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ESG regulations rising – are you ready?

October 2020

There’s a raft of sustainable investing and ESG-related regulations to get to grips with. Here we highlight some of the key changes and measures advisers need to know about.

Playing by the rules

We all know demand for sustainable investment solutions and all things ESG – environmental, social and governance – related is rising. The Covid crisis is only accelerating this trend. Over the past few years, global regulators have been paying attention to the role of ESG factors in investment risk and performance. They also recognise the importance of directing capital into sustainable investments that can support resilient economic growth and help build a better future. And with the surge in client interest, there is a need too for greater scrutiny and improved transparency to protect consumers – your clients.

As a result, regulations in this ‘green space’ are rising, so what do you need to know?

EU Action Plan for Financing Sustainable Growth – serious change to support sustainability

Released in 2018 by the European Commission, this action plan is a framework for channelling private capital towards investments that support sustainable economic growth. It supports both the Paris Agreement target of a neutral-carbon economy by 2050, and the United Nations Sustainable Development Goals (SDGs). Broadly, it aims to mitigate climate change, reduce pollution and protect biodiversity. The UK Financial Conduct Authority (FCA) has confirmed their ambition to match that of the EU Sustainable Finance Action Plan. Within it, there are the following work streams.

  • Sustainable Finance Taxonomy – EU-wide classification system and performance thresholds to help investors, companies and other stakeholders measure sustainable economic activities. Companies must demonstrate that their activities make a substantive contribution to one of the taxonomy’s six environmental objectives.
  • Climate Benchmarks and Benchmarks’ ESG Disclosures – to enhance the ESG transparency in the methodologies of benchmarks and to propose standards for low-carbon benchmarks.
  • Green Bond Standard – aims to enhance the effectiveness, transparency, comparability and credibility of the green bond market. To also encourage market participants to issue and invest in EU green bonds.
  • Sustainable Finance Disclosures – requires asset managers to publish policies on how they integrate sustainability risks into their investment decision-making processes. Due to come into effect on due 10 March 2021.
  • Corporate disclosure of climate-related information – guidance for companies on how to report both the impact of their business on the climate and the effects of climate change on them.

Proposed ESG Amendment to MIFID II, UCITS Directive and AIFMD – biggest impact on advisers

These planned amendments focus mainly on improving disclosure by investment managers on sustainability risk. So disclosing potential volatility in the value of an investment due to ESG factors.

The amendments to MiFID II will probably have the biggest impact on advisers. It will be mandatory to ask clients about their ESG preferences, as part of the advice process. Advisers must also take sustainability risks into account when selecting financial products, regardless of the client’s sustainability preferences.

Shareholder Rights Directive II (SRD II) – major change in corporate governance

Another EU directive, SRD II aims to strengthen the position of shareholders, prevent voting abuse, and reduce short termism and excessive risk taking by companies. Many of these issues came to light during the global financial crisis. This directive, brought into force in September 2020, marks a major change in corporate governance.

Non-Financial Reporting Directive (NFRD) – better disclosure

This directive requires large companies to disclose information on the way they operate and manage social and environmental challenges. The aim is to help investors, consumers, policy makers and other stakeholders to evaluate the non-financial performance of large companies. It also encourages companies to develop a responsible approach to their business operations.

2020 UK Stewardship Code – dialling up the importance of stewardship

In October 2019, the UK’s Financial Reporting Council (FRC) published an updated version of the Stewardship Code. The original 2010 Code contained principles and guidance to enhance the quality of engagement between institutional investors and companies. The aim was to improve long-term returns to shareholders and help with the efficient execution of governance responsibilities.

This update to the Code, which took effect on 1 January 2020, requires signatories to report annually on their actions. It also contains new expectations of how investment and stewardship should be integrated, including ESG issues. In addition, there are 12 new principles for asset owners and asset managers, and six separate principles for service providers that support them. For more details on these changes to the Stewardship Code, read our latest article.

UK Green Finance Strategy – supporting sustainable economic growth

Launched in summer 2019, the strategy supports the UK’s economic policy for strong, sustainable and balanced economic growth. It also aims to deliver the government’s commitments on climate change, the environment and sustainable development. It has three core elements.

  • Greening finance: to ensure financial risks and opportunities from climate and environmental factors are integrated into mainstream financial decision making. Also, that the markets for green financial products are robust.
  • Financing green: to accelerate finance to support the UK’s carbon targets and clean growth, resilience and environmental ambitions. It also aims to support international objectives.
  • Capturing the opportunity: ensuring UK financial services capture the domestic and international commercial opportunities arising from the ‘greening of finance’. This includes climate related data and analytics. It also aims to capture opportunities from ‘financing green’, such as new green financial products and services.

Further afield

Regulators across the rest of the world are also joining forces to improve ESG standards and practices. We expect to see more focus on ESG Capital Market regulations in the US and Asia, for example.

In other global initiatives, it’s now mandatory for signatories of the UN Principles for Responsible Investment (PRI) to adopt the Taskforce on Climate-related Disclosures (TCFD). This is helping to bring greater transparency to climate risk throughout the world’s capital markets. In turn, it should also help make markets more efficient and economies more stable and resilient.

Regulation agitation

All this regulatory scrutiny demonstrates the scale of change in the sustainable investing space. Some, not all, of the changes we’ve highlighted will have a direct impact on your business. And some of you will have outsourced your investment management to a responsible and sustainable discretionary fund manager to alleviate these additional pressures. Regardless, the adviser community has a long history of adapting to new regulatory regimes and grasping new opportunities. We know this time will be no different.

Many of these new and pending directives will enable our industry to measure sustainability far more effectively. They will also help tackle ‘greenwashing’ – where companies, funds, investment solutions and products claim to be more sustainable than they really are.

Most importantly, these regulations will provide much needed clarity for clients who wish to understand the ESG worthiness of their investments. And that’s no ‘bad thing’ when they’re trying to do ‘the right thing’ with their investments.

To find out more, please get in touch with your usual contact at Aberdeen Standard Capital.

You can also email us at asc@aberdeenstandard.com or visit aberdeenstandardcapital.com/responsibleinvesting

Warning

Investment involves risk. - The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.