Safeguarding the greenness of ESG

By Jayson Forrest - Managing Editor  - IMAP Perspectives

The regulatory landscape of ESG is changing rapidly. At the IMAP InvestTech 2021 conference, Stuart Alsop took a deep look at the regulatory landscape - both here and overseas - and explains where the industry needs to go with ESG disclosure.

With research from the Responsible Investment Association Australasia (RIAA) showing that 90 per cent of Australians expect their superannuation and other investments to be invested responsibly and ethically, it’s hardly surprising that ethical, sustainable and ESG (Environmental, Social, and Corporate Governance) investing is gaining increasing traction amongst investors.

Add to this the 86 per cent of Australians who believe it’s important their financial adviser asks them about their interests and values in relation to investments, and ESG is becoming an important space for the advisory market. Yet, despite the growth of ESG investing, it still remains a largely unregulated area, but things are changing. Just ask Stuart Alsop - Head of Business Development Australia/New Zealand at FE fundinfo - about how he sees the future of ethical and ESG investing, and he is firmly of the opinion that the long-term success of this space will depend on how ESG investments and advice are regulated.

Speaking at IMAP’s InvestTech 2021 virtual conference, Stuart referenced the UK’s NextWealth ESG Tracker Study, which revealed that the biggest driver and adoption of ESG and responsible investing was regulation.

“There is a substantial regulatory focus on ESG and responsible investing in Europe and the U.K., particularly with respect to disclosure, which is driving a lot of interest in these products and investment space,” says Stuart. “However, if you compare that to the Australian market, it’s a different scenario. Here you’ve got investors and consumers driving the popularity of ESG, with regulation lagging behind. So, the Australian market has a lot to learn from overseas jurisdictions, like Europe.”

According to Stuart, Europe is widely acknowledged as leading the way with disclosure and regulation across the ESG investment spectrum. He points to the following regulations that are transforming the ESG landscape in Europe by improving transparency and disclosure.

1. Task Force on Climate-related Financial Disclosures (TCFD)

The Financial Stability Board - an international body that monitors and makes recommendations about the global financial system - created the TCFD to improve and increase reporting of climate-related financial information, including the risks and opportunities presented by rising temperatures, climate-related policy and emerging technologies.

The TCFD - which is committed to market transparency and stability - consists of 32 members from across the G20. 

2. Sustainable Finance Disclosure Regulation (SFDR)

The SFDR - which came into force in 2021 - is a set of European Union rules that aim to make the sustainability profile of funds more comparable and transparent, enabling them to be better understood by end-investors. These rules focus on pre-defined metrics for assessing ESG outcomes of the investment process.

The SFDR is also responsible for dividing products into different categories, with the key feature being the mandatory disclosure of how to incorporate sustainability risks into the investment decision-making process. The disclosure obligations vary based on each category.

According to Stuart, this is the type of regulation Australia should be aiming for in order to improve the transparency and comparison of ESG funds available locally.

3. Regulatory Technical Standards (RTS)

The RTS are a set of technical compliance standards that need to be met by all parties involved in ESG products, including fund managers and financial advisers. The standards include 32 mandatory indicators around climate and the environment, social, employee and human rights, anti-bribery, and anti-corruption issues. As part of the regulation, advisers must publish a statement on their website explaining how they select the products they recommend and how they use information available to them from product providers.

“I think this type of regulation is increasingly relevant when you look at ASIC and its review of ‘greenwashing’ products. We need to remember that ‘greenwashing’ doesn’t just apply to a fund manager. It can also apply to financial advisers, particularly when they’re speaking to clients about how their portfolios, advice or businesses are aligned to ESG metrics,” says Stuart.

A key element of the RTS, which will come into force in 2022, is the standardisation of European ESG Templates (EET), which list several sustainability impact indicators that need to be included in this disclosure from fund managers.

