Reporting and Governance

Regulation will be a key tool used by US government departments and agencies as an alternative to legislation in the coming years. This is reflected in recent moves by the country’s regulators, which are preparing the ground for significant changes during President Biden’s first term in office. By Joe DiGiglio, Rebecca Thorpe and Michael Johnson at Bovill

The US Securities and Exchange Commission (SEC) has recently issued multiple public statements regarding ESG investing. The agency’s increased attention is clear from both its public comments on the subject and not-so-hushed rumblings from market participants over the past 12 to 18 months about SEC examinations and ESG investing.

In early March, the SEC published its Division of Examination 2021 Examination Priorities. This stated that the agency will review the consistency and adequacy of the disclosures by registered investment advisers and fund complexes provided to clients regarding ESG strategies, determine whether the firms’ processes and practices match their disclosures, review fund advertising for false or misleading statements, and review proxy voting policies and procedures and votes to assess whether they align with the ESG strategies.

This was rapidly followed by the SEC’s announcement of the creation of a Climate and ESG Task Force within its Division of Enforcement. The task force will develop initiatives to proactively identify ESG-related misconduct and co-ordinate the effective use of the division’s resources. It will also analyse disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.

In early April, the SEC’s Division of Examinations published a risk alert highlighting observations from recent exams of investment firms and advisers and private funds offering ESG products and services. It noted that examinations of firms claiming to engage in ESG investing will focus on three key areas: (i) portfolio management, (ii) performance advertising and marketing and (iii) compliance programmes. 

The obligation for firms to meet the SEC’s new requirements will be substantial, and those doing business in the US should seek external support to meet the regulator’s expectations. This includes familiarising themselves with examination processes, holistically reviewing systems and controls, and seeking advice on developing a global ESG programme to ensure a cohesive approach across international markets.

Tighter disclosure rules

A Green and Sustainable Finance Cross-Agency Steering Group has been established in Hong Kong, co-chaired by the Securities and Futures Commission (SFC) and Hong Kong Monetary Authority (HKMA). This group has said it recognises climate change as one of the defining issues of our time, and issued its strategic plan in December 2020 to raise awareness, enhance capability and encourage innovation. The HKMA outlined its three-phase approach to promote green and sustainable banking in 2019, which includes:

• developing a framework to assess the ‘greenness baseline’ of individual banks;    

• issuing a consultation to set tangible deliverables for promoting the green and sustainable developments of the Hong Kong banking industry; and

• setting the targets, implementing, monitoring and evaluating banks’ progress in this regard.

HKMA chief executive Eddie Yue recently highlighted one of the challenges faced in ESG, of particular relevance for Hong Kong. It is widely recognised that the difference in taxonomies defining green finance is impeding global co-ordination, a fact that Hong Kong, being the gateway between mainland China and the west, feels particularly acutely. HKMA considers the two leading global taxonomies to be those developed by the mainland and the EU, and is tracking the harmonisation efforts being made by China and by the EU to reconcile some of the key differences between the two taxonomies. One of the first priorities of the steering group is to develop a local Hong Kong taxonomy to incorporate the harmonisation work being done by the mainland and the EU so that all regulators and financial institutions can be on the same system, in Hong Kong at least. 

ESG has also been taken up as a priority topic by Ashley Alder, CEO of the SFC and chair of the International Organization of Securities Commissions. As he pointed out in February this year, one of the most important regulatory themes of today relates to climate change and finance, particularly with regard to the asset management industry.  

Firms should therefore expect not just industry guidance but rule changes in the very near future regarding mandatory ESG disclosures for asset managers.  

Following a survey conducted by the SFC, published in December 2019, the Hong Kong securities regulator initiated a consultation across the industry, which closed in January, the conclusions of which are expected to be published shortly. 

The survey noted that industry participants consider ESG issues and the potential risks associated with climate change as important. However, there is currently no consistent approach to disclosure of information, to integrating such risks into investment decisions or to manage the financial impact of climate risks. As such, the SFC has proposed to incorporate amendments to the Fund Manager Code of Conduct in Hong Kong, which will require managers of collective investment schemes to consider the potential risks arising from climate change in their investment and risk management processes, as well as disclose relevant information to investors as appropriate.  

The SFC has also established a Climate Change Technical Expert Group to help set the expected standards, as well as a cross-agency steering group with other local regulatory and governmental bodies.  The expected implementation timeline for such changes is 9 to 12 months, with different levels of regulatory obligations to be imposed and a shorter or longer transition period for compliance, depending on firms’ assets under management.  

The Monetary Authority of Singapore is taking a different tack to its Hong Kong counterparts, preferring to issue guidance documents to the industry rather than impose specific rule changes. 

Among these are:

• guidelines on Environmental Risk Management (ERM) for asset managers, banks and insurers, issued in December 2020 with an 18-month transitional period;

• a proposed taxonomy for Singapore-based regulated firms to identify activities that are green or are transitioning to being green; 

The Green Finance Industry Taskforce has also issued a handbook with guidance to insurers, banks and asset managers on best practices for ERM. The hope is that these will help financial institutions implement the ERM guidelines above.

Onerous requirements

The EU Sustainable Finance Disclosure Regulation (SFDR) began to affect asset managers in March of this year. It imposes disclosure requirements on practically all products managed from or marketed into the EU. Particularly onerous and prescriptive requirements are reserved for funds that purport to have ESG features and managers with more than 500 employees. Reporting on all the mandatory metrics set out in the SFDR will prove to be a real challenge for firms as the required data is not yet widely available. 

Recent EU proposals to augment non-financial reporting requirements for large companies may improve the availability of data, though only for the largest EU-based companies.

The EU’s disclosure regime is underpinned by the Taxonomy Regulation, which makes a bold attempt to classify activities across the entire economy into those that make a substantial contribution to a range of environmental objectives and those that do not. Funds that promote environmental characteristics will be expected to report on the proportion of their investments that meet the Taxonomy Regulation’s criteria for qualifying as making a substantial contribution to environmental objectives.

The EU’s sustainable investment package is, therefore, complex and wide-ranging. Firms will need to undertake extensive scoping exercises and gap analyses, review and amend current policies and procedures and improve governance around their investment processes to ensure compliance.

The UK has made its own moves to improve the quality of ESG reporting. Rather than creating a highly prescriptive bespoke regime in the vein of the EU, the UK has put the Task Force on Climate-related Financial Disclosures (TCFD) recommendations at the forefront of new requirements on climate disclosure. From this year, UK-listed companies will be required to make climate-related disclosures in line with the TCFD recommendations in their annual reports. The UK government has also set out plans to extend TCFD reporting to large private companies and Financial Conduct Authority-regulated asset managers in stages from 2022, starting with the largest firms. 

The TCFD is a widely recognised international framework for climate-related disclosures and already has significant take-up among some of the world’s largest companies. As such, it is expected that the UK’s TCFD-based regime to be easier for firms to comply with and of greater use to investors than the EU’s quixotic disclosure regime.

The ESG push is global

Clearly different jurisdictions are adopting different approaches to ESG regulation, often moving at varying speeds. But the trend towards more scrutiny of ESG factors and greater disclosure requirements for firms of all types is clear. Voices around the globe have been demanding climate-aware investing and carbon reduction, the ethical treatment of employees, customers and other stakeholders, and well-managed companies, for some time. Regulators are responding to this in more tangible ways and at an ever-increasing pace. Firms operating globally are obliged to get ahead of the game and invest to ensure they can keep pace with what is required.