Recent significant policy developments and financial market implications

• The UK Transition Plan Taskforce Disclosure Framework published for consultation
• The UK FCA released its draft proposal on SDR to tackle greenwashing

Other announcements and publications

Global

• The International Sustainability Standards Board (ISSB) made key announcements towards the implementation of climate-related disclosure standards in 2023
• Taskforce on Nature-related Financial Disclosures (TNFD) released the third iteration of its disclosure framework on nature-related financial disclosures
• COP27: International Organisation of Securities Commissions (IOSCO) launched consultations on carbon markets

UK

• UK FCA announced the creation of a group to develop a Code of Conduct for Environmental Social and Governance data and ratings providers

EU

• The European Central Bank (ECB) set deadlines for banks to comply with its guide on climate and environmental risks
• The European Financial Reporting Advisory Group (EFRAG) adopted the first set of European Sustainability Reporting Standards
• European Supervisory Authorities (ESAs) launched a call for evidence to better understand greenwashing risks
• European Securities and Markets Authority (ESMA) included ESG disclosures as a new strategic supervisory priority and launched a consultation on guidelines for the use of ESG or sustainability-related terms in funds’ names
• EU Taxonomy Technical Screening Criteria for remaining environmental objectives
• European Banking Authority (EBA) is gathering feedback on ways to support green mortgages and loans to SMEs

USA

• The Biden-Harris administration proposed plan to address greenhouse gas emissions and protect federal supply chain from climate-related risks

What to look out for, for the rest of 2022 and Q1 2023

• COP15 on Biodiversity taking place in December 2022
• Planned review of EU Sustainable Finance Disclosure Regulation (SFDR) regulation to be delayed

The UK Transition Plan Taskforce Disclosure Framework published for consultation

Last year at COP26, the UK Transition Plan Taskforce (TPT) announced its plans to develop a standard for private sector climate transition plans. NatWest is involved in the TPT with membership on both the Steering and Delivery Groups. In November 2022, the TPT published its Disclosure Framework and accompanying Implementation Guidance; with public consultation open until 28th February 2023. A ‘Sandbox’ is also available for companies and financial institutions to help users create their own transition plans. While open for public comments and voluntary for companies to implement, the UK Government and the FCA will draw on the TPT’s outputs to develop disclosure requirements across the UK economy.

The Disclosure Framework focuses on concrete, short-term actions that can be taken by companies and financial firms across the economy. It also urges companies and financial firms to consider the full range of levers at their disposal to contribute to, and prepare for, an economy-wide transition to net zero to avoid potential unintended consequences of ‘paper decarbonisation’. The Disclosure Framework outlines the elements to create high-quality and credible plans that should create transparency and accountability for companies and financial institutions to meet their net zero targets and will enable investors to make better informed capital allocation decisions. See the summary of key recommendation in Table 1 below.

The Implementation Guidance sets out the steps to develop a transition plan, as well as when, where, and how to disclose the plan. It also recommends organisations publish standalone transition plans at least every three years, and sooner when there are significant changes to the plan, suggesting that progress against these plans can be reported annually as part of Task Force on Climate-Related Financial Disclosures (TCFD) disclosures.

The taskforce also announced plans to publish a range of sector guidance in 2023, starting with an overview of sector-specific metrics from existing guidance which can supplement the recommendations of the TPT Disclosure Framework. (PDF, 147KB) for the full set of TPT Summary Recommendations. (adapted from the TPT publication).

Key considerations for market participants

Issuers / Borrowers

A transition plan is integral to issuers’ overall strategies and, as mentioned above, is paramount for transparency and accountability to enable investors to make better-informed decisions. Although it’s UK-focused, the TPT recommendations are one of the more comprehensive initiatives on this topic. Therefore, even for non-UK issuers, the elements of a good practice transition plan – covering issuers’ high-level ambitions to mitigate, manage and respond to the changing climate, and to leverage opportunities of the transition to a low GHG and climate resilient economy – are still relevant. This should include GHG reduction targets (e.g., a net zero commitment): short, medium, and long-term actions, an organisation plans to take to achieve its strategic ambition, alongside details on how those steps will be financed. Plans should also include the governance and accountability mechanisms that support delivery of the plan and that identify material risks/opportunities that may impact the wider natural environment and key internal and external stakeholders. Finally, plans should also include specific details on how progress will be reported. The taskforce recommends that entities publish transition plans at least every three years, and more frequently if there have been material changes to the plan. In terms of progress reporting, issuers should be including key performance indicators (KPIs), advancement and other qualitative and quantitative disclosures, annually. 

