Robin Powell: ESG investing needs easy rules now, regulators

ESG has an oversight problem. And it seems everybody is trying to solve it at once. For those keen to invest with a view to environmental, social and governance (ESG) issues, the regulatory attention is welcome. But that doesn’t make it easier to understand.

It is hard enough for the average finance professional, never mind the lay investor, to keep track of the rapidly multiplying list of acronyms and initiatives associated with those monitoring the sustainable finance movement.

Part of that complexity is due to the combination of global attempts to achieve consistency in transparency, disclosure, goal definition and measurement of outcomes, alongside national regulatory regimes, each running their own course.

Alphabet soup

There’s now an alphabet soup of acronyms in the ESG regulation space we need to get our heads around.

in a progress report issued last year only about half of companies it reviewed had since begun to disclose climate-related risks in some form

The first is the TFCD – the Task Force on Climate-Related Financial Disclosures. This group was created in 2015 by the Financial Stability Board, which is an international body that monitors and makes recommendations about the global financial system.

In 2017 the TFCD released climate-related financial disclosure recommendations designed to help companies provide better information to support investors in how they make decisions and to improve the functioning of capital markets.

But in a progress report issued last year the TFCD found only about half of companies it reviewed had since begun to disclose climate-related risks in some form. On average they had covered only a third of the task force’s 11 recommendations.

Part of the issue with the slow take-up is the TFCD’s recommendations are voluntary and it is up to individual regulators to pursue more mandated disclosure regimes. The results so far have been inconsistent and patchwork.

Reporting standards

One breakthrough in global standardisation on reporting was the announcement at the COP26 event last November of the creation of an ISSB – or International Sustainability Standards Board by the body controlling international financial reporting standards.

it is up to individual regulators to pursue more mandated disclosure regimes

The new proposed disclosure standards, drafts of which were released for feedback in March this year, seek to create a global baseline for sustainability disclosures, allowing each jurisdiction to go further if they wish.

The process at this point is one of consultation. The ISSB is seeking global feedback on the proposed minimum disclosure requirements until the end of July. It will review that feedback and aim to issue new standards by the end of 2022.

ESG ratings

Aside from the efforts to generate greater consistency in company disclosures, the other major focus for securities regulators is providing better policy for the rapidly multiplying ESG investment rating and data providers.

IOSCO, the umbrella body for securities regulators worldwide, has proposed a global framework to improve the comparability of ESG products and increase trust among users. This is amid longstanding concerns over a lack of consistency in ratings.

In research issued in 2019 and updated early this year, a team at the MIT Sloan School of Management found huge divergence in ESG ratings, based on data from six prominent specialists.

Differences in measurement contributed 56% of the divergence, variations in scope another 38% and differences in weights 6%.

Highlighting the risk of greenwashing, IOSCO’s proposed framework makes five broad recommendations:

  1. regulators setting appropriate expectations for asset managers
  2. improvements in product disclosure
  3. the provision of adequate enforcement tools
  4. the adoption of common terminology and 
  5. the promotion of investor education

Individual Initiatives

While efforts at global consistency continue, individual jurisdictions are doing their own thing. The European Union next year plans to introduce its own corporate sustainability reporting directive — one that goes beyond the ISSB’s proposed standards.

Meanwhile the European Commission has launched an ambitious sustainable finance strategy which is designed to facilitate the EU’s transition from fossil fuels. This includes a new European Green Bond standard.

Here in the UK, the Financial Conduct Authority has also positioned itself as at the vanguard of jurisdictions on disclosure.

Issuers of equities must now include a statement in their annual financial reports about whether their disclosures meet the global task-force’s standards.

The FCA has also proposed distinct categories for labelling of investment products — from those not promoted as sustainable, to “responsible” investments to “sustainable” investments, in turn divided into “transitioning”, “aligned” and “impact”.

The danger of overkill

With so many initiatives globally and locally in trying to improve regulation of ESG and deliver greater clarity for investors, asset managers, companies and intermediaries, there is clearly a risk of sowing even greater confusion.

ESG is a hugely complex subject, and yet, in my experience, investors, and even many professionals, struggle to understand the basics. Tackling the climate emergency requires much greater clarity. 

Regulators need to provide it — and fast.

Robin Powell is a journalist and author and editor of The Evidence-Based Investor.