate-related disclosures. The standards will be issued by end Q2 2023, and will be applicable from 1 January 2024. 

These dates are deliberately aligned with those of the European Sustainability Reporting Standards (ESRS). The European Commission, the European Financial Reporting Advisory Group (EFRAG) and the ISSB had previously announced their commitment to maximising interoperability of standards. Additionally, ISSB members voted to reference the ESRS within the appendix of S1. From now until publication, the bodies will work together on refining the detailed terminology within the standards. 

The ISSB is considering its future standard-setting projects and will consult on these in Q2 2023.

IASB to consider climate in financial statements

To complement the ISSB standards, the International Accounting Standards Board (IASB) has begun a project to explore how companies can provide better information to their investors about climate-related risks in their financial statements. The IASB’s project is narrow in scope, and it has assured stakeholders that it will not deviate from its principles-based approach.

ESAs Opinions on the ESRS

The ESAs — the EBA, EIOPA and ESMA  — provided opinions on the ESRS to the European Commission. All agree that the ESRS are broadly consistent with both international standards and relevant EU directives. However, they seek further clarification from the Commission on technical matters:

• The EBA (PDF 395 KB) asked for additional guidance on alignment with the EBA's Pillar 3 requirements and consistency between the ESRS and European directives on accounting and on fraud.
• ESMA (PDF 678 KB) highlighted that the materiality assessment process required clarification. 
• EIOPA (PDF 358 KB) noted that low-risk undertakings should be allowed to apply simplified standards under the Corporate Sustainability Reporting Directive (CSRD) to level the playing field with the banking sector.

Separately, EFRAG, which devised the ESRS, has published its 'basis for conclusion' for each of the 12 standards. These are not legal or regulatory requirements, but illustrate the objective of each draft standard, the reasoning behind its inclusion, and (where relevant) reference other standard-setting initiatives. 

ESAs and ECB call for enhanced climate-related disclosures on structured finance products 

The ESAs and the European Central Bank (ECB) have published a joint statement (PDF 136 KB) on climate-related disclosure for structured finance products, encouraging the development of disclosure standards for securitised assets. These are not currently eligible for classification and reporting under the Sustainable Financial Disclosure Regulation (SFDR) due to lack of harmonised data and information requirements. 

The statement calls on originators, sponsors and issuers of securitisation products to “proactively collect high-quality and comprehensive information on climate-related risks during the origination process”. These stakeholders will therefore wish to understand the sustainability-related features of their financial products at the earliest opportunity, to reduce the reporting burden when it is eventually mandated.

SFDR disclosures for fossil gas and nuclear energy activities 

The European Commission has now published amendments to the SFDR level 2 Regulatory Technical Standards (RTS), reflecting the inclusion of certain fossil gas and nuclear energy generation activities in the EU Taxonomy. The amendments are based on the draft RTS submitted by the ESAs last year, and came into effect on 20 February 2023.  

UK Pensions Regulator increases its focus on climate and ESG non-compliance 

The UK Pensions Regulator (TPR) has launched a new campaign to ensure that pension trustees meet their ESG reporting duties. TPR has emailed defined benefit, defined contribution and hybrid schemes to warn them that it will review ESG disclosures in the spring and summer of 2023, checking their statement of investment principles (SIP), implementation statements (IS) and, where relevant, TCFD-aligned disclosures. The review findings will be shared with industry. TPR will take enforcement action where trustees have not produced the correct disclosures — it has the power to impose fines up to £50,000.

TPR has also recently published the results of its 2022 review of trustees' TCFD-aligned disclosures. TPR noted some good examples of trustees taking action, such as developing trustee policies on investment beliefs relating to climate change, conducting due diligence, and working with investment managers to obtain better data. However, some reports lacked sufficient background, were difficult for savers to access online, and did not provide strategy and scenario disclosures at an appropriate level.

IOSCO — promoting a global assurance framework for sustainability disclosures

IOSCO has published a report on promoting an effective global assurance framework for sustainability disclosures. The framework will be developed by assurance and ethics standard-setters. The International Auditing and Assurance Standards Board (IAASB) and the International Ethics Standards Board for Accountants (IESBA) will each issue exposure drafts by the end of 2023 (the former in September and the latter in December), with final versions expected by later 2024. IOSCO notes that when developing the framework, the following key themes should be considered: profession-agnostic standards, timely progress, engagement with relevant stakeholders, the ability to address challenging issues, connectivity, transparency and capacity building.

