ESG (Environmental, Social and Governance) is becoming an increasingly important area of regulatory compliance, with mandatory reporting growing in prevalence globally.
ESG ratings are a hot topic for lenders, borrowers and regulators right now, with an increased focus on steering business towards a more transparent, environmentally and socially responsible way of working. Though not mandatory in many countries, according to the KPMG Survey of Sustainability Reporting in 2020, 78% of the 100 largest companies in the world produced sustainability reports in 2020. The World Economic Forum’s latest Global Risks Perception Survey identified “climate action failure” as a top 2 risk, by both likelihood and impact. And last year saw a marked shift in investments to more ESG-focused offerings, with issuance of sustainable bonds up 96% compared to the same period in 2019. The number of social bonds issued was also eight times higher.
To put that into context, Tesla’s valuation is now higher than the valuation of the five largest European oil and gas companies, including BP and Shell. “We are seeing a green revolution,” says Adeline Diab from Bloomberg Intelligence, “which is, in my opinion, the biggest disruptive trend maybe since the internet.” This shift in priorities means that how your firm reports and records its ESG data has never been more important - not just in terms of attracting investment, but also in relation to the additional regulatory burden. When you think of ESG risks, your first thought is likely to be about industries such as coal or oil extraction. But the financial services industry also has considerable exposure to ESG risks because of the industries it funds, the companies and individuals it provides services to - and of course its own carbon footprint.
Creating a successful ESG compliance programme
A successful ESG compliance programme must adopt a holistic approach to ESG, integrating it into the entire regulatory compliance framework so that all risks can be aligned with the relevant ESG regulation. Firms should be mindful of not prioritising any one of the three pillars which comprise ESG. The environment, societal factors and adequate governance and oversight need to be managed synergistically, without one compromising either of the others.
There are several voluntary guidelines available for banks to follow in relation to ESG risk management, such as those published by the World Economic Forum, and currently adhered to by 61 global companies, employing a combined total of seven million people. Despite these frameworks not being mandatory, it would serve firms well to implement them now so they are well placed to meet the inevitable regulatory challenges on the horizon. Investors have long lamented inconsistency in sustainability reporting requirements, making it extremely difficult to make fair decisions based on a company’s ESG credentials. As such, it’s likely that a much-anticipated standardised approach is in the pipeline. The International Financial Reporting Standards Foundation (IFRS) and the European Financial Reporting Advisory Group are in discussions with the aim of reaching this goal in the not-too-distant future; and have published proposals to create a new, global Sustainability Standards Board. Larry Fink, CEO of BlackRock, whose open letter in January 2020 was a turning point for the ESG movement, expressed his desire for a standardised approach in his 2021 letter: “We strongly support moving to a single global standard, which will enable investors to make more informed decisions about how to achieve durable, long-term returns,” he wrote.
There are several regulatory developments happening in the area of ESG right now, in particular in Europe as the EU Action Plan for financing sustainable growth is implemented. In the US, the election of Joe Biden is set to see a focus on more ESG-friendly regulation; and China, Korea, India and the UK are also witnessing a tightening on climate-related disclosure regulation. ESG is so wide reaching as an investment concept, the best risk mitigation method is to stay ahead of the curve and address issues before they are highlighted by regulatory issues. Setting your own exacting standards is the best way to ensure you are ready to meet those set by the regulators, investors and the wider public.
This is an extract from ESG regulation: what you need to know, by RiskBusiness. To download the full report, which goes into greater detail on regulatory developments in the regions mentioned above, click here.