Europe

A little remarked-upon but potentially transformational announcement to come out of COP26 in Glasgow was the creation of the International Sustainability Standards Board, which could streamline a plethora of ESG standards. By John Ahern and Thomas Reilly at Covington

The importance of this announcement will be clear to those companies and stakeholders that have up to now faced a frequently bewildering array of different sustainability standards, frameworks and metrics, as it represents an important step towards the creation of a single, consolidated, consistent and global ESG reporting standard against which companies can report.

The announcement is also good news for investors, as the application of a single, comparable set of internationally-recognised ESG reporting standards should help investors make better-informed investment decisions. 

The concept behind the International Sustainability Standards Board (ISSB) is to create globally consistent, trusted, non-financial reporting standards that are as robust and reliable as those that underpin modern-day financial reporting (see Nov GRR: New board to bring ‘welcome’ consolidation of ESG standards).  

Properly done, those standards should also give investors a better understanding of a company’s long-term performance and value-creation prospects. This improved transparency will also help investors identify links between ESG risks and opportunities and the financial performance of a company.

The creation of the ISSB is very much in line with a number of other non-financial reporting requirements which authorities are increasingly willing to impose on companies. The high profile of COP26 and the increasingly recognised urgency of addressing the climate crisis has and will only serve to encourage this trend. 

As further examples of this, it is worth highlighting two new initiatives that are likely to become law in 2022.

First, the EU’s proposal for a Corporate Sustainability Reporting Directive. This proposal would amend existing EU reporting requirements and extend them to all large companies and those listed on regulated markets. It would introduce more detailed reporting requirements, including one to report according to mandatory EU sustainability reporting standards (to be developed by the European Financial Reporting Advisory Group. The EU proposal aims for its policies to build on international standardisation initiatives.

Second, the EU’s recent draft Deforestation Regulation. This proposal would impose mandatory due diligence rules for those companies which place specific commodities and derived products on the EU market (including soy, beef, palm oil, wood, cocoa, coffee, leather, chocolate and furniture). Companies will be obliged to collect geographic co-ordinates of the land on which the commodities were produced. The commission would grade the risk of the country or region of production and companies’ due diligence obligations would depend on the grade of risk. The draft regulation gives enforcement authorities in member states strict oversight powers.

Green bonds

On November 5, 2021, the Bank of England published its approach to greening the Corporate Bond Purchase Scheme (CBPS). The approach, published alongside a market notice, implements the principles set out in a discussion paper the bank had issued in May 2021. It is consistent with targeting a 25% reduction in the weighted average carbon intensity of the CBPS portfolio by 2025, and full alignment with net zero by 2050. Firms will now need to satisfy climate-related eligibility criteria for their bonds to be purchased by the CBPS, with purchases of eligible firms’ debt being tilted towards the stronger climate performers within their sectors.

In addition, the UK government has made two ‘green gilts’ issues since September last year, both of which were significantly oversubscribed. This move has been followed by other sovereign debt issues which are focused on climate change and sustainability. Work on taxonomies in 2022 to extend them into adaptation and resilience criteria will offer governments additional sources of eligible expenditures for green bonds. Both the EU Taxonomy and the China Green Bond Endorsed Project Catalogue are being extended to encompass a broader range of potential assets. Taxonomies are also being extended to social objectives.

Global carbon markets

Finally, one other new initiative to look out for in 2022: the development of global carbon markets (GCM). The final agreement of the rules governing GCM was another of the small triumphs of Glasgow, with the details of Article 6 stuck in abeyance since Paris. The agreement reached at COP26 solved the issue of avoiding double counting and created two systems for trading in credits (open market and between governments). The full potential impact of a globally-functioning GCM will only become clear as the market begins to work, but at the very least, it has the potential to create a significant movement of capital from one jurisdiction to another which creates new financing streams for major infrastructure projects in developing countries. How those capital flows will be monitored and controlled is likely to have a potentially important impact on financial institutions around the world.

These are just a few of the potential new requirements (and opportunities) that global efforts to address climate change will impose on/offer to financial sector firms in 2022. There will be more, and it is likely that we will see an increasing tempo of their introduction. 

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