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ESG Standards and Taxonomies Remain in Flux, But Order is on the Horizon

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The ways in which financial institutions receive the data they need to fulfil their ESG targets is determined largely by the regulations that cover its disclosure and dissemination. This year will be an important one in this respect; changes to existing regulations, and the taxonomies on which they are based, are due to be introduced, as are new rules for countries that have yet to adopt their own.

Additionally, substantial changes are expected in the reporting standards that guide firms in submitting the right data.

During A-Team Group’s most recent ESG Insight webinar, ESG standards and Taxonomies – A Progress Report, leading industry participants took a stock-take of the reporting environment, and highlighted a number of key developments.

Taxonomies Are Bedding in and Standards are Converging

While the ESG regulatory landscape may look confusing, with many leading economies yet to adopt reporting rules, there is an expectation that order will come from the chaos soon.

Mark Davies, a partner at data management provider Element22 said he saw parallels between the development of ESG regulations and the creation of rules covering derivatives following the financial crisis. The meeting of minds and governments that happened at a Pittsburgh conference in 2009 that set the ball rolling on new banking rules can be seen today in the efforts to establish an international ESG reporting framework.

That summit saw regulators go off and create their own reporting requirements, and from those came Dodd Frank and many other safeguarding initiatives, Davies said. The Paris Climate Agreement is acting in a similar way – galvanising governments and regulators. That can be seen in the EU’s creation of the Sustainable Finance Disclosure Regulation (SFDR) and green taxonomy as well as work that’s happening to build similar structures in the UK and US.

Convergence of reporting standards, of which Panagiota Balfousia, head of sustainable business strategy at Kieger AG estimated there are about 3,000, is also proceeding at pace, especially in the form of the International Sustainable Standards Board (ISSB). It will unveil its first sets of standards next week (read this week’s blog Debut ISSB Standards May Usher New Era of More, Better ESG Data for more information).

Bodo Windmöller, senior vice-president of product management at RegTech provider Regnology said the global convergence of standards was maturing quickly. The creation of ISSB showed how stakeholder agencies, including regulators and standards setters, could work together.

We’re definitely getting there, was the opinion of Navin Rauniar, co-chair, ESG working group and UK SteerCo member of non-profit Professional Risk Managers’ International Association (PRMIA). He sees the commonalities between the EU’s green Taxonomy and the Taskforce for Climate-related Disclosures (TCFD), and the Taskforce for Nature-related Disclosures (TNFD) as proof that a unified set of frameworks is possible.

Things Will Change

Windmöller warned against alignment complacency, arguing that the data that banks have in place now may not be adequate later. With so many moving parts and so many external influences, taxonomies are likely to evolve over time.

Just as importantly, counterparties will too. Windmöller said it was likely at some point that a partner that a bank had been engaged when its activities were assessed as green could later become brown as its business moved into less sustainable realms.

The same would be true for projects or products that are funded by loans; the sustainability assumptions made about them at the time of funding may prove hasty or misjudged once they are complete and their intended green performance turns out to be anything but.

Financial institutions will be obliged to fulfil certain requirements by their regulators and those will be reframed over time too, he said. That’s partly because the regulators readily admit they don’t yet have all the answers to the questions covering how ESG performance should be reported. They will be learning as they go along, changing their codes and rules as they do.

It’s Not Over Yet

While there is a sense that standards and taxonomies are coming together globally, there are still many hurdles to overcome.

Rauniar said the elephant in the room was the fact that jurisdictions didn’t appear to be working closely enough with each other. Already there are “salient differences” in nascent regulations, he said. The SEC’s proposal for climate disclosures differs greatly from the European Financial Reporting Advisory Group’s (EFRAG) ****sustainability reporting standards and those set out by the UK’s Financial Conduct Authority.

Differences are particularly apparent in the quantification of scope 3 emissions from value and supply chains, which are likely to form the lion share of data disclosures in coming years. That’s making it impossible for financial institutions to accurately compare the relative performances of portfolio companies, he said.

Davies added that even when there is convergence, in their current states existing regulations would still not fill all the gaps in the data record. Small companies, start-ups and private markets will not be covered by the rules. That will be a handicap to banks and investors, whose loan books and portfolios will be heavily populated by such enterprises.

You can still view the webinar here and don’t forget to register for our next two:

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