Environmental, Social, and Governance (ESG) has become an important topic across business. It has become an increased priority, not only to meet customer demands, but also an increasingly complex regulatory environment. Regulators around the world are expanding the legal frameworks around ESG. The EU’s European Sustainability Reporting Standards (ESRS) is probably the ESG regulation at the top of the priority list for many, but there are several others on the horizon.
Standardisation
Position Green managing director Brussels Julia Staunig believes that the best route forward is for standardisation within the regulation. She noted that rather than more uncoordinated rules, with each country building their own rules, it would be far better to create alignment across ESG rules that already exist.
Staunig added, “The EU has put in place a world-leading regulatory rulebook for sustainable finance. To make this work, we need more standardised, high-quality ESG data from corporates. The EU’s rules on sustainability disclosures aim to achieve that, but there is a politically motivated push to water those down. That is regrettable, as now is not the time to lower our ESG ambitions.”
The lack of standardisation makes ESG processes more complex as companies try to assess and adhere to the rules of the various countries they are engaged in. A set of consistent rules would not only reduce confusion but also improve the consistency of output and enhance the impact of the regulations. Staunig added, “Without an alignment on CO2 emissions reporting, we cannot make progress on climate change, for example.” Unfortunately, Staunig is uncertain international alignment will happen any time soon. This means regulatory frontrunners, like the EU, need to keep pushing the bar higher and foster dialogues to foster collaboration.
Work towards a standardised ESG framework is already underway. The International Sustainability Standards Board (ISSB) was created in 2021 with the aim of bringing some consistency to ESG reporting space. The body recently teamed up with the Global Reporting Initiative to create common ground for Asian companies to report on their environmental, social and governance impacts.
A lack of standardisation is not exclusively an international problem, as seen within the US, where the Democrat and Republican parties appear to have very differing opinions on the topic. Earlier in the year, the US House of Representatives approved legislation aimed at blocking a new law allowing the consideration of climate and ESG factors by retirement plan fiduciaries. However, the movement resulted in President Biden issuing the first veto of his presidency. Following this, Ron DeSantis, the Governor of Florida, headed an 18-state alliance aimed at banning the use of ESG considerations in state and local pension funds. This attempt to block ESG considerations followed a similar move from DeSantis in his home state, as he barred fund managers for state and local entities in the state from considering ESG factors in investment decisions.
Elsewhere, Wyoming voted down two pieces of anti-ESG legislation that would have impacted the state’s ability to invest in a range of funds, Arizona ended investigations into ESG investing practices and US Republican congressmen proposed a new legislation to restrict ESG investing in retirement funds. The constantly changing rules makes it hard for firms to know where they stand, and a standardised set of rules would give more stability to ESG.
While Permutable.AI CEO and co-founder Wilson Chan was in favour of a standardisation within ESG regulation, he offered some caution regarding this approach. “Global standards often adopt a one-size-fits-all approach, which may not account for the diversity of industries, sectors, and regions. This could make it challenging for companies to tailor their ESG practices to their specific contexts.”
Walter Gontarek, CEO and chairman at Channel added, “We absolutely think that countries should be encouraged to voluntarily sign up and follow global standards, but feel forcing countries is not the best way forward. There are of course potential incentives to realise for those that follow standards, including access to lower cost of capital and relaxed trading.”
Increased regulation
In terms of some specific regulations, Permutable.AI’s Chan highlighted a standardised reporting process would help streamline the evaluation of corporate performance, making it easier for investors and stakeholders to compare companies. On top of this, he added that mandatory ESG reporting requirements for all publicly traded companies, regardless of their size, would boost transparency and accountability. “Governments could also provide tax incentives to companies that demonstrate substantial ESG improvements, encouraging them to adopt sustainable practices.”
Finally, he noted that by integrating ESG considerations into financial regulations and risk assessments would help to encourage financial institutions to weave ESG factors into their decision-making.
As for Iceberg Data Lab CEO Matthieu Maurin, he believes there needs to be greater regulation to ensure best standards are applied during the development of ESG signals. “The underlying science is complex, and we should rely on judgement calls to correctly estimate for instance attribution of responsibility in a value chain (think for instance to software developers). So, a regulator cannot and should not validate a right signal or even methodology. Competition and lack of uniformity are desirable at this stage of the industry to foster research for innovation and quality.”
A risk of a tick-box approach
While increased regulation within the ESG space would bring greater transparency, standardisation and alignment, it could also have a negative impact. One of the biggest downsides of increased regulatory scrutiny could be compliance teams being flooded with work. This could result in companies resorting to a tick-box approach to their sustainability. Staunig said, “ESG becomes something for the lawyers, not the core business. Regulators have a crucial role to play in preventing this, if they take a balanced approach to enforcement.”
Similarly, Chan noted that while larger corporations might have the resources and infrastructure to adhere to the requirements, smaller companies might struggle. This could put smaller firms at a disadvantage in the market as they allocate more of their limited resources to meet compliance.
Next 5 years
The ESG landscape is evolving fast and is likely to look very different in the coming years. Staunig believes that over the next five years disclosure and ESG data quality will continue to be a high priority for regulators around the world. She added that some regions will align with international standards and others will follow the EU’s best-practice approach. “Many actors – including major international financial players – are lobbying strongly for global alignment on ESG reporting, so I definitely see more global coordination happening over the next five years.”
However, she believes there is a chance for more disharmony for sector or industry-specific rules. For example, countries will want to be the leading provider for solar or for EV, and these mentalities could create trade disputes, like that between the US, EU and China. “Given the geopolitical shifts of the past years, the race for strategic autonomy is likely to continue. Hopefully, these forces will accelerate the sustainable transition. But there is reason to fear that this global rivalry will make the systemic change our societies and economies so desperately need more inefficient.”
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