According to Stuart, the EET is an ambitious project that is a key part of the SFDR framework, which has been set up to increase transparency on how financial market participants integrate sustainability risks and factors into their investment decisions. SFDR also seeks to eliminate ‘greenwashing’ by enforcing additional disclosure requirements for the marketing of an ESG-related financial product or advice, and to create a clear classification scheme.

So, what is the EET?

The EET is a data standard for ESG data, which is applicable for the SFDR regulation. The EET provides the required data set for all funds to explain the fund’s ESG characteristics. There will be three different levels of reporting depending on the fund’s definitions (Article 6, 8 and 9).

These three categories are:

• Article 6 funds - funds are not promoted as having ESG factors or objectives;
• Article 8 funds - funds that promote ESG characteristics but do not have it as the overarching objective; and
• Article 9 funds - funds that specifically have sustainable goals as their objective.

“This means that by the end of 2022, Europe will have a defined data standard and templates for ESG data and characteristics. This will ensure market participants have the same data sets, which will allow for the alignment of ESG products to this framework,” says Stuart.

“This will allow market participants to build and compare products that align to the same ESG metrics, just as we have with other comparison tools that look at product fees and returns. The sharing of this data will dramatically increase transparency and disclosure with ESG products.”

According to Stuart, Asia - and more specifically, China - is beginning to align its ESG definitions to the European Union, which could lead to a standardisation across jurisdictions.

This emerging alignment of definitions between Europe and China covers 61 activities across six sectors and outlines potential overlaps to improve interoperability between the regions. It is expected this will enable better data sharing and more consistent regulation across the various jurisdictions.

“As we start to see that rolled out, it’s only a matter of time before we see this alignment of definitions move into Australia and New Zealand,” says Stuart.

And what about Australia?

“Again, the importance of disclosure is paramount as ESG investing develops and evolves within Australia,” says Stuart. “Recently, APRA announced its prudential guidance for climate risk, and while the regulator has decided not to mandate any climate risk disclosure at this point in time, we believe it’s something that needs to be looked at quite urgently.”

However, it’s interesting to note that while APRA said it would not mandate any climate risk disclosure, the regulator did add that it would recommend alignment of ASX listed companies with the TCFD framework.

There have also been a number of other tangible developments in the Australian regulatory landscape. One of these is Australia’s likely move to join the International Sustainability Standards Board (ISSB), which sits alongside the International Accounting Standards Board (IASB). The ISSB provides global benchmarking and streamlined frameworks around ethical investing.

Another development has been ASIC’s ‘greenwashing’ review, which highlights the regulator’s understanding of the importance of the ESG sector. Earlier this year, ASIC announced its intention to improve governance and accountability of ESG funds in the market, by conducting a review of ‘greenwashing’, with the aim of establishing whether the practises of fund managers offering ESG products align with their promotion of these products. Or in other words, to determine whether a financial product or investment strategy is as ‘green’ or ESG-focused as claimed.

Recent in-depth analysis by PwC of ESG reporting across ASX 200 companies, revealed that ESG reporting is “moving in the right direction, but not fast or far enough”, indicating that more work needs to be done in this space.

Some of PwC’s key findings include:

• 70 per cent of ASX200 companies have a sustainability strategy;
• 21 per cent of companies have sustainability as an integral part of their core strategy;
• 36 per cent of companies have a net zero target; and
• 38 per cent of companies provide short, medium and/or long-term timelines for ESG targets.

“But despite some of these findings, companies in Australia still haven’t gone far enough with their ESG disclosure,” says Stuart. “In fact, the PwC report found that 43 per cent of ASX 200 companies don’t even consider and disclose negative impacts of their value chains.

“So, while we’re gaining traction in the domestic Australian market, we still have a way to catch up with those other jurisdictions that are leading the charge in the ESG regulatory space around disclosure and transparency.”

Stuart Alsop is Head of Business Development Australia/New Zealand at FE fundinfo. He presented a session on ‘Tools for advisers to have engaging ESG conversations with clients’ at InvestTech 2021.

The session was moderated by the Joint Managing Director at Finura Group, Peter Worn.