Sustainable finance has also been evolving in 2023, and regulatory bodies and financial institutions globally have taken significant strides to address environmental, social, and governance (ESG) considerations. In this article, we have summarised the most significant regulatory developments in 2023 in the E.U., U.K., Switzerland, and USA and set some outlook on developments we can expect in 2024.
European Union
Corporate Sustainability Reporting (CSRD/ESRS):
The Corporate Sustainability Reporting Directive (CSRD) and the European Sustainability Reporting Standards (ESRS), enacted in 2022 and 2023, respectively, marked a significant shift in sustainability reporting requirements for companies. It has introduced new concepts, such as the definition of double materiality, stakeholders, and mandatory external assurance. Despite recent developments, the key aspects remain unchanged:
Objection to General ESRS: A group of Members of the European Parliament (MEPs) objected to the general ESRS, citing a burden on companies. However, the objection was voted down, maintaining CSRD timelines for reporting under ESRS. Large companies on E.U. stock exchanges are expected to report sustainability information 2025 for fiscal year 2024.
Delay of Sector-Specific ESRS (SS-ESRS): The Commission proposed a two-year delay (from June 2024 to June 2026) for SS-ESRS issuance to reduce administrative burdens. The proposal is part of the 2024 Work Programme and is subject to approval by the European Parliament and the Council of the European Union.
Changes in Qualifying Thresholds: The Commission has adjusted thresholds in the Accounting Directive for small, medium, and large entities to account for inflation. This change aims to prevent unintended inclusions due to inflated revenues and balance sheets. This will impact the scope of applicability of the CSRD.
Companies must stay vigilant despite potential delays in sector-specific standards, as the CSRD and general ESRS requirements remain unaffected
EU proposal on fund labelling:
ESMA (European Securities and Markets Authority) has initiated a consultation to address concerns about fund managers using SFDR categorizations (articles 8 or 9) as a marketing tool, potentially leading to greenwashing and misleading investors. The self-identification nature of SFDR has prompted ESMA to develop guidelines to ensure fund names align with sustainability objectives. Key elements in the consultation include:
If a fund uses ESG-related terms in its name, at least 80% of investments must align with social or environmental characteristics disclosed in the investment strategy.
For funds using "sustainable" or similar terms within the 80% mentioned above, a minimum of 50% must be allocated to sustainable investments, following SFDR article 2(17) definitions.
Inclusion of exclusion criteria as minimum safeguards for all investments for funds using ESG or sustainability-related terms.
Additional considerations for specific fund types.
ESMA proposes increased supervisory convergence among national competent authorities to assess fund names and their use of ESG terms, aiming to prevent unsubstantiated sustainability claims. The guidelines complement existing SFDR and Taxonomy Regulation requirements without intervening in them. The proposed guidelines are expected to apply to AIFMD requirements, ensuring AIFMs conduct honest and fair activities.
EU Regulation on ESG Ratings:
ESG ratings have been scrutinized for the last few years, and the regulators have recognized the need for action.
On June 13, 2023, the European Commission unveiled a sustainable finance package, which includes a regulatory framework for Environmental, Social, and Governance (ESG) rating agencies. The proposal aims to regulate and provide a framework for ESG ratings in the European Union, enhancing their quality to enable better-informed investment decisions, prevent greenwashing, and build investor trust. Critical aspects of the proposal include:
Scope and Definition: The regulation applies to ESG ratings issued by rating providers operating in the E.U., excluding private ESG ratings and those used for in-house purposes. The proposal defines ESG ratings as opinions, scores, or combinations regarding entities, financial instruments, products, or an undertaking's ESG profile, characteristics, or exposure to ESG risks.
Authorization and Supervision: Legal entities in the E.U. providing ESG ratings must obtain approval from the European Securities and Markets Authority (ESMA). Third-country providers can operate under certain conditions, including an implementing/equivalence decision, endorsement authorization, or recognition.
ESMA's Supervisory Role: ESMA holds supervisory powers, allowing it to issue authorizations, take measures to withdraw or suspend authorizations, impose fines or penalty payments, request information, and conduct investigations or on-site inspections.
Addressing Transparency and Reliability Issues: The proposal tackles deficiencies in the current ESG rating market, focusing on improving transparency, clarity, and reliability.
Next Steps: The proposal will undergo the E.U. legislative process, requiring review by the European Parliament and the Council of the European Union. If approved, it will enter into force 20 days after publication in the Official Journal of the European Union, with application beginning six months later.
The proposal emphasizes the need for a comprehensive regulatory framework to govern ESG ratings, aligning with the E.U.'s broader sustainability objectives.
SFDR consultation:
The European Commission has initiated two public and targeted consultations seeking feedback on potential changes to the Sustainable Finance Disclosure Regulation (SFDR) regime. The SFDR aims to enhance transparency for investors regarding sustainability risks and adverse environmental and societal impacts of investments. The consultations, launched in September 2023, address practical issues market participants face in complying with SFDR requirements, such as challenges in data-gathering for disclosures. The questions indicate a willingness for regulatory reform, but the format limits stakeholder commentary to "agree" or "disagree" responses on a scale of 1 to 5. The Commission also conducted online workshops in October 2023 to discuss SFDR challenges and potential pathways for improving sustainability disclosures, including introducing new SFDR product categories. Deadline in December, more to expect in 2024/2025.
