The shifting ESG regulatory landscape

Northern Trust report.

Environmental, social and governance (ESG) in the future may look very different from today, as all regions continue their commitment to responsible investments, according to Northern Trust’s new whitepaper ‘A Global Shift to an ESG Mindset’.

Drivers behind the change include the impact of Covid-19, and the ensuing economic fallout which shone an ever-brighter spotlight on the environment, diversity, equity and inclusion initiatives and governance requirements.

This helps explains why 63% of the 200 global fund buyers polled believe all funds would incorporate ESG factors in five years.

However, the white paper warned that market participants need to be more aware how the regulatory landscape is diverging and converging across different regions.

As the report put it, “Now, as regions look closer at their ESG practices, regulatory bodies are stepping up their plans for oversight. Though certain geographic regions are more advanced in their ESG approaches than others, regional differences are quickly reducing as global frameworks and standards develop.”

It added that, “As asset owners put more emphasis on ESG investing globally and asset managers answer this rise in demand, they’ll need to ensure they have a grasp on the varying regulations across the globe, especially if more regions follow the European Union (EU) lead by building out a framework of multiple ESG regulations.”

In Europe, these range from the Taxonomy Regulation aimed at asset managers, the Non-Financial Reporting Directive, targeting corporations; the Sustainable Finance Disclosure Regulation, seeking to combat greenwashing of financial products. and the Pensions Directive or IORP which regulates institutions’ management of collective retirement schemes.

Overall, it found that Europe is far out in front, being home to over 80% of the world’s sustainable assets.

The report points to the Nordic countries in particular – Sweden, Denmark, Norway, Iceland and Finland – as well as the Netherlands as the original ESG investing advocates or the first ones to embrace the approach, influencing the rest of Europe and other regions to follow.

In fact, Morningstar’s 2021 Sustainability Atlas named the Netherlands as the best scoring country in terms of sustainable investing, followed by Finland and Sweden in the top three.

The rest of Europe has begun to follow by example and implement policy standards covering ESG practices.

The paper says that the UK, which holds £56 bn in sustainable assets, has its own version of the Pensions Directive policy for schemes, requiring plans to include ESG in their statement of investment principles and report on how they invest from an ESG perspective.

In June 2021, it added additional disclosure requirements for pension funds with more than £5 bn in assets, mandating them to report specifically on how they will manage their climate risk in line with the Task Force on Climate-Related Financial Disclosures (TCFC).

Eligible pension schemes must start complying by this October.

By contrast, the US and Asia are not only lagging behind the EU but also have a less straightforward approach, according to Northern Trust.

It observed that the US lost steam during the Trump presidency, but interest has been reignited under the Biden administration.

ESG assets account for 33% of all assets under management in the country and as the paper puts it, they have begun to consider how to filter a sustainable approach into its oversight of financial markets.”

It cites the new Securities and Exchange Commission chairman Gary Gensler who has named ESG matters – including disclosures, adherence to policies, and operations – as a priority in 2021.

In addition, the government is taking steps to include an environmental perspective in its oversight of US. financial markets while President Joe Biden signed Executive Order 14030, which addresses the risks that climate change poses to financial markets.

This means that the Financial Stability Oversight Council has to assess and report on climate-related financial risks, and then monitor and report on the progress of FSOC member agencies (for example, the Securities and Exchange Commission or the Consumer Financial Protection Bureau) as they integrate climate related financial risk considerations into their practices.

As for Asia Pacific, the white paper found that several of the region’s independent developed countries are beginning to make headway on their own policies. They are also moving quickly to standardise ESG regulation in an attempt to become the region’s go-to locale for domiciling ESG investments and funds. The main driver has been Covid-19 with almost 80% of investors increasing ESG investments moderately or significantly in response to the pandemic.

The report notes that as ESG emphasis accelerates in APAC, an interesting dynamic is evolving between Singapore and Hong Kong as they jostle to be the most attractive home base for ESG funds.

The Monetary Authority of Singapore announced a green investments programme in November 2019 that would give up to $2 bn to asset managers that have designated Singapore as their sustainability hub in the region.

Meanwhile, Hong Kong’s ESG framework is considered one of the strongest globally outside of Europe with mandatory ESG disclosure requirements and strong fund labelling.

According to the report, with a variety of sophisticated players and no uniting political or economic union (such as the European Union within EMEA), APAC could foster healthy rivalry and impressive ESG progress as independent countries race to become ESG leaders within the region and be regarded as a hospitable locales for ESG investments and funds, like Singapore’s and Hong Kong’s current ESG dynamic.

“When it comes to ESG awareness and regulatory oversight, Europe has long led the pack of these global regions. But as we see asset managers, asset allocators and corporations in the Americas and APAC increase interest in ESG opportunities, regulators will follow to keep up with the growing pace,” it said.

©Markets Media Europe 2021

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