While some corporates authentically value and consider ESG issues, others have missed the mark and are being challenged to go beyond ticking the box.
The growing concern over greenwashing has pressured governments and regulators to define and enforce clear standards. Recent developments in the US and UK are building momentum towards such standards.
The drive to global standardisation
At the UK-hosted G7 summit in June, members secured an agreement to mandate climate disclosures across member economies by 2025. The G7 agreement has the objective of globally standardising the approach to ESG compliance to minimise greenwashing.
Under the G7 agreement, climate-related disclosures should align with recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD) in 2017 that created an initial framework for companies to improve their ESG culture, and give stakeholders a clearer view for assessing ESG compliance.
However, the recommendations drew criticism because they were not mandatory and arguably lack sufficient detail. ESG enthusiasts hope that the G7 agreement will address such concerns.
The G7 agreement follows other recent ESG initiatives actioned by governments across the globe, such as measures by the US Securities and Exchange Commission and UK government agencies to place increased emphasis on ESG reporting.
The SEC takes a tougher stance
In March, the SEC’s Enforcement Division announced its Climate and ESG Task Force, solidifying a division-wide effort to proactively identify ESG-related misconduct, as public investors become increasingly more reliant on corporate disclosures when making financial decisions.
The task force will look for “gaps or mis-statements in issuers’ disclosure of climate risks under existing rules” and analyse “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies”. This search for misconduct is poised to involve heavy data mining and analysis to assess information across issuers and whistleblower tips to identify potential violations.
The task force follows the SEC’s other recent ESG-related actions, including the appointment of a senior policy advisor for climate and ESG, and the Division of Corporate Finance announcing its priority to ensure issuers’ compliance with existing disclosure rules and to update its 2010 guidance on climate-related disclosures.
The existing SEC Commission Guidance Regarding Disclosure Related to Climate Change sets an expectation that issuers consider climate change risks within corporate disclosures and provides example climate change issues and the impact to consider, such as possible manufacturing disruption caused by extreme weather.
Modernising the guidance moves us closer to a framework for consistent, comparable and reliable ESG-related disclosures. This may come sooner rather than later with the US House of Representatives passing the ESG Disclosure Simplification Act to mandate standardised ESG disclosures among SEC issuers and form a new advisory committee to the SEC.
Eyes remain on the US as the legislation moves to the Senate.
A green taxonomy in the UK
Emphasis on ESG is growing in the UK too. In June, the UK government appointed a Green Technical Advisory Group (GTAG) to advise the government in establishing a green taxonomy to stamp out greenwashing. The taxonomy aims to answer the question 'what does green mean?' with clear, data-driven criteria to better inform investors, businesses and consumers in their ESG-related decisions.
ESG enthusiasts should pay close attention to the output of the GTAG, which first met in June and will provide initial recommendations to the UK government in September.
Establishing the GTAG is one step in a series taken by the UK government in recent years post-Brexit to launch its own ESG framework. In November 2020, a cross-Whitehall and regulator task force published an interim report and roadmap that outlines a strategy towards “mandatory TCFD-aligned disclosures across the UK by 2025” – a target adopted by G7 members.
In December 2020, the Financial Conduct Authority introduced an ESG disclosure rule for commercial companies with a UK premium listing and, as of June 2021, proposes to extend the rule to include issuers of standard equity shares and others such as asset managers, insurers and pension providers.
The ESG disclosure rule states that in-scope firms must now disclose, on a comply-or-explain basis, aligned with the TCFA’s recommendations and must consider ESG-related risks and opportunities in their disclosures. This rule will overlap and interact with the EU’s Sustainable Finance Disclosure Regulation.
The FCA indicated that compliance basis for this rule may become more robust, requiring more detailed expectations – particularly regarding quantitative disclosures (for example, metrics, targets and scenarios) – to supplement the existing principles-based approach.
It is evident that ESG-related regulatory action and enforcement in the UK is far from its full potential in identifying cases of greenwashing that ultimately lead to enforcement action. The FCA is one to watch, particularly as it gathers public feedback on the proposals to make its disclosure rule more broadly applicable.
Not for the first time, the US has moved ahead to root out misconduct in ESG metrics reporting with a view to enforcement, possibly accompanied by new legislative mandates, while the UK and the EU spend time defining the problem.
However, because of the scale of the issue, it will not be long before stricter regulation becomes a global trend. Whatever the regulators do, there is a bigger problem to keep the C-suite up at night: consumers, investors and wider stakeholders stand ready to take action on climate-related issues that could bring even the biggest companies to their knees should they stray from their sustainability commitments. The public’s demand and political pressure for enforcement in this area will only grow.
To avoid regulatory and legal actions, capital flight or stakeholder backlash, companies must rise to the challenge of producing comprehensive ESG data and aligning disclosures with required standards in their jurisdictions. Systems and controls for reporting financial data are second nature in most companies, and modern accounting principles have been established over many decades.
The same cannot be said for ESG reporting, where businesses struggle to define and capture accurate data across the value chain and to understand the fragmented reporting requirements.
Many major jurisdictions have taken aim at greenwashing. It remains to be seen whether these will hit the target before a true international consensus emerges on ESG disclosure standards.
Simon Taylor is a partner at Forensic Risk Alliance