ESA final report on revised RTS SFDR from December 4th, 2023:
The European Supervisory Authorities (ESAs) have released draft Regulatory Technical Standards (RTS) proposing changes to disclosures outlined in the SFDR Delegated Regulation, following a public consultation from April to July 2023. Eurosif supports the proposed adjustments to Principal Adverse Impact (PAI) indicators and SFDR templates for improved end-investor understanding. The suggested changes include new social PAI indicators, adjustments in wording and calculation methods, additional definitions aligned with European Sustainability Reporting Standards, and disclosure requirements for estimated PAI share. The ESAs also recommend clarifying the relationship between PAIs and the Do No Significant Harm (DNSH) principle, specifying disclosure of thresholds/criteria, and considering EU Taxonomy-aligned activities as sustainable investments. The draft RTS proposes modifications to SFDR templates, including changes to disclosures for products targeting GHG emissions reduction, integration of a sustainability dashboard, and simplification of templates. The European Commission has three months to endorse and modify the SFDR Delegated Regulation, with subsequent approval required from the European Parliament and E.U. member states.
United Kingdom
The U.K.'s Financial Conduct Authority (FCA) has released final rules on sustainability disclosure standards and investment labels, aiming to address greenwashing and provide clarity for investors. The rules cover investment labels, consumer-facing disclosures, product-level and entity-level disclosures, naming and marketing, and an anti-greenwashing rule. Notably:
The rules primarily apply to U.K. authorized managers, with certain aspects also relevant to U.K. distributors. Non-UK entities are currently exempt.
New labels include "sustainability mixed goals" alongside existing labels like "sustainability focus" and "sustainability impact."
Labels are available only for products with positive sustainability outcomes, requiring at least 70% of gross assets to align with sustainability objectives.
The "sustainability focus" label does not mandate external verification but requires an internal, independent assessment disclosed to investors.
The "sustainability impact" label eases the "additionality" requirement and extends beyond products focusing on underserved markets.
Consumer-facing disclosures must reveal potential negative outcomes of pursuing sustainability objectives, and labeled products must avoid conflicting assets.
The regime remains opt-in, but non-labeled products can use sustainability-related terms with restrictions and required disclosures.
Anti-greenwashing rules, effective from May 31, 2024, mandate consistency and fairness in product sustainability characteristic references.
Implementation dates vary, with the anti-greenwashing rule effective from May 2024 and other rules applying from July 2024, December 2024, and 2025 based on product labels and disclosure types. Entity-level disclosures apply from December 2025.
The FCA will publish guidance alongside the anti-greenwashing rule and will consider industry feedback before finalizing guidelines.
Switzerland
The Federal Department of Finance (FDF) will draw up a proposal for implementing the Federal Council's position on the prevention of greenwashing. Accordingly, the FDF informed the Federal Council at its October 25, 2023 meeting.
In December 2022, the Federal Council published its position on the prevention of greenwashing in the financial sector. At the same time, it instructed the FDF, together with representatives of the Federal Department of the Environment, Transport, Energy and Communications (DETEC), the Federal Department of Economic Affairs, Education and Research (EAER), the Swiss Financial Market Supervisory Authority (FINMA), the banking industry and non-governmental organizations, to assess how these requirements could be implemented most efficiently. In the financial sector, "greenwashing" refers to misleading clients about the sustainable characteristics of financial products and services.
After evaluating the input from the working group members, the FDF has decided to implement the Federal Council's position by proposing principles-based state regulation at the ordinance level. Such regulation could be supplemented by industry self-regulation. The FDF will submit a consultation draft to the Federal Council by the end of August 2024 at the latest. If the financial industry presents a self-regulation solution that implements the Federal Council's position effectively, the FDF will dispense with further regulatory efforts.
USA
As indicated by its recent regulatory agenda, the U.S. Securities and Exchange Commission (SEC) has delayed adopting its highly anticipated climate change disclosure rules to spring 2024. Notably, the agenda does not provide details on the re-proposal of climate change disclosure rules. Additionally, the SEC has postponed to spring 2023 the adoption of rules related to SPACs, ESG disclosure rules for funds, Rule 14a-8 amendments, and the publication of proposals on human capital management disclosure and amendments to Regulation D. The agenda outlines critical dates, with the adoption of climate change disclosure rules, SPAC rules, Rule 14a-8 amendments, Fund ESG disclosure rules, and the proposal for human capital management disclosure all expected in April 2024. While the agenda is not binding on the SEC, it serves as a guide for expected rulemaking in the near term. Notably, the SEC has a history of missing deadlines, and the climate change disclosure rules, initially slated for October 2022, were successively rescheduled to April 2023, October 2023, and now April 2024.
Last note: 2024 will bring many important developments in the sphere of sustainable finance and WISF is engaged to monitor the implementations and impacts.