Sustainable finance: a top priority

IOSCO¹ and the FSB² continue to grapple with common issues at the international level. In the meantime, jurisdictions are at different stages of their regulatory journeys. 

The EU has published a package of measures to build on and strengthen the foundations of its existing and detailed sustainable finance framework, to encourage and facilitate much-needed additional financial flows into sustainable investments. South Africa has stated that sustainable finance is a strategic priority, which will eventually lead to a roadmap. Canada is closely following the divergence of developments in the US and the EU to plot a middle path. Switzerland does not adopt EU standards, but relies on a framework based on industry self-regulation standards.

Some cross-border collaboration is evident, such as through the green finance taskforce that has been established between the Monetary Authority of Singapore and the People's Bank of China to facilitate greater public/private sector collaboration. 

Across the world, jurisdictions are establishing local working groups to tackle the practical realities of specific topics. For example, the Japanese Financial Services Agency (JFSA) has established a working group to discuss measures for expanding impact investment that contributes to solving social and environmental issues and creating new businesses. The Singapore and UK regulators have established external advisory panels to guide their policy initiatives, and Singapore has created an “impact hub” to increase collaborate between sustainable start-ups and other stakeholders. 

Regulatory divergence is particularly pronounced in the context of sustainable finance, especially relating to ESG³. Although there is convergence around corporate reporting on environmental issues for companies in general, a stark contrast is emerging on financial services regulation between the EU and the rest of the world (for example, EU requirements to embed sustainability into the investment process — see below). This is likely to reduce the scalability of asset managers' business models and make it more difficult for firms to run the same investment strategies in multiple jurisdictions. Also, due to differing ESG disclosure requirements, a single fund product is unlikely to comply with rules across different regions and jurisdictions.

The EU, the UK and the US are pressing ahead with the most detailed requirements for asset managers and funds. Although the regulators all have the same goal of mitigating greenwashing, their scope and approach are fundamentally different. While the ESG disclosures proposed by the US SEC⁴ are rules-based, the EU's approach is more principles-based (and is subject to frequent revisions). Adding to the complexity, some US states have proposed their own anti-ESG legislation. The UK's proposed Sustainability Disclosure Requirements (SDR) do not align closely with either set of requirements, especially the proposed product labelling requirements.

The EU Sustainable Finance Disclosure Regulation (SFDR) is having extra-territorial impacts, given that fund managers marketing into the EU are in scope. And some investors outside the EU are stating a preference for products that meet the descriptions in SFDR Articles 8⁵ and 9⁶.  Regulators in jurisdictions such as Singapore and Guernsey have stated that SFDR compliance would achieve at least partial compliance with local requirements. 

Expectations regarding firms' fiduciary duties are also evolving. The US Department of Labor published a final regulation to clarify that fiduciaries may consider climate change and other ESG factors when they make investment decisions and when they exercise shareholder rights. And the UK government committed to providing further information and clarity for pension trustees on their fiduciary duty in the context of the net zero transition, via review of its stewardship guidance. 

Greenwashing — false or misleading claims that a service or product is environmentally friendly — remains regulators' key concern and is being expressed in a variety of new rules and disclosure requirements. 

Some jurisdictions are defining greenwashing for the first time. In May 2023, the EU European Supervisory Authorities (ESAs) set out their common understanding of greenwashing: “a practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services.” The ESAs will publish final reports in 2024 with recommendations for mitigating greenwashing.

While some regulators have introduced detailed disclosure requirements to prevent greenwashing (see below), others are relying on supervision based on existing rules and recently issued guidelines. For example, the Australian Securities & Investments Commission (ASIC) summarized its key enforcement activities following publication of its “how to avoid greenwashing” information sheet. Some firms then adjusted down their own claims — not unlike how EU fund managers have recently downgraded the categorization of some funds under SFDR. Similarly, in Canada, there has been a heavy supervisory focus on disclosures against existing general disclosure rules, but with many of the regulators' comments focused on ESG disclosures.  

The Guernsey regulator has issued guidance to counter the risk of greenwashing. Explicit claims or statements that indicate that a fund or its underlying assets are environmentally sustainable investments should not be misleading. Disclosures aligned to SFDR would be deemed compliant with this guidance. The AFM⁷ in the Netherlands consulted on guidelines for financial institutions and pension providers making sustainability claims. The proposed guidance included three principles — claims should be accurate, representative and up to date; specific and substantiated; and understandable, appropriate and easy to find.

