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May 9, 2023

ESG reporting regulations explained

Greenwashing is in the sights of regulators in the UK, EU and US.

The Roadmap to the UK’s Sustainable Disclosure Requirements (SDR) published in October 2021 states, “Better information will not only improve decision-making, but also help to build trust and combat potential greenwashing”.

One of the EU’s Sustainable Financial Disclosure Regulation’s (SFDR) stated aims is also, “to counter greenwashing”. And in the US the Securities and Exchange Commission (SEC) is consulting on “ESG risks (including greenwashing) and opportunities”.

Each regulator is seeking consistent standards for measuring and communicating ESG performance in a manner that’s consistent with the widely accepted standards of financial reporting. (See International Sustainability Standards Board below).

EU – Sustainable Financial Disclosure Regulation (SFDR)

The EU’s SFDR came into force in April 2021 and introduces ESG disclosure standards for financial market participants, advisers and products. The Regulation is being extended in 2022.

The latest regulation extends ESG reporting to nearly 50,000 companies in the EU (up from 11,000). It applies to asset managers, venture capital funds, banks, financial advisors, pension fund providers and insurers who conduct business in the European Economic Area (EEA).

The SFDR has three core aims:

  1. To improve disclosures so that institutional asset owners and retail clients can understand, compare, and monitor financial products’ and firms’ sustainability characteristics.
  2. To ensure a level playing field within the EU so that European firms will not be exposed to unfair competition from firms outside the EU.
  3. To counter greenwashing.

EU Taxonomy

As part of the Sustainable Financial Disclosures Regulation (SFDR) investors are required to report on the EU Taxonomy (EUT).

The EUT consists of 18 mandatory indicators covering Articles 6, 8 and 9 of the SFDR. The European Commission’s Technical Expert Group on sustainable finance developed the taxonomy for environmentally-sustainable economic activities covering: climate change adaptation, climate change mitigation, water use and marine resources, circular economy, pollution, and biodiversity.

It aims to set a common language between investors, issuers, project promoters and policy makers for assessment of whether investments meet robust environmental standards and are consistent with the Paris Agreement on Climate Change.

UK – Sustainable Disclosure Requirements (SDR)

The SDR is designed to ensure that sustainability information flows into the real economy in order to empower investors, consumers and employees to make financial decisions which align with their values. It was announced in October 2021.

The UK Green Taxonomy will adopt the same six environmental objectives that comprise the EU Taxonomy each underpinned by technical screening criteria, and the principle of “do no significant harm” to the other objectives.

In the next 2-3 years the Government has stated that it will require the most “economically significant” UK-registered and UK-listed companies to incorporate ISSB, TCFD and Green Taxonomy disclosures in their company annual reports.

Just as the standards for financial reporting are reduced for small businesses, a lite-version of ESG reporting for SMEs (and their VCs and PE funds) is on the horizon.

US – Securities and Exchange Commission (SEC)

The SEC is preparing to step in to bring transparency and credibility to ESG investments in the U.S. An announcement is expected in 2022.

International Sustainability Standards Board (ISSB)

On 3 November 2021, the International Financial Reporting Standards (IFRS) announced the creation of the ISSB – the International Sustainability Standards Board.

The intention is for the ISSB, “to deliver a comprehensive global baseline of sustainability-related disclosure standards that provide…information about companies’ sustainability-related risks and opportunities”, to help people make informed decisions. Just as the IFRS does with financial reporting standards.

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