European Union: Sustainability Regulation: How Can Financial Market Participants Prepare?

Over the last four years, the EU has been at the forefront of regulating sustainable finance, having introduced multiple new legislations that have completely changed the playing field for financial market participants. The terms SFDR, Articles 6, 8 or 9, and Taxonomy, have become regular topics of conversation for fund managers.

So, what has changed in 2022?

What has not changed is that the EU has continued to approve and finalise new legislations. What has changed is that other jurisdictions are catching up. Notably the United States and the United Kingdom.

Quick Regulatory Update: 2022, a busy year for sustainability regulation

In the EU...

• The final draft of the Regulatory Technical Standards (RTS) was published in July as Commission Delegated Regulation (EU) 2022/1288 providing clarity on Level 2 Disclosures.

• The above RTS were amended on September 30th to include additional disclosures for financial market participants with respect to the extent to which their portfolios are exposed to nuclear and gas activities that comply with the EU Taxonomy.

• The Corporate Sustainability Reporting Directive (CSRD) was adopted by the EU parliament and approved by the European Council and entered into force on the 5th of January 2023. Member states have 18 months to implement the CSRD (for more information see this article).

• The proposal for a Corporate Sustainability Due Diligence (CSDD) directive was adopted by the European Commission in February. This proposal aims to address human rights and labour issues in the value chains of companies.

In the UK...

• As part of the UK Financial Conduct Authority's (FCA) ESG Strategy, the consultation paper CP22/20 was published in October 2022 regarding Sustainability Disclosure Requirements (SDR) and investment labels. The consultation paper proposes rules to improve sustainability labels of investment products and to introduce restrictions on the way in which terms like 'ESG', 'green' or 'sustainable' can be used in the hopes of countering greenwashing in the market.

In the US...

• The Securities and Exchange Commission (SEC) proposed three new sets of rules:

• the 'Names Rule Proposal' aimed at preventing misleading or deceptive fund names,

• the 'Enhancement and Standardisation of Climate-Related Disclosures for Investors' focussing on registered companies and requiring them to disclose information regarding climate-related risks that may have a material impact on the value of their business, and

• the 'ESG Strategy Proposal' with the aim of promoting consistent, comparable and reliable information for investors concerning the incorporation of ESG factors in financial products. The latter set of rules does not apply to all financial market participants marketing products in the US, unlike its EU counterpart, the SFDR.

What does this mean?

It is safe to say that a lot can be expected this year.

New Rules: Pushing for Transparency and a Holistic Approach

• In the EU, the SFDR RTS have been applicable since January 1st and the Principal Adverse Impact (PAIs) indicators will have to be published for the first time by June 2023.

• We expect and hope that the scope of the EU Environmental Taxonomy will be expanded this year with the publication of the Technical Screening Criteria (TSC) of the four remaining environmental objectives.

• The CSRD will begin applying in 2024 (reports to be published in 2025) to large EU undertaking (both private and public).

• The CSDD will have implications for how compliance with the Minimum Social Safeguards of the EU Taxonomy is achieved.

• SEC and SDR rules are expected to be rolled out and approved this year.

Protecting investors against greenwashing:

Greenwashing is at the forefront of the agenda. Fears of greenwashing and misleading claims with respect to the sustainability of products continue to grow and regulatory bodies are proactively facing this challenge:

• The European Supervisory Authorities (ESAs) have published a call for evidence on greenwashing seeking input on potential greenwashing practices in the financial sector in the EU.

• The European Securities and Markets Authority (ESMA) launched a consultation on guidelines on fund names using ESG or sustainability-related terms.

What's next? Prepare, prepare, prepare.

The rapid rollout of sustainability rules and regulations across multiple jurisdictions may seem daunting, but preparedness can provide asset managers with a competitive edge. Understanding the implications of each is crucial and can guide the way towards the proper implementation of robust processes to face these new challenges, head on.

At MJ Hudson, we believe in future-proof strategies. Although certain regulations such as the CSRD, the SEC rules and the UK's SDR may not necessarily apply in the immediate term, anticipating the different implications of the various disclosure obligations and how they will affect financial market participants is necessary. We understand the difficulties implied in doing so, which is why our Regulatory Hub team is well versed in sustainability regulations across these different jurisdictions and comprehends the importance of laying down the groundwork.