The growing pursuit of sustainability

Policymakers are pursuing common global standards for reporting by companies on sustainability matters in their annual reports and related documents, including financial firms.

Banking supervisors around the globe are underlining their expectations regarding firms' consideration of climate-related risks, but the EU continues to lead on introducing financial services regulation.

The trustees of the International Financial Reporting Standards (IFRS) Foundation have announced plans to establish a new board for setting sustainability reporting standards. It will focus on information that is material to the decisions of investors and other creditors, initially on climate-related matters, and will build on the recommendations of the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD). The International Organisation of Securities Commissions (IOSCO) will collaborate (PDF 97 KB) in the work.

The announcement was widely welcomed, including in Europe. ESMA has suggested that the IFRS standards should be based on the EU's concept of “double materiality”, where companies disclose the impact of environment, social and governance (ESG) factors on performance, alongside their impact on the environment and society, with some leeway offered in jurisdictions where ESG investing is less developed.

Meanwhile, the European Commission has issued proposed changes to the Non-Financial Reporting Directive. The recast Corporate Sustainability Reporting Directive (CSRD) will cover around 49,000 entities (a more than four-fold increase), extend the scope of non-financial information to be reported and introduce a limited assurance requirement. A new EU sustainability reporting standard setter will produce standards covering all reporting specified in CSRD, by end-October 2022.

The European Supervisory Authorities (ESAs) have issued their individual opinions to the Commission on how financial firms should meet their obligations under Article 8 of the Taxonomy Regulation, which amends NFRD by requiring large public interest entities (PIEs) to include in their annual reports the proportions of revenue and capital and operating expenses related to environmentally sustainable activities. The three opinions set out proposed KPIs and methodologies for the different financial sectors.

The UK government is considering requiring PIEs to publish annual “resilience” statements. It is consulting on whether these could provide a means for companies to provide disclosures consistent with the TCFD's recommendations.

US Treasury Secretary, Janet Yellen presided over her first meeting as head of the Financial Stability Oversight Council on 31 March 2021. The public portion of the agenda included climate change and its potential impacts on financial stability. Special Presidential Envoy for Climate, John Kerry is holding discussions with US financial sector leaders about how to mobilise capital for green technology and clean energy. And the SEC has created an enforcement task force on climate and ESG issues, which will develop initiatives to identify ESG-related misconduct. It will look for material gaps or mis-statements in issuers' disclosure of climate risks and will analyse disclosure and compliance issues related to ESG strategies used by investment managers and funds.

On 31 March 2021, the Network for Greening the Financial System (NGFS), which comprises central banks and banking supervisors, released an overview (PDF 293 KB) of sustainable finance market dynamics. It identifies disclosure, risk management and mobilisation of capital as the three main channels through which financial markets can help steer the transformation of the real economy towards higher levels of sustainability. The report provides examples of policies, regulations and guidance to market participants on these three topics, and a set of key takeaways for further consideration by policymakers and market participants:

• Financial authorities to support global disclosure frameworks, efforts to establish a comprehensive corporate disclosure standard aligned with the TCFD recommendations and development of a global set of sustainability reporting standards
• Multinational financial institutions to adopt and promote global voluntary sustainability standards and disclosure frameworks in the different jurisdictions in which they operate
• Credit and ESG rating providers to enhance transparency surrounding their methodologies — the criteria used to assess the materiality of climate and sustainability factors, the manner in which these are measured and incorporated into ratings, and the weights assigned to them
• Regulators to require financial institutions to consider material climate and sustainability factors as financial factors, and financially material climate and sustainability factors to be part of the fiduciary duty of asset managers
• National and multilateral development banks to strengthen their support to mobilise capital towards green investment projects, particularly in developing and emerging markets

The Basel Committee on Banking Supervision (BCBS) will (PDF 163 KB) conduct a gap analysis to identify areas in the current Basel Framework where climate-related financial risks may not be adequately addressed or are not captured. The analysis will be comprehensive and cover regulatory, supervisory and disclosure elements. The BCBS will explore practical solutions to address any identified gaps. In addition to a set of principles or guidelines on effective supervisory practices for assessing climate-related financial risks, the Committee will explore whether any policy measures under the regulatory framework should be taken, and how the Committee could support international efforts related to the development of globally consistently sustainability reporting requirements.

The EBA is consulting on technical standards for Pillar 3 ESG disclosures under the Capital Requirements Regulation, to ensure stakeholders are informed about ESG exposures and strategies and can make informed decisions and exercise market discipline. The proposals are consistent with the EBA's recommendations to the Commission on Article 8 of the Taxonomy Regulation (see above), including a green asset ratio.

Preliminary findings from the ECB's first economy-wide, desktop climate stress test, which encompasses around four million companies worldwide and 2,000 banks and looks, 30 years ahead, show that in the absence of further climate policies, the costs to companies arising from extreme weather events would rise substantially and greatly increase their probability of default. The final results — expected in the summer — will inform the separate supervisory climate stress-test of individual banks that the ECB will carry out in 2022. Meanwhile, preparation for the Bank of England's 2021 Climate Biennial Exploratory Scenario for the largest UK banks and insurers is underway, with the full exercise to launch in June 2021.

Asset owners (insurers, pension funds and investment funds), asset managers and financial advisers now have the final changes to various existing EU regulations to include references to sustainability risks. They cover investment risk, product governance, suitability and conflicts of interest – see KPMG’s Delivering sustainable finance. Insurers await the outcome of EIOPA’s consultation on capturing climate-related risks in solvency requirements, and banks and investment firms await the EBA’s decision on incorporating ESG risks into firms’ governance, risk frameworks and supervision.

Asset owners and managers also await the final Level 2 rules under the Sustainable Finance Disclosure Regime (SFDR). The ESAs sent recommended (PDF 2.6 MB) text to the Commission in February 2021, just one month ahead of the first SFDR implementation deadline of 10 March. The ESAs have recommended that the deadline for complying with certain of the Level 2 rules should be delayed but that, in the meantime, firms should refer to the recommended text for guidance. The Commission has yet to adopt the rules. Meanwhile, the ESAs are now consulting on Level 2 rules to underpin the additional requirements for “light green” and “dark green” products under the SFDR, which were introduced via Articles 5 and 6 of the Taxonomy Regulation. The ESAs recommend that the main SFDR Level 2 rules should be amended to incorporate these additional requirements.

As reported in the February edition, progress in finalising the detailed Level 2 rules under the Taxonomy Regulation for the climate change mitigation and adaptation objectives has been difficult. In addition to industry concerns, member states have differing views on how nuclear power and gas should be classified. The final texts have just been published and are significantly reduced in scope, but with more to come. Also, Commission proposals on an EU green bond standard and an EU ecolabel for investment products have yet to emerge, and there are calls for ESG data and rating providers to be regulated and for stress tests of central counterparties to consider sustainability risks.

The UK is not directly implementing new EU ESG-related regulation, but given global and market pressures, new UK rules and further supervisory statements in all the above areas may be expected. The UK Chancellor has written to the FCA and the Prudential Regulation Committee (PRC), requiring them to take into account the government's economic policy when undertaking their regulatory activities. The letter to the FCA simply includes the phrase “to transition to an environmentally sustainable and resilient net zero economy, including through regulation”, whereas the letter to the PRC includes relevant text under sections on growth and competitiveness.