Other regulators are bringing forward rules specifically aimed at preventing greenwashing. For example, the UK Financial Conduct Authority (FCA) has proposed a general “anti-greenwashing rule” for all UK regulated firms, requiring them to ensure that the naming and marketing of financial products and services is clear, fair and not misleading, and consistent with the sustainability profile of the product or service. Brazil has also introduced a new regulation requiring ESG funds to comply with several governance requirements, including controls, policies, and procedures to prevent greenwashing.

Jurisdictions are taking fundamentally different approaches when it comes to the notion of a “taxonomy” (a dictionary of sustainable activities). Views vary on whether they are needed, and whether prescription or high-level principles work best. In some cases, the slowing development or absence of taxonomies means that firms need to create their own sustainability frameworks or rely on evolving industry practice.

Jurisdictions such as Japan and Canada do not have environmental taxonomies and instead require firms to follow existing rules that require disclosures to be clear, fair and not misleading. Where this is the case, asset managers are operating without consistent standards on what can be defined as sustainable.

At the other end of the spectrum, the EU has completed its detailed environmental taxonomy. Having added certain nuclear and natural gas activities to climate change-related aspects of the taxonomy (effective January 2023), it has added technical screening criteria for the remaining environmental objectives relating to water and marine resources, recycling and re-use, pollution prevention, and biodiversity and ecosystems. Proposals for a social taxonomy appear to have been abandoned. The Platform on Sustainable Finance, an EU advisory group noted that the “minimum standards” criteria on human rights, bribery/corruption, taxation, and fair competition can be achieved through existing or proposed EU regulation.

The French AMF⁸ would like the taxonomy to be amended by adding a complementary macro-economic view and classifying economic activities into three categories: already sustainable, contribute to an orderly transition plan, and must be stopped. Meanwhile in the UK, the government plans to consult on a green taxonomy in Q3 2023, considering lessons learned from other jurisdictions, with two years of voluntary disclosures before the introduction of mandatory obligations.

Regulators continue to mandate sustainability-related disclosures for asset managers and their products, but jurisdictions are at different stages. Some are providing clarifications and consulting on changes to existing regimes, or expanding the scope of existing requirements to cover broader sustainability topics. Others are introducing disclosure requirements for the first time. 

In Q4 2023, the US SEC is expected to publish its final requirements for funds and advisers to provide more specific disclosures based on the ESG strategies they pursue (aligned with “integration”, “ESG-focused” or “impact” categories). Meanwhile, the SEC's supervisory focus is on whether funds are operating in the manner set out in their disclosures, whether ESG products are appropriately labeled, and whether recommendations for retail investors are made in investors' best interests.

In Hong Kong (SAR), China, new rules on climate-related disclosures became effective in November 2022, requiring fund managers to take climate-related risks into consideration in their investment and risk management processes and to make appropriate entity-level disclosures. In a similar manner, the UK FCA required larger UK asset managers to publish climate-related TCFD-aligned disclosures at entity- and product-level for the first time by mid-2023. Smaller asset managers have an additional year to comply. 

The FCA is expanding these disclosures to capture wider aspects of sustainability. Its proposed SDR would introduce pre-contractual and ongoing sustainability entity- and product-level reporting requirements for asset managers. Originally due in June 2023, the FCA has delayed publication of its final rules until Q4 2023, given significant feedback from industry.  

The EU SFDR continues to evolve. Notable publications and amendments since last year's report include:

• More detailed “Level 2” entity- and product-level disclosures.
• Proposed amendments to broaden disclosures and address known issues.
• Revisions to product-level disclosure templates to reflect the inclusion of certain nuclear and gas activities in the EU taxonomy.
• Clarifications on certain aspects of the regulation — including on the definition of a sustainable investment — which allow more flexibility for firms.

The SFDR is due to be reviewed by the European Commission later in 2023. In the meantime, EU member states have set out their own proposals. The French AMF believes that the flexible nature of the SFDR has created a gap between disclosures and investors' expectations, and fueled greenwashing. It therefore proposed to introduce minimum environmental standards for Article 8 or 9 products. This could include clarifying the vague definition of a sustainable investment, a requirement for Article 9 funds to have a minimum proportion of taxonomy-aligned investments, and the adoption of a binding ESG approach for Article 8 and 9 funds. 

