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Blog Posts — June 5, 2019

What’s Next for ESG Regulation of Investments?

The asset-management industry will face increasing regulatory pressure in coming years to invest along sustainable principles, according to a panel of experts at the Innovate2Invest conference last week.  

Some countries including the UK and France have already issued mandatory guidelines for investors to report how they are observing certain environmental, social and governance (ESG) criteria. Global agencies are meanwhile issuing non-binding recommendations on investment behavior, which will drive more assets to be invested responsibly, said the experts.  

“Regulation is coming,” said Bruno Rauis, Head of the London Office at Carbon Delta, an analytics firm that focuses on climate data. Rauis pointed to several national and global initiatives that seek to establish sustainability parameters for climate-related disclosures. He cited the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD)1, and compared it to the Basel Accords on banking supervision. 

“Basel was at the beginning a set of recommendations, and it was eventually ratified into law by more than a hundred countries,” he said. “Will we see the same with TCFD? I don’t know but that’s certainly a direction it could take.” 

Carbon Delta recently supported a pilot project from the United Nations Environment Programme’s Finance Initiative, where 20 institutional investors evaluated and stress-tested their portfolios under different scenarios in line with the TCFD recommendations. Three scenarios representing a global temperature increase above pre-industrial levels of 1.5°C, 2°C and 3°C were considered.

Simon Howard, Chief Executive Officer at the UK Sustainable Investment and Finance Associationreviewed the recent activity of climate-related regulation in the UK at the STOXX event. He mentioned last April’s supervisory rules from the Prudential Regulation Authority applicable to banks and insurers to manage climate-change risk, and a similar requirement on pension funds to consider ESG risks and detail stewardship policies of investments. Britain has also proposed an enhanced Stewardship Code that integrates ESG, and the government is working on a Green Finance Strategy draft aimed at attracting investments in the clean economy. 

“Regulation is definitely positive for our cause,” said Howard, who helps banks, asset owners, managers and advisers grow sustainable and responsible finance. 

France, meanwhile, became the first country to introduce mandatory climate change-related reporting for institutional investors in recent years.2

Common cross-border rules?

While many countries are working to define climate-related regulation and legislate around it, a task that looms large will be the standardization of rules across regions, the panel’s presenters said. 

“The debate on harmonization is to come,” said Howard. “But it is far more important to start activity. We are in a territory where perfect is the enemy of good. Let’s start getting something done. And increasingly in the UK, it is being done.”  

Olivier Jaeggi, Managing Director of ECOFACT AG, said that there is additionally an increasing body of conduct principles and jurisprudence around climate change and human rights that could make investors liable for failing to take climate-change risk into account. 

Institutional investors “may not be legally required, but are expected to conduct due diligence,” Jaeggi said during the panel. “There is a call for action. Ignoring such expectations is a risky option.” ECOFACT provides research on regulatory change pertaining to sustainable finance and performs portfolio risk screening.

The role of self-regulation

Roberto Lazzarotto, Global Head of Sales at STOXX and the panel’s moderator, asked the participants whether self-regulation should play a key role on the regulatory path or whether authorities should take the lead. 

“When we write the history of how we beat climate change, and beat it we will, we will see different layers at different times,” said Howard. “The voluntary layer has set the scene for what’s happening. But I think we’re at the stage now where we need the regulatory clout to force it out on the laggards.” 

Howard added that it is imperative that governments and legislators talk to the industry and climate experts to come up with the right set of rules. 

Jaeggi agreed. “If you just see how much has been achieved, it is really amazing; but if you look at it on a global level, the question is how much have we really achieved?” he said. He added that some governments now consider that voluntary action by itself won’t suffice to reach carbon-emission targets. “We have to switch to regulation, and I think that is what we see happening now.”

On climate, “it is very clear that we need policy, we need some intervention,” said Carbon Delta’s Rauis. “We need a set of incentives because for some people” climate isn’t a priority. “We need them to do the right thing even if it is for the wrong reasons.”

The FSB Task Force on Climate-related Financial Disclosures will develop voluntary, consistent climate-related financial risk disclosures for use by companies when providing information to investors, lenders, insurers, and other stakeholders.
IP&E, ‘France aims high with first-ever investor climate-reporting law,’ Feb. 1, 2016.