5 Things to Understand About ESG Regulation
ESG regulation has changed drastically in recent years, with new requirements and recommendations for organisations to consider emerging all the time. This article will focus on 5 crucial things that will make it easier to understand and successfully navigate the ESG regulatory landscape.
1. It Can be Confusing
Even before the term ESG had even been coined, the Global Reporting Initiative (GRI) launched the first framework for sustainability reporting in the year 2000. During the following two- and a-bit decades, the ESG regulatory landscape has been inundated with new frameworks, guidelines, and standards; comprising of different scopes, recommendations, requirements, and metrics for organisations to consider when reporting on ESG issues.
The Task Force on Climate-related Financial Disclosures (TCFD), Sustainability Accounting Standards Board (SASB) and Carbon Disclosure Project (CDP) are just a few examples of other different ESG frameworks that have entered the landscape since the start of the millennium. It is a heavily acronymised space, and each framework often has its own guidance and reporting recommendations. Coupled with the fact that depending on size, location and economic activity, organisations may fall under different jurisdictions of mandatory regulations, meaning even greater confusion and difficulty in understanding ESG requirements.
Unfortunately, a completely standardised ESG regulatory landscape would be too much to expect at this point in time. However, over the coming years, standardisation will continue to occur through the adoption of complementary frameworks and the good work of the International Sustainability Standards Board (ISSB) which will make it easier for different organisations to understand their regulatory obligations and ESG reporting requirements.
2. It Can Be Obligatory
Although the majority of companies are not currently required by law to disclose information on ESG topics, certain organisations in various jurisdictions must now report on these issues. With some examples of mandatory ESG regulations in the EU and the UK listed below, they highlight some of the key ESG considerations that different organisations must report on.
Targeting the financial markets, the Sustainable Finance Disclosure Regulation (SFDR) was introduced in 2018 and requires Financial Market Participants (FMP) in the EU to disclose on the Principal Adverse Impacts (PAI) that their investments may have on aspects of sustainability.
Another piece of EU regulation that complements SFDR is called the EU Taxonomy. This classification system with 6 environmental objectives defines the conditions an economic activity must achieve to be considered environmentally sustainable.
The Non-Financial Reporting Directive (NFRD), currently transitioning to the Corporate Sustainable Reporting Directive (CSRD), requires listed companies in the EU that have over 500 employees to disclose policies, policy outcomes, risks and KPIs on several ESG topics, including the protection of the environment, social responsibility, and treatment of staff. Currently, around 11,000 companies in the EU fall under the NFRD’s scope.
On a more global level, the TCFD suggests companies disclose on 11 recommendations that focus on issues of governance, strategy, risk management, and metrics and targets. Companies in the UK that have over 500 employees and that are required to produce non-financial information statements are now legally required to disclose on these TCFD recommendations.
These mandatory disclosures currently mainly target the largest companies in the EU and UK. In March of this year however, the Securities and Exchange Commission (SEC) released new climate-related disclosures for publicly listed companies in the US. Evidently, these requirements are currently only legally relevant for certain organisations. However, as explained later in this article, the scope of this regulation is expected to grow significantly in the coming years and companies currently not in scope should consider the implications of needing to report on ESG matters now.
3. It Can Be Beneficial
Regulation is often viewed negatively by incumbent businesses. However, aligning to an ESG framework or standard can be extremely beneficial. Although the above requirements are mandatory only for certain organisations, it is still possible to align to them even if not legally mandated to. There are also many voluntary frameworks and standards in the ESG regulatory landscape that companies could follow even if not currently required to do so.
Implementing ESG strategies can result in greater efficiencies and therefore, greater cost savings. For example, Telstra, a telecommunications company, became part of a CDP partnership in 2020, which has seen the company experience real benefits to its business operations. By using CDP’s framework, Telstra identified that the production phase of their product’s life cycle emitted the most carbon. They realised that by tackling this issue, they were able to make their packaging more sustainable which in turn significantly reduced their shipping costs.
Performing regular disclosures will increase stakeholders’ confidence that a company is actively engaged in considering, measuring, and working on ESG issues. Bloomberg started their alignment to the SASB standards in 2014, reporting on metrics for their technology, communications, and services sectors. Consequently, in the following years, the company noticed their reputation improved in the media, as well as seeing their employees’ loyalty increase as a result of the company’s considerations for sustainability issues. Due to SASB requirements, Bloomberg were also able to improve their business operations, becoming more energy efficient and improving risk management processes.
Addressing ESG issues can also be very important for identifying potential supply chain risks. For example, if forced labour is identified to be taking place along a company’s supply chain, then the trust of consumers and investors will be damaged, and the company’s reputation could be tarnished. Companies that disclose in line with recognised ESG standards on how they manage these risks along their supply chain will likely be more attractive in future business opportunities.
4. It Will Be Changing
It is important to understand that there will be more changes to come for ESG regulation. Several key updates to the ESG regulatory landscape are scheduled for the next 3 years.
Firstly, an update to the EU Taxonomy, scheduled for December 2022, will require all companies under its scope to start to disclose activities related to all 6 of the Taxonomy’s environmental objectives.
In January 2023, new disclosures (Level 2 RTS) are predicted to come into effect for the SFDR, which will provide specifications for the content methodology and presentation of certain disclosures. The update will also see reporting templates with annexes made available to reporting companies.
The 2024 financial year will be the CSRD’s first reporting period and will see approximately another 40,000 companies required to report on the disclosures. There will be additional disclosures on double materiality that companies will have to start to report on.
Finally, in 2023, certain UK companies that must report in line with TCFD will release their first disclosures on the Task Force’s 11 recommendations.
Looking solely at the updates to these 4 pieces of regulation, it is evident that this space will continue to adapt and change. However, these updates should continue to standardise the ESG regulatory landscape. The expansion of the CSRD in the EU is crucial for standardisation as it considers TCFD, GRI, SASB frameworks and will align to SFDR’s indicators and the EU Taxonomy’s definitions.
5. It’s Not Going Anywhere
Evidenced by the growing scopes of various frameworks, guidelines, and standards, ESG regulation is not going anywhere and thousands more companies across the globe will soon be mandated to implement ESG into their wider strategies.
Research by Deloitte projects that by 2024, 50% of professionally managed assets will be ESG-mandated, largely due to the implementation and adoption of SFDR and other ESG regulation in the EU, such as CSRD and the EU Taxonomy.
At Eight Versa, we understand that aligning to ESG frameworks can be confusing and daunting for companies. However, given the projected expansion of ESG’s regulatory scope and the numerous opportunities that companies will be able to benefit from, we believe that aligning to an ESG framework or standard is something that all companies should be considering currently.
- CDP – Carbon Disclosure Project
- CSRD – Corporate Sustainable Reporting Directive
- GRI – Global Reporting Initiative
- NFRD – Non-Financial Reporting Directive
- SASB – Sustainability Accounting Standards Board
- SEC – Securities and Exchange Commission
- SFDR – Sustainable Finance Disclosure Regulation
- TCFD – Task Force on Climate-Related Financial Disclosures
- ISSB – International Sustainability Standards Board
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