EU regulators have been supervising firms' compliance with the SFDR; including:

• The ESAs reviewed SFDR entity-level disclosures by firms with less than 500 employees. 
• The Maltese regulator carried out further analysis of firms' website disclosures. 
• The Luxembourg CSSF⁹ undertook a data collection exercise on information contained in pre-contractual disclosure documents and issued a guide for firms. It also published observations from its supervisory work on SFDR and broader ESG requirements. The observations touched on disclosures (such as on the fund’s characteristics or name), organizational arrangements (for example, on delegation and risk management), and monitoring investment portfolio compliance.
• A report by the Central Bank of Ireland (CBI) focused on how firms have complied with the SFDR and EU Taxonomy disclosure requirements, and outlined potential greenwashing risks.
• The AFM in the Netherlands found that disclosures on the integration of sustainability risks in the investment decision-making process and remuneration policies could be made more specific, that many fund managers had reclassified their funds from Article 9 down to Article 8, and that reported taxonomy alignment was very low, due to a lack of reliable data.
• The Swedish regulator reviewed Article 9 funds and found room for improvement in terms of the information provided to investors.
• The Spanish regulator reviewed the websites of fund managers managing funds with ESG characteristics and their annual reports. 

To ensure supervisory convergence across the EU, ESMA will commence a common supervisory action on sustainability-related disclosures and the integration of sustainability risks. 

The position in Germany is unique, in that the periodic reports for Article 8 and 9 funds are included in funds' annual statements and are therefore subject to audit requirements. This brings the benefit of additional assurance over the included disclosures but adds to operational costs and concerns about data gaps.

Since January 2023, the Monetary Authority of Singapore (MAS) has required retail funds that use or include ESG factors, or represent an ESG-focused scheme, to meet specific disclosure and reporting guidelines. The MAS confirmed that an EU fund with SFDR Article 8 or 9 status is deemed to have complied with the disclosure requirements, but the fund should still comply with some other local requirements.

The Securities and Exchange Board of India has established an advisory committee on ESG matters. One aspect of the group's work will be to enhance disclosures that are specific to ESG mutual funds with a focus on mitigating risks of mis-selling and greenwashing. There is a longer-term plan to prescribe ESG disclosures for all mutual funds.

Some regulators have also introduced or are introducing restrictions on fund names and references to sustainability in funds' marketing materials.

In Q4 2023, the US SEC is expected to publish final amendments to its fund “names rule”. The existing rule requires funds to adopt a policy to invest at least 80 percent of assets in line with the investment focus suggested by the fund's name. The amendments would extend the rule to capture terms suggesting that funds focus on specific characteristics, including names that indicate a fund's investments incorporate one or more ESG factors.

Japan published guidelines on fund names for investment trusts, defining specific checks for supervisors. Where trusts do not fall under an ESG category, supervisors will review whether the trust's name excludes ESG-related terms. Other checks would include ensuring that certain information is captured within disclosures about the objective of the fund — such as details about how key ESG factors are considered. Singapore's 2022 circular required retail funds using ESG-related or similar terms in their name to reflect an ESG focus in their investment portfolio or strategy “in a substantial manner”.

ESMA has consulted on guidelines regarding the use of ESG or sustainability-related terms in EU fund names. The guidelines would introduce quantitative criteria for fund names — if a fund has any ESG-related words in its name, at least 80 of investments will need to meet at least 80 per cent of ESG characteristics or sustainable investment objectives. If a fund has the word “sustainable” in its name, at least 50 percent of investments within the above 80 percent of investments will need to be sustainable investments. 

Some EU member states have already implemented their own requirements. For example, France requires consistency between what is said in marketing material and the actual investment management of the fund (by imposing minimum standards on products that hold themselves out as having ESG characteristics), including rules on fund names. 

The UK FCA's labelling proposals would codify its existing guiding principles and prohibit the use of specific terms in product disclosures and marketing material where a label is not used (for example, ESG, environmental, sustainable). The proposed restrictions would go as far as capturing “any other terms” that imply sustainability characteristics. Significant work would be needed to remove these terms from fund documentation, or to uplift products to ensure they are eligible to use one of the labels.

Proposed EU requirements on corporate sustainability due diligence would require certain companies to identify and prevent, end or mitigate the actual and potential impacts of their activities on the environment and on human rights abuses — including on the activities of subsidiaries and other entities in their value chain. The exact extent to which asset managers and their funds would be captured by the proposals is yet to be finalized. Industry has noted that the SFDR already imposes due diligence obligations on asset managers. 

In the UK, there is a particular focus on stewardship. The FCA's SDR proposals include increased focus on engagement. A separate review of the UK's corporate governance code is looking to include ESG requirements.

Asset managers have struggled to produce their own disclosures because of a lack of standardized, consistent and readily available data and information from investee companies. However, public and private companies of all types are increasingly subject to disclosure requirements within their annual reports. Some asset managers may themselves be captured directly by these requirements.