Issuers are dealing with a myriad of emerging and required disclosure standards, the TPT’s recommendations can be helpful in ensuring that forward-looking plans include the material and relevant information that investors and other stakeholders require. Furthermore, timing and reporting recommendations allow for alignment and coordination with existing and emerging frameworks and issuers can use the TPT ‘Sandbox’ to test out the recommendations and create a plan, even though it is currently a voluntary exercise.

Investors / Lenders

For finance providers, the development of the Transition Plan framework is a welcome development from several perspectives. Firstly, whilst voluntary initially, it provides a rather clear signal that it will likely become mandatory; for application by investee companies/borrowers. For example, the TCFD rules already recommend the disclosure of transition plans, and it is expected that the ISSB’s global ESG reporting standards will do the same. Availability of climate transition disclosures, including on material Scope 3 emissions, should provide investors and lenders with the long-awaited information on whether and how companies are working to adjust their strategies and business models to achieve their net zero commitments. The role of investment stewardship, active ownership and general customer engagement will become more prominent as finance providers will become better informed about companies’ transition strategies and actions and thus would be equipped to promote accountability for the delivery on climate commitments made. 

Broad availability of transition plans will be inherently linked to the development of new financing products and structures to support the transition. To this end, the UK SDR for investment managers (see next section of this article) will introduce several sustainable investment product labels, one of them being “Sustainable Improvers”, whereby the underlying assets would be expected to provide information/KPIs consistent with the recommendations of the UK TPT. More generally, the market may see more “transition” labelled financing products – products that have been emerging rather cautiously due to the lack of clarity on what ‘transition’ means. Investors may also see further development of the sustainability-linked instruments market whereby KPIs and sustainability performance targets (SPTs) may be closely linked to those articulated in the issuers/borrowers’ transition plans.

The UK FCA released its draft proposal on SDR to tackle Greenwashing

The UK FCA has proposed definitions for investment product sustainability labels, as well as disclosure requirements around those labels, to clamp down on greenwashing in sustainable investing. Through these measures, the FCA wants to ensure that consumers and firms can trust that financial instruments have the sustainability characteristics they claim to have. These rules are primarily aimed at the UK-domiciled asset managers and cover: product labels, entity level and product level disclosures and restrictions on the use of ESG related terms – in product names as well as product marketing and distribution. As sustainable investment continues to be the norm, there will be an expectation around the label for new fund launches. Like with SFDR, there will be different approaches between asset managers, and it may take some time for there to be consistent market implementation.

The FCA is proposing three categories of sustainable investment product labels: “sustainable focus”, “sustainable improvers”, and “sustainable impact”. Sustainable focus products would aim to invest in assets with at least 70% of portfolio, that are environmentally and/or socially sustainable (meeting a credible standard of environmental and/or social sustainability, or aligning with a specified environmental and/or social sustainability theme). Sustainable improver products would look to improve the environmental and/or social sustainability of assets potentially from stewardship and engagement activities. Finally, sustainable impact products should result in real-world measurable impact to solve environmental and social problems.

Products that apply exclusion or ESG integration strategies or thematic tilt alone would not qualify for a sustainable investment label but would need to disclose on such strategies in product documentation. In relation to fund naming conventions, the FCA also proposed how products could be marketed, including restrictions on terms like “ESG”, “green” and “sustainable”, being used on products which do not qualify for the sustainable investment product labels. 

In addition, the FCA proposed that investment funds should be required to make more granular disclosures at both a product and entity level that are suitable for a broad range of stakeholders. Like EU SFDR, the proposal focuses on pre-contractual and periodic reporting covering the sustainability-related features of investment products. For retail investors the FCA suggests disclosing the investments that consumers may not expect to be held in the fund so that they understand the key sustainability-related features of such investments. Further recommended disclosures include ongoing sustainability-related performance information for the product and entity-level reporting; covering how firms are managing sustainability-related risks and opportunities at entity-level.

The consultation on these proposals is open until 25 January 2023 and the final rules are planned to be published by 30 June 2023 and to begin applying after 30 June 2024.

Key considerations for sustainable finance market participants

Issuers / Borrowers

While these potential new rules are aimed at asset managers, issuers should track these developments as they will have implications for issuers’ own reporting and expectations for how investors view them. If an issuer will be included in any of the three types of funds, investors will need to have entity level data to support that inclusion. Therefore, any additional clarity on the fund labels can inform issuers of the expected information to disclose on ESG-related performance, so that investors can have confidence in including them in those funds. For the ‘improvers’ product, issuers can expect enhanced engagement and interaction with investors. Initially, this label will only be used for equity investment, but issuers should expect that eventually debt-holding investors will also leverage their stewardship capabilities. 

