10: Recommendations and regulation

The Taskforce on Climate Related Financial Disclosures (TCFD) was created in December 2015 by the Financial Stability Board to improve and increase reporting of climate-related financial information.

As the FSB states: “Financial markets need clear, comprehensive, high-quality information on the impacts of climate change. This includes the risks and opportunities presented by rising temperatures, climate-related policy, and emerging technologies in our changing world.”

Initially chaired by Michael Bloomberg, the TCFD has 32 members, all aiming to develop guidelines for voluntary climate-centred financial disclosures across industries. The first recommendations were published in 2017.

Unlike the SFDR, the TCFD is voluntary and serves as a guideline for businesses to share and identify climate-related financial risks, which will then allow investment firms and asset owners to better assess the value of the companies in their portfolios. The organisation’s goal is to have climate-related disclosures in companies’ mainstream financial filings.

In October 2021, the TCFD issued its most recent guidance on implementing its recommendations. There are four parts to the framework:

  • Governance – the organisation’s governance around climate-related risks and opportunities
  • Strategy – the actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning
  • Risk Management – the processes used by the organisation to identify, assess, and manage climate-related risks
  • Metrics and Targets – the metrics and targets used to assess and manage relevant climate-related risks and opportunities

The guidance also includes seven principles for effective disclosure:

  • Principle 1 – Disclosures should present relevant information.
  • Principle 2 – Disclosures should be specific and complete.
  • Principle 3 – Disclosures should be clear, balanced and understandable.
  • Principle 4 – Disclosures should be consistent over time.
  • Principle 5 – Disclosures should be comparable among organisations within a sector, industry, or portfolio.
  • Principle 6 – Disclosures should be reliable, verifiable, and objective.
  • Principle 7 – Disclosures should be provided on a timely basis.

There are other climate-related disclosure regimes, which raises the issue of climate disclosure convergence. For example, the SEC in the US and the ISSB have recently released their own proposals for climate-related disclosure. This has inevitably led to calls from market participants – issuers, investors, brokers and asset managers – for consistency and alignment with international standards.

The Sustainable Finance Disclosure Regulation (SFDR) came into effect on March 10, 2021. Part of the EU’s Action Plan on Sustainable Finance, it imposes mandatory disclosure requirements on asset managers in terms of how ESG factors are integrated at both an entity and product level.

The aim is to eliminate greenwashing and to give investors more transparency into asset managers’ ESG credentials.

More specifically, managers must decide if their funds fit into one of three categories:

  • Article 6: Funds without a sustainability scope
  • Article 8: Funds that promote environmental or social characteristics (light green)
  • Article 9: Funds that have sustainable investment as their objective (dark green)

The regulation has not been without controversy. This is partly because it was only been partially implemented back in March 2021, having gone live without the level 2 regulatory technical standards (RTS).

The 13 RTS will require more detailed disclosures from managers but have been repeatedly delayed due to the length and technical detail involved. As of May 2022, they are due to take effect from January 2023.

One of the most challenging requirements facing firms is the completion of the 18 principal adverse impact statements. But while the delay will give firms more time to prepare their submissions, there is still uncertainty as to what the final rules will look like.

Meanwhile some of the article 8 and 9 requirements have since been amended due to concerns of greenwashing and the absence of the RTS. Article 9 funds must disclose their environmental objective to highlight how they have impacted the environment while article 8 funds will face pre-contractual and periodic product disclosures.

And then there is the possibility that the SFDR will diverge from similar standards in other countries, such as the UK’s Sustainability Disclosure Regime and whatever rules will emerge from the US following the recent proposal from the Securities and Exchanges Commission to add ESG factors to firms’ reporting requirements.

And then there is the cost. Channel Islands-based thinktank ISICI believes the SFDR will increase operating costs for the asset management sector by more than €20 billion.

Yet despite the delays and the greenwashing concerns, investor demand for ESG funds continues to rise. By the end of 2021, assets in article 8 and 9 funds exceeded €4 trillion, according to Morningstar data.

Read the full report

1. Survey highlights

2: Creating a climate risk framework

3: Importance of investment risk overlooked

4: Internal governance still developing

5: Education and skills are key

6: Data availability challenge misplaced

7: Reporting issues

8: Product development

9: Engagement vs divestment

10: Recommendations and regulation

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