Regulatory context
RESPOND helps investors to understand how their responsible investment (RI) practices compare to current and upcoming regulations, and how they can be strengthened to ensure alignment with the Sustainable Development Goals (SDGs) and the Paris Agreement.
The pace of regulations is accelerating
Recognising that climate change and natural capital degradation will have impacts on economic growth and financial stability, regulators and policymakers are taking action. As of 2019, the PRI reported that across the world’s 50 largest economies, there have been over 730 hard and soft-law revisions supporting, encouraging or requiring investors to consider long-term value drivers, including ESG factors. Of these revisions, 97% were published after 2000, with more than 80 enacted in 2019 alone.
Unfortunately, despite this recent momentum, current regulations will not achieve the Paris Agreement's ambition of limiting global warming to well-below 2°C. The PRI warns that a forceful regulatory response to climate change, within the near term is likely, but is not yet priced into today’s markets; such an “inevitable policy response” would create significant transition risks and negative financial impacts for portfolio companies and the asset managers invested in them if they do not begin to address these now.
Key regulatory developments in Europe and Asia
New and updated stewardship codes
The Dutch Stewardship Code, developed in 2018 by institutional investor platform Eumedion, came into force in January 2019. Of particular interest, Principle 2 of the code states that it is critical for asset managers to “consider environmental (including climate change risks and opportunities), social and governance information (including board composition and diversity) when assessing investee companies.”
In 2018, the European Fund and Asset Management Association revised its Stewardship Code to ensure alignment with the revised EU Shareholder Rights Directive. Environmental and social concerns are included in the principles’ scope.
Effective as of 1 January 2020, the new UK Stewardship Code 2020 is a substantial revision to the 2012 code. The updated code sets forth a range of new expectations specific to ESG; for example, Principle 7 asks signatories to “systematically integrate the stewardship of material environmental, social and governance issues, including climate change, into all investment decisions.”
In Asia, voluntary stewardship codes have been a leading driver of RI, with Hong Kong, Japan, Malaysia, Singapore, South Korea, Taiwan and Thailand all having implemented codes since 2014. Many of these codes recommend that signatory investors take actions to monitor portfolio companies’ environmental and social performance and engage company management over environmental and social issues. The codes articulate that asset owner signatories should require their external managers to implement them as well.
Most recently, the Council of Experts on the Stewardship Code, established by Japan’s Financial Services Agency, published the second revision of Japan’s Stewardship Code in March 2020, to which 280 institutional investors have signed up. Key changes reflected in the revised code include a focus on sustainability and ESG factors, a recommendation to disclose proxy voting rationales, and clarification on stewardship responsibilities of asset owners. For example, Principle 1 includes explicit guidance for investors to “specify how they take the issues of sustainability into consideration in their policy” and Principle 4 references engagement on sustainability issues.
The Taiwan Stock Exchange also released a revised version of its Stewardship Principles for Institutional Investors in August 2020. Here as well, the revised code includes a focus on sustainability and ESG factors. For instance, Principle 1 advises investors to “integrate environmental, social, and corporate governance (ESG) factors into the investment evaluation process” and Principle 3 recommends to “use ESG factors to monitor, analyze, and evaluate the related risks and opportunities of an investee company.”
The Securities and Exchange Board of India (SEBI) has also recently developed a Stewardship Code for all Mutual Funds and all categories of Alternative Investment Funds, in relation to their investment in listed equities. This code came into effect in April 2020. Of particular interest, Principle 1 advises institutional investors to monitor and engage with investee companies on "material environmental, social, and governance (ESG) opportunities or risks". Principle 3 and 4 recommend institutional investors to "formulate a policy on monitoring" the ESG risks of their investee companies and subsequently "have a clear policy on intervention".
Tighter and more forward-looking regulations
While older sustainable finance regulations were somewhat reactive and sporadic, the new generation are more forward-looking and holistic, leading to the establishment of comprehensive national and regional sustainable finance strategies.
The 2018 European Commission’s (EC) Action Plan on Financing Sustainable Growth is a key example that has been driving rapid regulatory developments with multiple implications for EU-based asset managers and other institutional investors.
Taxonomy
One of the Action Plan’s major developments includes the Taxonomy Regulation which details an EU classification system for environmentally sustainable economic activities. In mid-December 2019, the European Parliament reached an agreement with the Council on the taxonomy’s climate criteria and in June 2020, the Taxonomy Regulation was published in the Official Journal of the European Union. The Taxonomy is a tool which helps investors and companies to make informed investment decisions based on the compatibility of economic activities with the EU taxonomy’s six environmental objectives.
