“Everybody’s talking at me,
I don’t hear a word their saying,
Only the echoes of my mind.”Everybody’s Talking at me- Harry Nilsson, 1968
An “Interesting” Year
As we move towards the end of one of the most tumultuous years in living memory, many people start to reflect on what’s happened and what’s to come as we turn the page on 2020. For most, the global pandemic will represent the defining story of the year, but there have been many other turbulent geo-political events such as the U.S. elections and Brexit and social unrest manifested in movements such as Black Lives Matter. At times, the news cycle felt like it came from a barely believable, low budget movie rather than reality. One of the few areas of broad consensus, common interest, and of mutual benefit to everyone, is the sustainability of the planet we live upon. That said, there remains both skeptics and widespread debate on how to achieve environmental goals as well as the pace of change as competing priorities remain. However, in the cacophony of 2020, it appears that in the sphere of asset management at least everyone broadly agrees that sustainability will remain a key driver for the foreseeable future.
While the EU policymakers remain at the forefront of ESG regulation, it is very much a global trend. Let’s take a whistle-stop tour of the globe and look at some of the latest developments:
EMSA Consultation on Taxonomy Key Performance Indicators
We’ve previously highlighted the broad and ambitious EU ESG policy agenda many times before and there is no end to the relentless nature of publications and consultations coming from the virtual corridors of Brussels. The latest comes in the shape of the European Securities and Markets Authority (ESMA) consultation on how in scope firms for the Non-Financial Reporting Directive (NFRD) will report in-line with EU Taxonomy using certain defined key performance indicators (KPI). The consultation aims to gather market feedback in order to allow ESMA to advise European Commission under Article 8 of the Taxonomy Regulation. As a brief reminder, the Taxonomy Regulation defines what is an environmentally sustainable economic activity, but it also requires certain assigned issuer disclosures.
Even describing what the consultation covers is complex and technical, which is an indicator of the level of difficulty asset managers have with marrying their current business processes to the EU rules. To that end, asset managers must ensure they have data backed evidence to prove that they are adhering to the complex requirements.
The consultation focuses primarily on the scope of the taxonomy and how best to calculate three financial KPIs for public disclosure. All of these KPIs are related to environmentally sustainable activities:
- proportion of a firm’s turnover
- capital expenditure (CapEx)
- operating expenditure (OpEx)
The paper asks how these should be calculated and how best they should be disclosed by security issuers and translating the methodology to allow asset managers to weigh and measure the KPIs for their respective investment portfolios.
Another defining feature of the EU ESG agenda is the ambitious and highly constrained timeline to get through each part. The consultation closes on December 4th, so the industry once more scrambles to respond and influence the final ruleset and ensure the theory is workable in practice. A tight schedule- and another one to keep on your ESG watchlist.
Post Brexit ESG Framework – First Step Towards Divergence?
Last week, the United Kingdom’s Chancellor of the Exchequer, Rishi Sunak set out a series of measures and ambitions to frame the UK’s post Brexit financial services policy framework as it readies itself to leave the European Union. A central component of this plan is to place the UK as a global hub for green finance. The speech pointed out that the UK would issue some “Green Gilts” for the first time, sovereign bonds which will be specially earmarked for environmental projects. This is timely given the UK, well Glasgow, Scotland, to be precise, hosts COP 26 net year (COVID-19 depending). The COP 26 summit is run by the United Nations and gathers governments, private sector, and academics together to discuss how to accelerate action towards the goals of the Paris Agreement and the UN Framework Convention on Climate Change. The wide-ranging speech also suggested that the UK would become the first country globally to mandate larger listed and private companies with disclosure of environmental factors affecting their businesses, including banks, insurance companies, and pension schemes.
Interestingly, the UK had previously decided not to onshore the EU’s Sustainable Finance Disclosure Regulation (SFDR) which comes into effect after UK has left the EU. Instead, the UK plans to adopt a similar (but not identical) disclosure regime based on the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) within the next five years rather than the EU Taxonomy aligned ruleset. This gives the UK market more time and more latitude than the EU rules which are highly specific and highly timebound.
This policy divergence, however, is both useful and problematic for UK managers who will continue to operate in some way, shape, or form in the EU post Brexit. It poses several difficult questions. The FCA will need to think hard before departing radically from EU standards, since EU standards are frequently adopted as international standards. How different the rules become will be a significant consideration for deemed regulatory equivalence. The UK might consider its own ESG ruleset as not representing “meaningful divergence,” but the EU may think the opposite. This could jeopardize hopes of a mutual equivalence determination for MIFID, AIFMD, and other regulations since they will also enshrine the EU Taxonomy and SFDR soon.
Such divergence means that UK managers who operate EU funds for example, will have dual, non-harmonized regimes to contemplate post Brexit. Having two similar but non harmonized rulesets makes it tricky for entities having to deal with both rulesets and is an indicator of the wider challenge for asset managers if the U.K. and E.U. rulesets do continue to diverge post Brexit.
Does a Biden Administration elevate ESG Policymaking?
We will likely come back to a wider assessment of what a new president and administration means for asset managers, but already it seems clear that in terms of ESG and sustainability, the US might indeed gravitate more toward ESG policy integration to a greater extent than the previous political administration did.
It’s probably too early to suggest anything definitively about US policy changes at this stage. In fact, with likelihood of a split government (senate and congress) there may continue to be curbs on big policy changes in any case and it’s likely that change will be seen more forcefully in appointments to various policymakers and agencies over time. However, a few signals that the U.S. might be more open to ESG are already evident:
- The President Elect, Joe Biden has already suggested that the U.S. will rejoin the Paris Agreement.
- Randall Quarles, the head of the US Federal Reserve has stated that the Fed applied to join the Network for Greening the Financial System (influential global group of central banks and market regulators).
- The appointees for Department of Labor each have track records of being invested in ESG initiatives. The Chair of the DOL either way is very likely to revisit the recent controversial DOL ESG rules which makes sale of ESG products to U.S. savers and pension plans difficult. It is also likely that with the forthcoming appointment of a new Chair of the Securities and Exchange Commission (SEC) with Jay Clayton leaving on January 1, we may also see the SEC revisit a more detailed ESG ruleset for U.S. funds and asset managers.
SFC Consultation on Disclosure of Climate-related Risks by Fund Managers
Not to be left out of the global trend, Asia and the Greater China region have also been considering ESG integration into both regulation and product trends. However, it is also clear that the speed and scale of change is not to the extent found in Europe or US markets. On 29 October 2020, Hong Kong’s Securities and Futures Commission (SFC) issued a consultation paper proposing certain changes to the Fund Manager Code of Conduct (FMCC) requiring fund managers to consider climate-related risks in their investment and risk management processes. The revisions would also require disclosures of climate risk information to combat greenwashing. There has been much talk about lower levels of trust in ESG among Asian investors as instances of greenwashing have been identified (products purport to be ESG but investments are anything but). So, it will be interesting to see if this is the start of an increasing focus on ESG and sustainability in Hong Kong and beyond as they look to adopt what are increasingly becoming global standards.
ESG is a global trend, and one that is not going away any time soon. It appears to be one of the very few topics where a consensus has formed: like it or not ESG is going to be a defining issue for global asset managers for the foreseeable future.