The UK government recently published its plans on Greening Finance: A Roadmap to Sustainable Investing.
The plans are to be implemented, after “consultation”, over at least two years – but with three or more years envisaged in some cases – and are founded on the creation of: “an integrated framework for decision-useful disclosures on sustainability across the economy [Sustainability Disclosure Requirements (SDR)] … build[ing] on the UK’s TCFD [Task Force on Climate-Related Financial Disclosures] implementation …”
Three types of SDR are outlined:
“Corporate disclosure: … reporting under proposed international standards … and … [on] environmental impact using the UK Green Taxonomy …”
“Asset manager and asset owner disclosure: … requirements for [those who] … manage or administer assets … to disclose how they take sustainability into account … [to] help consumers determine whether … assets are managed according to [consumers’] sustainability preferences …”
“Investment product disclosure: … requirements for creators of investment products to report on [their] sustainability impact and relevant financial risks and opportunities … [to] form the basis of a new sustainable investment labelling regime … [to] make it easier … to navigate the range of investment products available …”
The plans say that “SDR will use the same framework and metrics across the economy to ensure a clear and direct link from investors, through the financial system to the businesses they are invested in and their relationship with the environment. Metrics will be drawn from international standards … to support international compatibility”.
International standards: climate, the environment and social sustainability
Central to the SDR will be the International Sustainability Standards Board (ISSB), established by the “International Financial Reporting Standards (IFRS) Foundation … the international body that governs the setting of global accounting standards …”
The ISSB will:
- “develop global baseline reporting standards for sustainability, building on the work of the TCFD and other voluntary standard setters” and
- provide comprehensive and granular corporate reporting standards for sustainability, focused on information which is material to investors.”
“The government expects the [ISSB] to be established later this year, and, in early 2022, … to consult on a draft climate-related standard, before expanding its standard-setting to broader environmental and sustainability factors … Regulatory changes will ensure that UK reporting under the ISSB standards is consistent with both existing and forthcoming disclosure requirements so that companies are not required to report the same information twice.”
The greenwash risk goes on
The proposals note that “Some ESG [environmental, social and governance] factors will not be covered by the UK Green Taxonomy or ISSB standards but may nevertheless be the subject of firms’ claims to consumers. The FCA [Financial Conduct Authority] has already set out its expectations regarding [Authorised ESG and sustainable investment funds: improving quality and clarity in their] design, delivery and disclosure[s] … SDR will go further in two areas:
- Substantiate sustainability claims: … asset managers/owners and investment products will be required to substantiate ESG claims they make in a way that is comparable between products and is accessible to clients and consumers. They will also need to disclose whether and how they take ESG-related matters into account in their governance arrangements, and in their investment policies and strategies.
- Minimum safeguards: … The SDR will require disclosure against [UK Green Taxonomy] minimum safeguards and any related metrics … In the meantime, the government and regulators encourage disclosure against established voluntary standards.”
The proposals also note: “ESG ratings are becoming increasingly important to the investment process. However, different ESG ratings agencies provide opinions on different aspects of sustainability performance and their assessments may not always be comparable. There are also typically more data gaps and assumptions made in producing ESG ratings than, for example, credit ratings. It is important that providers deliver ESG data and ratings transparently, and that they have strong governance and management of conflicts of interests. The government is therefore considering bringing these firms into the scope of FCA authorisation and regulation. The government will set out further detail next year.”
Taxonomy and alignment
The UK Green Taxonomy is underpinned by two “climate change” objectives:
- “Climate change mitigation – stabilisation of greenhouse gas emissions consistent with … net zero by 2050”; and
- “Climate change adaptation – reducing the risk of adverse impact of current or future climate change on an economic activity, people, nature, or asset”.
There are then four “environmental objectives”:
- “Sustainable use and protection of water and marine resources”
- “Transition to a circular economy – maintaining the value of products, materials and resources for as long as possible, thereby reducing the environmental impacts of their use”
- “Pollution prevention and control”
- “Protection and restoration of biodiversity and ecosystem”
As per the second proposition in our previous ‘ESG-ellence’ article, on developing an effective ESG sustainability and responsibility (S&R) programme, the proposals address the concept of ‘resilience’ as an end, but ‘alignment’ as a means:
“Each of the environmental objectives will be underpinned by a set of detailed standards, known as Technical Screening Criteria (TSC). There will be an individual TSC for each economic activity included in the Taxonomy, which identifies how that activity can make a substantial contribution to the environmental objective. To be considered Taxonomy-aligned, an activity must meet three tests:
- Make a substantial contribution to one of [the] six environmental objectives (listed above): The criteria for making a substantial contribution are set out in the TSC for the activity in question.
- Do no significant harm to the other objectives: This is also defined for each activity in the TSCs. This aims to ensure that activities which support one objective, such as climate change mitigation, do not have a significant adverse impact on another, such as biodiversity.
- Meet a set of minimum safeguards: These are minimum standards for doing business, constituting alignment with the OECD Guidelines for Multinational Enterprises, and the UN Principles on Business and Human Rights.”
As the proposals explain: “Taxonomy-alignment focuses on reported data, rather than projections. This provides a clear snapshot of the areas in which a company is currently making a substantial contribution to environmental objectives … the Taxonomy also recognises companies which are working to meet environmental objectives in the future in two ways:
- [Net zero and (implicitly, and to an extent) circular economy] transitional activities: Due to technological constraints, some economic activities cannot currently be conducted in a way which is aligned with net-zero ambitions. For a number of these activities, the TSCs will set the threshold for Taxonomy alignment at the best-in-sector emissions level (subject to not locking in carbon-intensive activities). The manufacture of cement is one example of this.
- Investment: Companies will report the proportion of their capital expenditure which is Taxonomy-aligned. This will enable companies to demonstrate their investment in producing green activities in the future.
The Taxonomy will also include enabling activities … [which] support the [net zero / circular economy] transition by enabling substantial contributions to environmental objectives in other sectors, but which are not yet sustainable themselves … [eg] the manufacture of components for wind turbines.”
Many will welcome the government’s articulation of ambitions to drive S&R as the output and purpose of the UK financial sector and wider economy. Some might however question whether the timescales and concepts import too much room for delay and diminution in implementation. Some might also question the value of yet another national taxonomy, and the risk of inconsistencies for activities built on cross-border supply and distribution chains.