The Taxonomy Regulation covers six environmental objectives: climate change mitigation, climate change adaptation, sustainable and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems. To be deemed environmentally sustainable, an economic activity should meet four conditions: substantial contribution to at least one of the six environmental objectives, do no significant harm to any of the other five environmental objectives, comply with minimum social safeguards, and comply with technical screening criteria. The first Delegated Act of the Taxonomy, covering the climate mitigation and adaptation objectives and describing the related technical screening criteria, should be adopted by January 2021 and enter into application by December 2021. The Delegated Acts regarding the four other environmental objectives should be adopted by the end of 2021 and will apply by the end of 2022. The newly launched Platform on sustainable finance, replacing the Technical Expert Group on Sustainable Finance, will play a key role in advising the Commission on the development of these technical screening criteria for the other four environmental objectives.
The Taxonomy will also be a crucial guiding light in the development of the EU’s COVID-19 pandemic recovery packages. The parliament’s Environment Committee, in addition to voting against the inclusion of coal, oil and gas from the EU’s €672.5B Recovery and Resilience Facility, is backing the use of the Taxonomy’s conditions, including “do no harm”, when disbursing funds.
Sustainability benchmarks
The EC Action Plan also targets to develop climate benchmarks and define ESG disclosure requirements for investment benchmarks. The Technical Expert Group published its final report in September 2019 and a complementary handbook in December 2019. In July 2020, the EC adopted the Delegated Acts, which details minimum technical requirements for EU climate benchmarks. In particular, benchmark administrators must respect these minimum standards when marketing EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks.
Disclosures
One of the most significant regulatory developments within the EU is the Sustainable Finance Disclosure Regulation (SFDR), initially introduced in 2019, which came into effect in March 2021. The overarching goal of the SFDR is to standardise guidelines and increase the level of transparency on how sustainable finance related disclosures are made by financial institutions.
The EU entities that fall within the scope of the SFDR disclosure requirements are “financial market participants”, which include asset managers and UCITs management companies and “financial advisers”, as defined in Article 2 of the SFDR. As such most EU regulated entities will fall under this scope.
Under the SFDR, entities are required to disclose at the entity level, how key adverse ESG impacts have been considered during the investment decision process, as well as what the sustainability impacts are from their investment portfolios. At the product level, there are further requirements to disclose the extent to which sustainability risks may impact on financial performance, as well as additional disclosures depending on the financial products’ classification under the SFDR.
Further detail on these disclosure requirements will be supplemented by the Regulatory Technical Standards (RTS) slated to come in force in July 2022.
- The Coalition of Finance Ministers brings together policymakers from 53 countries in leading the global climate response and in securing a just transition towards low-carbon resilient development. The coalition’s finance ministers have signed the Helsinki Principles to demonstrate their commitment to mobilize the financing needed to implement their national climate action plans and develop financial sectors capable of supporting this goal.
- Network for Greening the Financial System (NGFS) promotes the sharing of best practices among central banks and financial supervisors for managing environmental and climate-related risks to financial stability and aligning financial flows to sustainable development. Its recommendations include for central banks and supervisors to incorporate sustainability considerations in their own portfolio management and external manager selection as well as to foster collective leadership and global action on climate-related risks. Today, the NGFS consists of 83 members and 13 observers.
- The International Platform on Sustainable Finance (IPSF) was launched in October 2019 by the European Union and relevant authorities of Argentina, Canada, Chile, China, India, Kenya and Morocco. Since the platform’s launch, Hong Kong, Indonesia, Japan, New Zealand, Norway, Senegal, Singapore and Switzerland have also joined. The IPSF, bringing together policymakers in charge of sustainable finance from its 16 members, works towards scaling up the mobilization of private capital towards environmentally sustainable investments. The IPSF published in November 2021 a Common Ground Taxonomy report comparing the EU and China taxonomies in an attempt to standardise the different taxonomies being created around the world.
- The ASEAN Taxonomy Board (ATB) which was set up in March 2021 by the Association of South East Asian Nations (ASEAN) announced its plan to develop an ASEAN green taxonomy to define businesses that support the region’s transition to a low-carbon and sustainable economy. A first report was published in November 2021, providing a framework upon which the taxonomy will be further developed.