Investors / Lenders

Initially most of the disclosure and labelling requirements will primarily target UK-domiciled asset managers, with a view to considering separate rules for foreign entities and regulated asset owners, as well as for additional products such as pension and insurance-based products. Whilst the FCA seeks to establish interoperability with the EU SFDR and US SEC’s draft proposal on ESG Disclosures for Investment Advisers and Investment Companies, there are fundamental differences in the approaches applied. Global asset managers will need to consider these differences when structuring and marketing investment products in different markets:

• The FCA’s proposal introduces specific requirements around sustainable investment labels, whilst SFDR and SEC regimes focus on product and entity level disclosures. Asset managers will need to be able to map the new requirements across jurisdictions and to relabel their products – for example, an “Art 9 fund” under EU SFDR may not automatically meet the requirements to qualify for any sustainable investment label under the UK SDR. “Art 8 funds” will unlikely meet any of the FCA labels unless they specify environmental and/or social objectives they would be seeking to achieve. The FCA provided helpful guidance on how this mapping exercise/assessment can be approached (see Tables 2 and 3 below).

Table 1: UK SDR vs EU SFDR

Table 2: UK SDR vs US SEC

• The FCA places a significant focus on consumer-facing disclosures for retail customers aiming to ensure that product information related to its sustainability features is more accessible and easier to understand. Unlike the amended EU MiFID II rules on product governance and suitability, the FCA does not prescribe any requirements on how to fulfil the end investors’ sustainability preferences.
• Unlike EU SFDR, the SDR proposal does not require investment product disclosures on the “do no significant harm” (DNSH), principal adverse impact indicators (PAI) or green taxonomies. Regarding the role of UK Green Taxonomy in product and entity level disclosures, the FCA will consider how it should be integrated in such disclosure rules after the Taxonomy has been adopted by the UK Government.

Asset managers should be aware that some requirements and concepts introduced by the FCA may be subject to interpretation – unless clarified in the final proposal. For example, requirements for the “sustainable focus” label refer to the underlying assets meeting a “credible standard of environmental and/or social sustainability” or “aligning with a specified environmental and/ or social sustainability theme”. It is not clear what these requirements may mean in practice.

ISSB made key announcements regarding the implementation of climate-related disclosure standards in 2023

The International Sustainability Standards Board (ISSB) has launched a new global ‘Partnership Framework’ for global implementation of climate-related disclosure standards. In its statement, the ISSB said the framework aims to build capacity in developing and emerging economies, and ultimately assist in the development of a “truly” global baseline of climate disclosure standards. There are over 20 member organisations forming the new partnership, including the Association of Chartered Certified Accountants, Deloitte, the UN development programme and more.

This comes at a time where the ISSB is engaging with jurisdictions globally and regularly consults with the International Organization of Securities Commissions (IOSCO) in preparation for potential IOSCO endorsement of the proposed international standards. It is a signal of significant momentum around the world, as more jurisdictions undertake work to consider how to incorporate the ISSB’s standards into their domestic systems of reporting. As a reminder, the ISSB is expected to finalise its first set of climate and sustainability-related standards by the end of 2022.

TNFD released the third iteration of its disclosure framework on nature-related financial disclosures

The Taskforce on Nature-related Financial Disclosures (TNFD), which was established in 2021 to help organisations factor nature into key business decisions, released the third iteration of its beta framework with updates such as new supply chain traceability disclosure recommendations, further guidance on risk and opportunity assessment, and target-setting developed with the Science Based Targets Network (SBTN).

The Taskforce has also issued discussion papers on scenarios and nature-related risk management and disclosure on societal considerations to incorporate feedback from market participants and key stakeholders. Supply chain dependencies and risks, the measurement of impacts, disclosure metrics guidance, and stronger support for priority sectors such as agriculture, aquaculture, and mining will be some of the major focus areas for the final draft version of the framework (v0.4).

Since the v0.2 release in June, a growing number of institutions (over 700) from across five continents are now part of the TNFD Forum supporting the Taskforce.

COP27: IOSCO launched consultations on carbon markets

The International Organization of Securities Commissions (IOSCO) has released two discussion papers on compliance and voluntary carbon markets – open for feedback until 10 February 2023.

The report on compliance (regulated) carbon markets provides twelve recommendations regarding primary and secondary functions of compliance carbon markets with a particular focus on transparency, structure, and integrity. The report also includes recommendations for relevant authorities such as policymakers and securities markets regulators to help establish effective regulated carbon markets.

