The evolving ESG regulatory landscape

Simon Lovegrove

Hello everyone and welcome to the first in our financial services videos on ESG. I am joined by Imogen Garner, a partner in our financial services team and also Beth Duff a manager from our Government Relations department in Brussels.

Imogen, to start off with, for those not familiar with the concept, what is ESG?

Imogen Garner

So, ESG is an umbrella term that we are increasing seeing with our financial sector clients. It stands for ‘Environmental, Social and Governance’ and what it really represents are a series of non-financial factors that have found their way into the investment process and investment decision-making and are becoming really increasingly important.

Environmental, think of things like impact on climate change, impact on biodiversity, pollution, waste.

Social factors might relate to the way in which a company treats its staff, its customers and its impact on the wider communities in which it operates.

And Governance is a more familiar term, so think of audit, internal controls, board diversity, that sort of thing.

Simon Lovegrove

And why is it important?

Imogen Garner

It’s really becoming increasingly so. That’s partly because of wider public concern around the issues and that’s really flowed through into investors so that we’re seeing, for instance, large institutional investors like pension schemes being increasingly engaged and demanding in relation to ESG issues.

There’s a second point too, though, which is that financial institutions are also becoming more cognizant of the impact of ESG risks on them themselves, more directly.

Simon Lovegrove

And Beth, turning to you and thank you for joining us. I know you’ve just had a meeting with a client on ESG. Starting off with the European Commission, there was an action plan on sustainable finance.

Beth Duff

Sure, so the Commission’s action plan actually stems from their wider commitment, both internally and globally to ensure that sustainability is part of their legislation. So, in May 2018 they published the action plan on sustainable finance. Now, there are two main objectives to this, the first, being to encourage capital flows towards more long-term and sustainable investments and, secondly, to incorporate ESG considerations into investment decisions and advice as a general practice. Now there are three main elements to this action plan, the first being what’s known as the taxonomy, and this is a proposal to create a unified taxonomy to determine what is a sustainable activity and therefore investments into that activity would be considered sustainable. In the short-term this will focus on the environmental factors that Imogen referred to, but going forward will also consider social and governance factors. At the moment, the European Parliament has a position on this but the Member States have so far failed to do so and so we don’t see an agreement being made until around Autumn of this year.

Simon Lovegrove

Taxonomy has received a lot of attention but there’s also the issue of disclosures, as well, Beth.

Beth Duff

Indeed, so the second element of the action plan is regulation on sustainable finance disclosures. Now, this will apply to quite a wide range of market participants, including investment firms, credit institutions, both where they have portfolio management services as well as UCITS management companies and AIF managers. The obligations on these market participants are again quite wide-ranging. Firstly, there are disclosure obligations on the entity itself to consider where they bring in ESG risks and how they consider the impacts of those ESG factors on their investments and then, secondly, there are obligations on the financial product itself, where a market participant would like to market that product as being sustainable.

Simon Lovegrove

And there was also something called ‘benchmarks’, Beth.

Beth Duff

Indeed, so there was an amendment to the existing Benchmark Regulation and the idea is to introduce a new category of benchmarks which will allow investors to better assess the carbon footprint of their investment.

Simon Lovegrove

Imogen, Beth has just mentioned we’ve got ‘in-flight’ EU legislative files dealing with the taxonomy and also disclosures. At this stage, we don’t know whether or not the Withdrawal Agreement between the EU27 and the UK is going to be finalised. So, in a hard Brexit scenario how will these files be implemented by the UK?

Imogen Garner

Thanks, Simon. So, in a hard Brexit, the Financial Services Implementation of Legislation bill provides a power for the UK to implement and make some limited changes to a specified list of ‘in-flight’ legislation, and by ‘in-flight’ what we really mean is either pieces of European law that are currently being negotiated but won’t be in force for about two years after Brexit Day or maybe they are already published in the Official Journal but they’re not going to be operative just before Brexit Day. So, we do know that two of the items that Beth just talked about are specified on that list and those are the ones relating to disclosure and to the taxonomy.

Simon Lovegrove

And Beth, I mentioned a moment ago that you’d actually seen a client about ESG issues before the video. What sort of issues are you talking about?

Beth Duff

I should say at the outset that actually our clients and the market as a whole are quite positive towards the action plan. Firstly, it certainly presents new opportunities as there is an increasing trend and demand for sustainable investments and, secondly, it will exclude so-called ‘greenwashing’ of products. That being said, there are certainly concerns arising from some of the proposals now that they are reaching the final stages, especially the disclosure file. The issues there are more related to how their existing disclosure requirements will then integrate or map against the new ones and there are quite a number of obligations there, and secondly, is the issue of the scope of what is considered a financial product as, in the Disclosure Regulation, the scope is different to that in MiFID II for example and so this could create some complications when they’re trying to integrate the new obligations into their existing obligations.

Imogen Garner

Actually, one of the things that we’ve been hearing is - we’ve just talked about some of elements of the European package, but there’s actually quite a lot more out there – there are European publications, international ones and there are some in the UK, for instance, the FCA’s recent publication on climate change. So, one of the things I’ve been hearing from clients, is “where do you find it all and there’s no one place that pulls it all together” and, of course, we are developing a hub to do just that.

Simon Lovegrove

And we’ve also created a tab on the ‘Regulation Tomorrow’ blog specifically for ESG and it will be interesting to see the FCA’s business plan - how that deals with ESG as well.

Thanks very much everybody.

Goodbye.