As noted in last year's report (PDF 205KB), many jurisdictions require companies to produce TCFD-aligned disclosures. The FSB's TCFD status report found that over 60 percent of surveyed asset managers and over 75 percent of surveyed asset owners currently report climate-related information to their respective clients and beneficiaries. Jurisdictions have taken different approaches to date. For example:

• The EU Corporate Sustainability Reporting Directive (CSRD) builds on existing requirements and will require many more companies to report against new EU standards, with phased implementation between 2025 and 2029. Asset managers have voiced concern that the implementation timeline will lead to continued data gaps. 
• Australia has consulted on internationally‑aligned requirements for companies to disclose climate‑related financial risks and opportunities. The consultation covered the coverage, scope, frequency, format, timing and international alignment of the proposed requirements.
•  The JFSA introduced new corporate reporting requirements for Japanese listed companies with year-ends after March 2023. It added a new disclosure section on sustainability-related information, and new requirements related to human capital and diversity.
• The SFC supported a consultation issued by the Stock Exchange of Hong Kong on proposed climate-related reporting requirements for listed companies in Hong Kong (SAR), China.
• In addition to a TCFD application guide for Malaysian financial institutions issued by the regulators, Bursa Malaysia proposed TCFD disclosure requirements for all listed companies by the end of 2026.
• The US SEC is expected to publish its final rules on climate disclosures for public companies in Q4 2023.
• The Saudi Arabian regulator has issued ESG disclosure guidelines for listed companies.
• The Canadian securities regulators, having previously proposed TCFD-aligned climate-related disclosure requirements, stated that they are “actively considering international developments”.
• The UK FCA reviewed TCFD-aligned disclosures made by premium-listed companies. It was “encouraged” by the overall improvement in disclosures but reminded firms of its expectations.

Separately, the MAS and Singapore Exchange launched a digital disclosure portal for companies to report ESG data in a structured and efficient manner, and for investors to access the data. The MAS considers that FinTech can be a key enabler in addressing ESG data challenges. It plans to consider the ISSB¹⁷ standards before imposing corporate reporting requirements. 

Notably, in June 2023, the ISSB published its first two standards which will become effective starting January 2024. Individual jurisdictions are considering their approach to adopting and applying the standards. The ISSB also consulted on its work plan, and on a methodology to integrate the Sustainability Accounting Standards Board (SASB) standards into its wider reporting framework. More than half of FSB jurisdictions stated that they already had, or were putting in place, structures and processes to bring the ISSB standards into local requirements. 

In July 2023, IOSCO endorsed the final ISSB standards and encouraged its members to apply or adopt them. It plans to review how jurisdictions are using them. IOSCO also welcomed progress by audit standard setters, which aim to have standards available before the end of 2024.

A wider range of firms and financial instruments in the ESG ecosystem are under scrutiny and are being brought within the regulatory perimeter.

ESG data and ratings providers are a particular focus. As the use of ESG data and ratings has grown in financial services, so has regulators' concern around issues such as data quality, transparency of methodologies and conflicts of interest. Japan has developed a principles-based code of conduct for ESG data and ratings providers, and Singapore and the UK are considering similar codes. However, a UK code may eventually be overtaken by regulation of ESG ratings providers. The EU has also proposed rules for ESG rating providers, with some similarities to the UK proposals. 

Also under supervisory scrutiny is the way in which asset managers consume these data and ratings. In Hong Kong (SAR), China, the SFC plans to review how fund managers use ESG ratings and data providers — this will result in guidance for the industry. More broadly, the French AMF completed a thematic review of the internal processes of fund managers with non-financial commitment in their funds. It found that firms had put in place human and technical resources to define, review, manage and monitor non-financial contractual commitments. However, the sampled firms remained dependent on external ESG data providers.

In some jurisdictions, the provision of benchmarks is already a regulated activity. For example, in the EU and the UK there are specific requirements around named categories of indices. In March 2023, the UK regulator wrote to benchmark administrators and highlighted significant issues in its review of ESG-related benchmarks, finding the overall standard of disclosure “poor”. 

Other regulators are focusing on green and social bonds. Further to the guidelines mentioned above, in Saudi Arabia there is increasing issuance of green Sukuk (a Shariah-compliant product). In the UAE, the DFSA set out guidelines on disclosures for ESG bonds and Sukuk, and the UAE Securities and Commodities Authority issued a resolution to regulate sustainability-linked green bonds and Sukuk. The EU's European Green Bond Regulation requires all proceeds of green bonds to be invested in economic activities that are aligned with the EU Taxonomy, for those sectors that are covered by it. And more broadly, in Japan, the JFSA established a Working Group on Social Bonds, which published examples of social indicators (building on social bond guidelines).

Finally, the regulation of carbon markets is likely to increase, given the fundamental need to reduce gross carbon emissions and facilitate the transition to net zero. For example, IOSCO has consulted on recommendations on how to establish compliance and voluntary carbon markets.