TNFD v0.4

The Taskforce for Nature-related Financial Disclosures (TNFD) has released v0.4 of its framework. For more information, see the article above. 

Basel Committee consultation on Pillar 3 climate disclosure frameworks

The Basel Committee will consult by the end of 2023 on a proposed Pillar 3 framework to disclose climate-related financial risks. This framework would be interoperable with parallel disclosure initiatives underway, such as that of the ISSB. 

Bank of England report on climate and capital

The Bank of England has published a report on climate-related risks and the regulatory capital frameworks. For more information, see the article above. 

Climate Financial Risk Forum publishes session 3 guides 

The PRA/FCA-convened Climate Financial Risk Forum (CFRF) has published a third round of guides to help the financial sector develop its approach to addressing climate-related financial risks and opportunities. The latest guides focus on scenario analysis (including learnings from the CBES exercise and specific guidance for asset managers), and climate disclosure, data and metrics. 

European Commission one-off climate scenario analysis exercise

The European Commission has written to the ESAs asking them to conduct a one-off climate risk scenario analysis to assess the resilience of the EU's financial system as it works to meet its 2023 climate targets. They will need to work together to develop severe but plausible scenarios around two broad scenarios in both benign and adverse macro financial environments:

1) Climate-change related risks materialising in the near term, most likely in the form of asset price corrections triggered by a sudden reassessment of transition or physical risks.

2) Climate-change related risks combined with other stress factors, as far as possible consistent with scenarios for regular stress-testing exercises.

The Commission has asked the ESAs to rely, to the extent possible, on available data collected by the ESAs/ECB to ensure feasibility and to limit the data burden for financial institutions. Results of the exercise are required by end Q4 2024 / no later than Q1 2025. As well as reporting results to the Commission, the ESAs may provide firm-specific feedback where relevant.

EIOPA report on climate-related adaptation measures 

EIOPA has published a report (PDF 454 KB) on insurers' use of climate-related adaptation measures in non-life underwriting practices. Its pilot exercise on the implementation of climate-related adaptation measures found that while the use of these measures demonstrates progress in making the economy more resilient to climate-related loss events, there is further room for improvement. 

Most insurers in scope of the exercise did not explicitly assess a potential link between climate-related adaptation measures and the solvency capital requirements for premium, reserve and catastrophe risk. While they acknowledged that the measures would have “clear risk-reducing effects” on underwriting risk, especially in the natural catastrophe space, they also noted the inflexibility of the Standard Formula in recognising the risk-reducing effects of climate-adaptation measures in capital requirements.

Insurers are not required to take further action. However, EIOPA will continue its work on assessing the prudential treatment of climate-related adaptation measures and will initiate the reassessment of capital charges for natural catastrophe risk in Solvency II Standard Formula.

IAIS consultation on climate risk supervisory guidance 

The International Association of Insurance Supervisors (IAIS) has released the first of its planned consultations on climate risk supervisory guidance. The IAIS proposes a revision to the introduction section of the Insurance Core Principles (ICPs) framework, to explicitly highlight climate-related risks as an area where “individual risks are often interconnected and may have an amplifying effect on other risks”. It emphasises the need for supervisors and insurers to consider how to assess and address risk management, governance, valuation of assets and liabilities, and business conduct in light of such interconnectedness. The consultation is open for comments until 16 May 2023. 

The IAIS will also publish future consultations on additional subjects, including enterprise risk management for solvency purposes and whether additional supporting material is warranted for Own Risk and Solvency Assessments (ORSAs) and climate scenario analysis. 

There is no direct policy implication for firms at this stage.

EBA industry survey on green loans and mortgages 

In response to a Call for Advice from the European Commission in November 2022, the EBA has launched an industry survey to collect quantitative and qualitative data from credit institutions on their green loans and mortgages, as well as market practices related to these loans. The survey is voluntary, though firms have been strongly encouraged to participate. The EBA has recently extended the deadline for submission to 19 April.

Provisional agreement on European Green Bond Regulation 

Provisional agreement has been reached between the EU Council and Parliament on a European Green Bond (EuGB) Regulation. The regulation lays down uniform requirements for issuers of bonds that wish to use the designation `European Green Bond' or `EuGB':

• All proceeds of EuGBs will need to be invested in economic activities that are aligned with the EU Taxonomy, provided the sectors concerned are already covered by it.
• For those sectors not yet covered by the EU Taxonomy and for certain very specific activities, there will be a flexibility pocket of 15%. The use of and need for this flexibility pocket will be re-evaluated as the EU's transition towards climate neutrality progresses.
• Requirements for a registration system and supervisory framework for external reviewers of European green bonds.
• Voluntary disclosure requirements for other environmentally-sustainable bonds and sustainability-linked bonds issued in the EU.

