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ESG: The Next Frontier for Financial Services

ESG is everyone’s favourite topic right now, but the mass of different regulations, standards and reporting requirements can be confusing. Last week at the RegTech Summit Virtual 2020, we were delighted to speak with Beate Born, Head of Strategic Projects, Investment and Trading Platforms at UBS Wealth Management, to discuss how firms could best address these complex compliance challenges.

ESG has seen a massive uptick over the last few years, and it’s one of the hottest investment trends in the world – but concerns have also emerged around issues of greenwashing and the lack of transparency around what can be trusted to be a sustainable investment. We’re finally seeing regulation catching up in addressing the need for standardization – but where is the drive coming from, and who is at the head of the charge?

The urgency stems from accelerating climate change and the fact that despite numerous commitments of the global community over the past decade, the required reduction of greenhouse gas emissions has actually not happened. Given that climate change is now having a genuine economic impact, and measurable risk is rising, the regulators are finally stepping in – and what changes behaviour? Money.

“The idea of the EU regulators is laid out in the EU Action plan which essentially looks to shift private sector funds into sustainable investments,” explained Born. “I think the regulators did initially expect self-regulation and self-policing to take place, but it didn’t, so now the EU is the first to really put the hammer down when it comes to implementing ESG regulations.”

Born explained in detail the most significant regulatory developments in the ESG space, and why they are important. “If we drill down into the actual regulations, there are a couple of main types. First, those that have been amended to include ESG topics, on both the conduct and the prudential side – for example, MiFID II, UCITS, AIMFD, while regulations like CRD II have also now pulled those ESG pieces into the regulation“.

“One of the most significant developments now though, is that everything is circling around data and transparency. It is similar to what we have already seen with the recent Investor Protection and Market Infrastructure regulations, but now it is all about ESG information, and the definition of what exactly is sustainable. So we have the Non-Financial Reporting Directive (NFRD), which is an EU reporting standard for larger corporations. Then there is the Sustainable Finance Disclosure Regulation (SFDR), which is specifically for financial services institutions, forcing them to show the SRI risks and adverse impacts as well as the ESG credentials of any product marketed as “sustainable”.

“And then finally the most important, in my opinion, is the EU Taxonomy Regulation. I think people haven’t yet woken up to the fact that this will really change the way we work with ESG data – the taxonomy defines exactly what a sustainable activity is, according to the industry it is undertaken in and specific metrics that have been defined for each scenario. It will then set the “sustainable activity” in relation to the revenue generated with that activity to arrive at an overall level of “taxonomy alignment” of a company.” It’s completely different from any other reporting standard that’s out there at the moment, including the TCFD, GRI, SASB or even the NFRD. Current standards follow a mostly narrative reporting model with great flexibility. The taxonomy is much stricter.”

These numerous new regulatory developments mean that firms are facing a whole new world when it comes to ESG compliance. So how should they handle it?

“The biggest challenge is the sheer volume of data. There’s a huge pile of data that could be reported, except no one really knows what has to be reported yet,” warned Born. “The second problem is that there are so many ways of reporting it – there is a variety of voluntary standards that give guidance, the TCFD (Task Force on Climate-Related Financial Disclosures) is the most prominent, but there’s also the SASB (Sustainability Accounting Standards Board), the GRI (Global Reporting Initiative) which are widely accepted. This makes it hard to compare companies reporting under different standards. Then ironically, amongst all these massive amounts of data, we are also seeing some quite significant data gaps. Because it’s not mandatory and data reporting and collection is resource intensive, there are gaps in the data sets, especially amongst smaller firms.”

The main problem is this scenario that the regulation doesn’t necessarily match up with the voluntary standards and the voluntary standards are also not aligned with each other.  This is an issue because some of the industry standards are quite powerful and are already aligning with one another (e.g. SASB, GRI, CDSB, CDP etc.). Different regulatory requirements might be confronted with an industry push back. So what can firms be doing to address these issues?

“Focus on simplification,” urged Born. “Figure out what’s relevant for you. Which stakeholders do you need to please? To stay in business, of course you need regulatory compliance. So pick out the products where that is easiest to achieve. If you’ve got products where it’s hard to do, and you can’t get the data, then you need to figure out if you’ve got the revenue base to actually support that activity. At the other end of the spectrum, if you want to be listed on a stock exchange, what reporting requirements does the exchange require? Are you compliant with those? Then figure out which of the voluntary standards are the biggest and most important for your stakeholders in your geography – the US is completely different from Europe in that respect, for example.

Finally, look to your corporate purpose. We hear a lot of buzzwords like integrated reporting, shareholder value, short-termism versus long-termism and so on. But in the end, we’ve gotten to the point where your strategy and your corporate purpose have to exactly mirror what you put out in terms of corporate reporting. Because if that doesn’t match up, that’s a recipe for disaster for a risk manager – you lose all your credibility in the market and you’ve got a massive reputational risk.”

Interested in the data management aspects of ESG? Sign up for the Data Management Summit 2021 to make sure you get your spot at the table.

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