The rise in popularity of sustainable finance products and green funds has been so rapid in recent years that in 2022 it was estimated 10% of the world’s assets were held in ESG-focused funds.
However, the soaring appeal of green finance has been allied with concerns that investors may not be receiving an accurate picture about the sustainability of their investments. This apprehension has led to recognition in many quarters that robust regulation is required to govern disclosure in the financial services arena to reduce the risk of investors being misled, or ‘greenwashed’.
This is the first of two articles considering various regulatory developments in this area, both in the UK and beyond.
Greenwashing is a false, misleading or exaggerated claim about the environmental benefits of a firm’s products or services. Greenwashing can be committed intentionally or accidentally, and research indicates it is prevalent across multiple industries. In a 2022 survey 58% of CEOs admitted that their organisation had committed greenwashing. The worst affected industry was financial services.
This behaviour has led to a recent fall in so-called ‘responsible investments’; 53% of respondents in a recent survey confirmed that they considered ESG factors prior to investing, a fall of 12% since 2021. This is despite 68% claiming that sustainability was an important feature of their everyday lives.
The International Sustainability Standards Board (ISSB)
The ISSB was formed at COP26 by the International Financial Reporting Standards Foundation (IFRS). Its primary purpose was to develop a high-quality and comprehensive global baseline of standardised sustainability disclosures focused on helping investors compare the sustainability features of products. A perceived benefit of such a charter was to end the ‘alphabet-soup’ of disparate ESG-related regulations, standards and indices that govern sustainable disclosure across a range of industries.
In June 2023 the ISSB published the IFRS Sustainability Disclosure Standards (IFRS S1 and IFRS S2).
IFRS S1 focuses on disclosure of the sustainability-related risks and opportunities that an organisation might face. This information may be useful to investors when deciding whether to invest. It envisages core disclosure around governance, strategy, risk-management and metrics and targets.
The emphasis of IFRS S2 is primarily on disclosure of climate-related metrics and targets. Companies will be required to report on their scope 1, 2 and 3 emissions in accordance with the Greenhouse Gas Protocol. Detailed guidance is provided on the calculation of scope 3 emissions. This may be a nod to the fact that calculating these releases is notoriously difficult and frequently leads to organisations inadvertently committing greenwashing.
Also of note in IFRS S2 is the extra disclosure burden placed on businesses participating in certain financial activities (specifically, commercial and investment banking, asset managers and insurance companies).
The ISSB cannot enforce the standards and it will be up to governments and regulators to decide whether and when to implement them. The standards are not designed to apply to any particular type of company; it will again be up to authorities to decide the scope of their application.
The reaction to the standards has been positive. The International Organisation of Securities Commissions – the regulator of the world’s securities and futures market – has endorsed them and called on its 130 member jurisdictions to adopt and apply them. Several countries have responded by indicating that they will consider giving effect to the standards, including Canada, Australia, China and Nigeria.
The Financial Conduct Authority (FCA)
The FCA is strongly in favour of the development of global sustainability reporting standards. It is therefore no surprise that it has committed to playing an active role in supporting implementation of the IFRS standards. Further, the FCA intends to update its various climate-related disclosure rules to reference these.
In other FCA-related news, we have previously reported on its 2022 consultation paper: Sustainability Disclosure Requirements (SDR) and investment labels. This paper was geared towards aiding consumers and institutional investors in identifying sustainable investment products and navigating financial markets.
The production of the FCA’s policy statement was originally due by June this year but ended up only being published this month. Although it was anticipated that elements of the SDR regime (namely a general anti-greenwashing rule) would take effect immediately upon production of the policy statement, it has been revealed that the implementation timeline will not commence until May 2024.
The UK government
The British government has acknowledged the importance of sustainable investing and the threats posed by greenwashing for some time. In its 2021 Greening Finance Roadmap the government indicated it would assess the standards and consider their suitability. Since then, the government has enacted legislation in 2022 which requires certain UK companies and LLPs to provide annual climate-related financial disclosure.
Most recently, in March 2023 the government published its Mobilising Green Investment: 2023 Green Finance Strategy. This reiterates the UK’s commitment to consider the suitability of the IFRS standards and the most effective way to implement them. This is part of the movement towards the production of the UK’s Sustainability Disclosure Standards (SDS).
The government is expected to make endorsement decisions on the first two SDS by July 2024.
January 2023 saw the laying down of the Corporate Sustainability Reporting Directive (CSRD) which documents EU requirements on sustainability reporting. The CSRD imposes reporting obligations concerning social and environmental issues on a range of larger companies and listed SMEs. Those companies include EU parent undertakings of larger groups and EU subsidiary undertakings with an ultimate parent undertaking incorporated in a third country (subject to certain criteria being met).
In July 2023 the European Sustainability Reporting Standards (EDRS) were adopted by the European Commission. The EDRS set down the rules that companies caught by the CSRD will have to abide by from the 2024 financial year onwards (with EU member states having until July 2024 to adopt the CRSD into domestic law).
It will be crucial for companies formed in the UK (and elsewhere) that are active in the European market and which fall within the CSRD and EDRS regime to get on top of their reporting obligations, and quickly. This will apply to each jurisdiction that they operate in.
There is an obvious global shift towards the enaction and reform of regulation surrounding disclosure in sustainable finance in a bid to tackle greenwashing. As things stand, the rules that dictate an organisation’s requirements are liable to be part of a complex web of legislation and regulation. The work of the ISSB and the warm reception its standards have received may offer hope to businesses operating in financial services that a universal framework is not too far away.
Companies operating in jurisdictions with impending regulatory change would be well advised to promptly identify the regulatory structure that will apply to the jurisdiction(s) they operate in and get to grips with the disclosure requirements they will one day face. Voluntary adoption of incoming rules is a particularly useful way for entities to build a brand identity and ensure a smooth transition when new regulations become mandatory.
A failure to understand and comply with reporting requirements may result in a company finding itself in hot water. The second article in this series will consider the various risks and liabilities that an organisation found to have been guilty of greenwashing might face.
The article was originally published on 27 November 2023, and was updated on 29 November 2023 to reflect the latest developments.
 The Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard (22004)
 The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 and the Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022.
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