National developments in major financial markets include:
The new UK Occupational Pension Schemes (Investment) Regulations, revised and launched by the Department for Work and Pensions (DWP) in September 2018, requires funds to disclose, before October 2019, their policies in relation to financially material considerations. In this regulation, the DWP explicitly defines financially material considerations to include ESG considerations (including, but not limited to, climate change).
Additionally in December 2020, the Financial Conduct Authority (FCA) published a Policy Statement requiring all UK premium listed commercial companies to make climate-related disclosures aligned with the recommendations of the TCFD with a “comply or explain” approach, for accounting periods beginning on or after 1 January 2021.
In France, the Autorité des Marchés Financiers (AMF) announced in July 2019 the creation of a Climate and Sustainable Finance Commission, which will contribute to the new mechanism for monitoring and evaluating the climate-related commitments of financial institutions while providing technical expertise and a forum for dialogue.
French regulators are also expanding the scope of new policies beyond climate change, to include a range of natural capital risks. In 2019, the French Parliament amended Article 173 of France’s Energy Transition Law to include biodiversity-related risk.
In July 2020, AMF revised its Position - Recommendation DOC-2020-03 regarding the information to be provided by collective investment schemes incorporating non-financial approaches. AMF clarifies its expectations towards asset management firms to ensure the quality of information provided to investors regarding sustainability or ESG offerings and prevent risks of greenwashing, in particular for retail clients.
In October 2021, Japan Exchange Group announced the creation of the Sustainable Finance Platform Development Working Group. This will be supported by the Financial Services Agency given the alignment with their goal of developing a platform to support the promotion of sustainable finance as part of its priorities from July 2021 to June 2022
In collaboration with the central bank, the Financial Services Agency will conduct scenario analyses on Japan's three mega-banks and top three non-life insurers to measure their resilience to risks posed by climate change. This will take place from now till June 2022
In April 2021, China revealed a plan to collaborate with the EU on Green Investment Standards. This common taxonomy is targeted to be implemented across the two markets for businesses by the end of 2021. Collaborations such as this are needed to reach its 30/60 goal of peaking carbon emissions by 2030 and achieving carbon neutrality by 2060 according to the PBOC. This is also inline with the PBOC’s primary goal of implementing and standardising a green finance system in the country in co-ordination with global partners within the next 5 years.
The 2021 edition of China's Green Bond Endorsed Projects Catalogue was released in April 2021 and took effect in July the same year. The release of the Catalogue will orient domestic green bonds toward the strategy of green and low-carbon development, better empower domestic green finance development, and boost international cooperation on green finance. The 3 major changes to Catalogue 2021 includes adopting more scientific and precise definitions on green projects, improving the mode of bond issuance & management and providing a stable framework and room for flexibility for domestic green bond development.
In April 2021, Bank Negara Malaysia introduced its own taxonomy in national climate-focused sustainability taxonomy for the financial sector, the Climate Change and Principle-based Taxonomy (CCPT). The CCPT sets out five Guiding Principles (GPs) intended to help financial institutions (FIs) assess and categorize economic activities according to the extent to which they meet climate objectives and promote the transition to a low-carbon economy.
Announced in September 2021, the Green Bonds Programme Office will develop a framework and work with statutory boards, as well as perform industry engagement and manage investor relations. Their aim is to help to catalyse sustainable financing and investments has been set up under the Ministry of Finance, as Singapore looks to expand its green finance ecosystem. The Green Finance Industry Taskforce (GFIT), convened by the Monetary Authority of Singapore (MAS), published in January 2021 a report laying out a proposed approach for a green taxonomy applicable to Singapore-based financial institutions, seeking input from stakeholders. The GFIT is currently working on further developing the taxonomy.
In October 2020, the Securities and Futures Commission (SFC) launched a consultation paper on the management and disclosure of climate-related risks by fund managers. In addition to highlighting that climate change poses financial risks for businesses and financial institutions, the consultation paper proposes to require SFC licensed fund managers “to take climate-related risks into consideration in their investment and risk management processes as well as to make appropriate disclosures to meet investors’ growing demand for climate risk information and to combat greenwashing.” Additionally, the Green and Sustainable Finance Cross-Agency Steering Group, co-chaired by the Hong Kong Monetary Authority and the SFC, launched in December 2020 their strategic plan to strengthen Hong Kong’s financial ecosystem and support the transition towards a more sustainable future.