The other report covers voluntary carbon markets, where market participants can buy carbon credits to offset a part or all their carbon emissions. The IOSCO has conducted a fact-finding exercise with stakeholders like standard setters, academics, and market participants to consider and identify the role of financial regulators in this market. The main concern raised was about market integrity which can be viewed from three different perspectives:

1. Concerns at project level, regarding the integrity of carbon credits.
   
2. Issues relating to the trading environment of these credits and how they are transferred, and the behaviour of market participants in doing so.
3. Issues regarding greenwashing and misleading information, especially regarding the communication around the buyers of carbon credits.

This report seeks feedback on a potential approach that regulators and market participants could take to help develop well-functioning voluntary carbon markets and, therefore, help these markets scale to allow them to achieve their environmental objectives.

The UK FCA announced the creation of a group to develop a Code of Conduct for Environmental Social and Governance data and ratings providers

The UK FCA announced the formation of an independent group to develop a Code of Conduct for Environmental Social and Governance data and ratings providers to support greater transparency and trust in the market for ESG data and ratings services – in line with the earlier published Feedback Statement on ESG integration in UK capital markets (FS22/4). M&G, Moody’s, London Stock Exchange Group (LSEG) and Slaughter & May will co-chair the group. The International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG) have been appointed as the Secretariat to lead this work.

Given that development of consistent global standards is so crucial, the code will also consider developments in jurisdictions such as Japan and the EU.

The ECB set deadlines for banks to comply with its guide on climate and environmental risks

In its most recent thematic review, the European Central Bank (ECB) published results that a proportion of banks still has some way to go towards properly managing climate and environmental risks.

The review adds that many banks are falling behind in developing sophisticated methodologies and providing detailed information on climate and environmental risks as well as having solid execution capabilities. This led the ECB to set staggered deadlines for banks to meet supervisory expectations as mentioned in its Guide on climate-related and environmental risks.

Two key upcoming deadlines are set for the end of 2023 and 2024; by the end of 2023 the ECB expects banks to include climate and environmental risks in their governance, strategy, and risk management and by the end of 2024 institution-specific deadlines have been introduced to encourage full alignment with its expectations. Alongside the review, the ECB also published a compendium of ‘Good practices for climate related and environmental risk management’ aiming to assist banks in complying with the ECB’s guide.

EFRAG adopted the first set of European Sustainability Reporting Standards

The European Financial Reporting Advisory Group (“EFRAG”) announced the submission of the first set of draft European Sustainability Reporting Standards (“ESRS”) to the European Commission for adoption.

In May 2022, EFRAG released its initial drafts of the standards and announced the launch of a 100-day consultation period to receive feedback. EFRAG notes in its letter to the European Commission that its goal is that the companies which comply with ESRS should also be considered as complying with the ISSB standards to avoid unnecessary multiple reporting.

In the updated submission there is also a significant reduction in the number of disclosure requirements and, significantly in terms of value chain reporting, the obligation to obtain data from value chain partners will not be required for the first 3 years (during which time undertakings use in-house data to provide insights on their value chain), except when value chain data is needed to enable users to comply with the requirements of other pieces of EU legislation.

The European Commission will now consult EU bodies and Member States on the draft ESRS which will then be scrutinised by the European Parliament and Council of the EU. The ESRS are expected to be adopted by way of delegated act in June 2023.

ESAs launched a call for evidence to better understand greenwashing risks

The European Supervisory Authorities (ESAs) published a call for evidence (CfE) seeking input on potential greenwashing practices in the EU financial sector. The CfE is asking for views across the financial sector on:

• How to understand greenwashing and the main drivers of greenwashing
  
• Examples of potential greenwashing practices across the EU financial sector relevant to various segments of the sustainable investment value chain and of the product lifecycle
• Evidence on potential greenwashing practices within and outside the scope of current EU sustainable finance legislation
• And, any available data to help the ESAs gain a concrete sense of the scale of greenwashing and identify areas of high greenwashing risks.

The deadline for responses is 10 January 2023, after which a progress report is expected by the end of May 2023 and a final report by the end of May 2024.

ESMA included ESG disclosures as a new strategic supervisory priority and launched a consultation on guidelines for the use of ESG or sustainability-related terms in funds’ names

ESMA is changing Union Strategic Supervisory Priorities (USSPs) to include ESG disclosures alongside market data quality.

With the increasing popularity of ESG-related financial products, ESMA is looking to foster comprehensibility and transparency of ESG disclosures across the sustainable finance value chain, such as investment managers, issuers, and investment firms, to tackle greenwashing. To further promote transparency and comprehensibility of ESG disclosures ESMA plans to build supervisory capabilities around sustainable finance into its supervisory practice.

