ESG regulations: what financial institutions need to know in 2022

All of this has risk and regulatory compliance implications. Indeed, the pandemic laid bare many legacy technology and process deficiencies, as well as the need to improve compliance systems at scale.

Across the Europe, Middle East and Africa (EMEA) region, regulators continue to refine existing regulations implemented in the wake of the financial crisis and are now doubling down on policy areas such as derivative reform. Sustainable finance is climbing to the top of the regulatory agenda with regulators mobilising their focus towards environmental, social and governance (ESG) to drive change across the entire financial services landscape. As these areas attract ever greater scrutiny, there are some regulatory developments that financial institutions in EMEA should expect and plan for over the next year.

Chief among those is the role of the financial services industry in facilitating the transition to a greener economy, as we grapple with ways to achieve ‘net-zero’ and mitigate global warming.

A recent report by the UN body for assessing the science, the Intergovernmental Panel on Climate Change (IPCC), was a wake-up call for many. It has been labelled “a code red for humanity” by UN Secretary General António Guterres. It reinforced just how much work is still required to reduce greenhouse gas emissions and slow the rate of rising temperatures. As the UN and world leaders move forwards with efforts to embed sustainable finance into the financial system, the EU is leading the charge on the ESG regulatory agenda. 

Under the European Commission’s Sustainable Finance Action Plan (SFAP) laid out by the commission in 2018, there are two key ESG regulations– the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy. The SFDR came into effect on March 10, 2021, preceded by the EU Taxonomy, which entered into force on July 12, 2020. Under both regimes there continue to be several key implementation dates over the next three years, notably in January 2022 when the SFDR regulatory technical standards’ first reference period and the EU Taxonomy delegated acts on climate change mitigation and adaption take effect. 

As the requirements of the SFDR did not come into force until March 2021 (after the end of the Brexit transition period), the UK government is not under any obligation to implement this legislation. However, it is committed to developing a similar set of objectives to the EU SFAP. With the country’s Financial Conduct Authority keen to be viewed as a global leader on ESG and the development of climate-related regulatory standards in December 2020, it put in place a ‘comply or explain’ requirement for premium listed companies to make climate-related disclosures. Pending the outcome of consultations which closed in September 2021, it is likely we will begin to see the UK regulator further lending its voice to this debate in 2022. 

With regards to ESG investing, regulators have imposed mandated controls on areas such as the design of a fund, ESG investment strategies and disclosure requirements. However, there continues to be fierce debate in the industry about the merits of ESG-focused investing, with high-profile critics claiming it is a marketing and greenwashing tool with little to no impact. As far as risk and regulation is concerned, institutions will be keen to limit any friction or costs associated with ESG. To achieve this, compliance and risk management teams will need to be mindful of ESG, upskill, and incorporate new processes across their operations.

The next year looks set to be a busy one for regulators and financial institutions across the UK and EMEA region, with several key anti-money laundering regulatory developments on the horizon in addition to those focused on ESG.

Ensuring compliance with all of these upcoming and evolving regulatory requirements will add an extra layer of complexity to already burdensome regulatory regimes. 

Technology is key to bringing these costs down and complying with an ever-greater number of rules and regulations. Much of the excessive costs we see today are due to overly manual processes and information siloes. By accelerating digital transformation and automating risk assessments and compliance processes, financial institutions will be better equipped to identify and mitigate risks – whether they fall under tax, data protection, investor protection, derivative reform or upcoming ESG regulations. 

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