National Competent Authorities (NCAs) shall be responsible for ensuring that issuers comply with their obligations under the new Regulation. 

The agreement is provisional and still needs to be confirmed by the Council and the European Parliament, then adopted by both institutions before it is final. It will apply 12 months after its entry into force.

Revised MiFID II product governance guidelines

Following its July 2022 consultation, ESMA has published a feedback statement and revised MiFID II product governance guidelines. The updates relate to the specification of a product's sustainability-related objectives, the approach to target market identification, determination of distribution strategy, and the periodic review of products. The revision of the guidelines follows various developments, including ESMA's 2021 common supervisory action and the sustainability-related amendments to MiFID II (effective November 2022). Compared with the proposals in the consultation, ESMA has made only relatively small changes. The guidelines will now be translated and will apply two months after publication in all EU official languages.

FCA improvements to ESG benchmarks

The FCA has written to benchmark administrators highlighting significant issues identified in its review of ESG-related benchmarks. The FCA found the overall standard of disclosures to be 'poor'. All benchmark administrators are expected to have strategies to address the issues identified in the review. The FCA will conduct further work in this area and benchmark administrators may be required to explain their response strategies on request.

FCA portfolio letter to asset managers 

The FCA has published its latest portfolio letter and supervisory strategy for `mainstream' asset managers and fund managers, which supersedes the previous letter published in January 2020. Asset managers are expected to comply with its 2021 'Guiding Principles' with larger firms publishing TCFD disclosures by end-June 2023. The FCA encourages firms to assess the extent to which net zero commitments have been considered in transition planning.

Firms will also need to pay close attention to the outputs from the FCA's consultation on proposed Sustainability Disclosure Requirements (see summary here), and conclusions from its discussion paper on sustainable governance, incentives and competencies (see here).

In the near future, the FCA will publish the results of a review of some firms' ESG oversight practices and focus its supervisory activity on governance structures that oversee ESG and stewardship considerations and test claims made to investors.

Improving shareholder vote reporting by UK asset managers 

The FCA has published more information on the recently formed 'Vote Reporting Group' (VRG) as part of its focus on firms' progress relating to ESG reporting and stewardship. The FCA has convened the industry working group and acts as the secretariat, with members being drawn from across the investment management community. The purpose of the group is to propose a comprehensive vote reporting framework and template for public consultation to meet the needs of asset owners and the wider market better. A consultation on recommendations for a vote disclosure framework will be published by May 2023, with a final report that considers industry views by the end of 2023. 

UK Pensions Regulator publishes equality, diversity and inclusion guidance

The UK Pensions Regulator (TPR) has published equality, diversity and inclusion (EDI) guidance for pension scheme governing bodies and employers. The guidance, developed with an industry working group, will be used by pension scheme governing bodies and sponsoring employers to improve the EDI of their scheme’s board. The guidance covers (i) the role of the chair, (ii) the need for an EDI policy and assessment criteria, (iii) enhancing board diversity, (iv) developing inclusive communications and (v) making reasonable adjustments. The detailed guidance sets out the outcomes TPR is seeking, alongside specific case studies to bring the subject to life with practical steps that pension scheme governing bodies and employers can adopt.

EBA report on diversity practices 

The EBA has published a report on diversity practices and the gender pay gap at management-body level across credit and investment institutions in the EU, Liechtenstein and Iceland. The report found that, while there are improvements in women's representation on boards, progress has been slow and there continue to be imbalances.

The EBA sampled 662 credit institutions and 129 investment firms. Key findings include:

• 27.75% of non-executive directorships are held by women.
• Only 18.05% of executive directors are female. 
• Gender balance in Northern and Eastern Europe is generally better than in other parts of the EU. 
• 27.05% of institutions still lack a mandatory diversity policy. 
• There is a clear positive correlation between gender balance and Return on Equity (RoE). 
• Women earn on average 9.48% less than male executive directors and 5.90% less than male non-executive directors. 

The EBA has concluded that further improvements are required in gender balance and diversity in general. It recommends that all institutions adopt a diversity policy, and notes that many need to improve the gender diversity of their boards in the short to medium term, including through the use of gender balance targets. The EBA will continue to monitor diversity in management bodies and issue periodic benchmark studies on diversity and on the gender pay gap.