Looking ahead, the ESMA will monitor the areas of ESG disclosures, market data quality, and the evolution of costs as a key element for investors’ protection.

Following the above, ESMA launched a consultation on draft guidelines on the use in investment funds’ names of ESG or sustainability-related terms (open until 20 February 2023). In order not to mislead investors, ESMA believes that ESG and sustainability-related terms in funds’ names should be supported in a material way by evidence of sustainability characteristics or objectives that are reflected fairly and consistently in the fund’s investment objectives and policy. ESMA is particularly seeking stakeholders’ feedback on the introduction of quantitative thresholds for the minimum proportion of investments sufficient to support the ESG or sustainability-related terms in funds’ names, such as:

• A quantitative threshold (80%) for the use of ESG related words;
• An additional threshold (50%) for the use of “sustainable” or any sustainability-related term only, as part of the 80% threshold;
• Application of minimum safeguards to all investments for funds using such terms (exclusion criteria);
• Additional considerations for specific types of funds (index and impact funds).

ESMA proposes that the draft guidelines would become applicable from 3 months after the publication of their translation on the ESMA website. Furthermore, a transitional period of 6 months is suggested for those funds launched prior the application date, to comply with the guidelines.

EU Taxonomy Technical Screening Criteria for remaining environmental objectives

The EU Platform on Sustainable Finance (PSF) published a report with supplementary advice on methodology and technical screening criteria (TSC) for the climate and other environmental objectives of the EU Taxonomy. This report complements the advice submitted by the Platform in March 2022 (Report with recommendations on TSC for the four remaining environmental objectives and Annex). This additional advice will inform the Commission’s next steps as the Commission is yet to adopt legislation to set out technical criteria for the rest of the environmental objectives beyond climate change mitigation and adaptation.

EBA is gathering feedback on ways to support green mortgages and loans to SMEs

The European Banking Authority received a Call for Advice from the European Commission on the definition and the potential tools that support green loans and green mortgages for retail and SME borrowers. This request is part of the European Commission’s Strategy for financing transition to a sustainable economy.

The Biden-Harris administration proposed plan to address greenhouse gas emissions and protect federal supply chain from climate-related risks

The Biden administration announced the ‘Federal Supplier Climate Risks and Resilience Proposed Rule’ which would require suppliers to set emissions reductions goals aligned with the Paris Agreement, and publicly disclose their greenhouse gas emissions as well as climate-related financial risks.

Contractors that have more than $50m in annual business with the government would have to disclose Scope 1, 2 and 3 emissions. Those with $7.5m to $50m in contracts would be required to report Scope 1 and 2 data, and those with less than $7.5m in business would be exempt.

The US government is the world’s largest buyer of goods and services, purchasing more than $630 billion annually on supplies and services. The proposed rule represents a significant step toward greening the government’s operations and one that could swell across the USsupply chain.

COP15 on Biodiversity taking place in December 2022

Part two of the UN Biodiversity Conference (COP15) will take place in Montreal, Canada, from 7-19 December. These face-to-face meetings follow the virtual meetings in October that covered continuation of operations, administrative and technical considerations of the Convention and the Protocols by the Bureau. These meetings are expected to address the remaining agenda items, including the finalisation and adoption of the post-2020 global biodiversity framework.

Planned review of SFDR regulation to be delayed

The ESAs will delay the planned review of key rules for financial products around indicators for principal adverse impact (PAI) and financial product disclosure under the EU SFDR, pushing its response by up to 6 months from the European Commission’s original April 28, 2023, deadline (as a reminder, the review was prescribed by the EU SFDR which was adopted in 2020). ESAs noted there were several challenges in delivering the requested input in the original timeframe, including the need for consultation with stakeholders and expert bodies, and the technical demands of working on aspects such as the Do Not Significantly Harm (DNSH) framework and to develop the [new] PAI indicators. It’s worth reminding that the mandatory reporting on PAIs starts only on 1 Jan 2023 and it was delayed itself due to the delays in the delivery of regulatory technical standards providing details around the reporting. Therefore, revising PAI when the related reporting barely started to apply may be indeed premature.

For those looking to discuss any of the above further, please reach out to our authors:

• Tonia Plakhotniuk, Vice President, Climate & ESG Capital Markets
• Daniel Bressler, Vice President, Climate & ESG Capital Markets, Corporates
• Tyler Mayzes, Analyst, Climate & ESG Capital Markets, Corporates