How to prepare for increased ESG legislations

6th October 2020

There has been much discussion about Environmental, Social and Governance (“ESG”) factors and the increased appetite of investors for sustainable, green and responsible investment choices. We look at what this means for market players in our sector and provide a suggested to-do list for now to be ready for the evolution.

Increasing Focus on ESG
In the UK, the popularity of ESG is demonstrably rising, with investors contributing £124m a week to ESG funds.[i] Between 2014 and the end of 2019, Morningstar has shown that investment into ESG products has increased some 2500%.[ii] ESG’s popularity has not waned as a result of the COVID-19 pandemic, with fund data from the UK finding that the amount of money invested into ESG equity funds between April and July equalled more than the past five years combined. There is the suggestion that goals related to governance, societal values and climate change should be taken into consideration in any upcoming stimulus package.[iii]

Increasing Transparency and Obligations

Rising popularity comes with rising scrutiny, and regulators and investors alike expect firms to put deliver what they advertise or represent. Regulators across various jurisdictions are pushing for increased transparency in sustainable and social impact funds to avoid ‘green-washing’. In the UK the FCA is designing its ESG disclosures framework, while some institutional investors will need to disclose how their investment strategy incorporates ESG. In the EU the Taxonomy Regulation, which aims to standardise the terms and language used in this context, is already in force and in March 2021 the wide-reaching and ambitious Disclosure Regulation becomes operational.

Aside from the increased regulatory burden, those firms that tout their ethical stance will be expected to substantiate such claims, or risk damaging their credibility and their reputation. A prime example of this is the recent coverage that 20 sustainable funds were invested in Boohoo.   The clothing brand has recently been accused of poor working conditions and paying staff below minimum wage, even though the brand scored well on ESG matrices, including MSCI. Firms will not be able to use ESG metrics at face value to retrospectively justify an investment decision or to label themselves as ‘ethical’. The integration of ESG, should firms choose to do so, must be robust and consider the multifaceted nature of sustainable investing. 

In Real Estate, the focus is on environmental factors which is readily applicable to this sector, eg. EPC and BREEAM (Building Research Establishment Environmental Assessment Methodology) ratings that can easily be used to substantiate claims of environmentally friendly assets.

Generally however, social and governance factors in the operations of a business should not be ignored, not least because of the reputational (and other) implications that a lax attitude to social impact and governance can have on a firm (illustrated by individuals and/or companies that has been vilified in the press recently on these matters).

What to consider now:

There is no legal requirement to have an ESG policy beyond compliance with the law that may apply to specific sectors, (e.g. in real estate, EPC disclosure and BREEAM rating requirements, carbon emissions in some industries, corporate governance, diversity and compensation regulations that may apply to larger corporates, listed sectors and financial market participants). 

However beyond the Disclosure Regulations which starts operating from next March, increasingly in our finance sector, ESG already comes up in general service provider due diligence and factors in choosing investments/partners in business.  By not having an ESG policy, firms are also making a decision that may affect third parties’ engagement with your business.  If firms wish to implement an ESG policy, there are meaningful and realistic ways to do so: e.g. considering charity or community work in areas in which firms invest or operate in, and designing and implementing a diversity and inclusion policy.

We suggest the following to-do list for now:

  1. Consider – consider if having or not having an ESG policy will affect the business going forwards.  If a firm does not plan to have an ESG policy, is there a party line for answering any third parties’ due diligence for why this is the case?  If the business wishes to implement an ESG policy, how ESG intersects with the business operations in all aspects, from internal operations, investment strategy to marketing and what values the firm would wish to incorporate into the ESG policy.
  2. Write – Put pen to paper in respect of the firm’s ESG policy, how this is being implemented, monitored and reported and who is responsible for these actions. Firms that elect not to have an ESG policy should be prepared to defend their position to market actors, and it may be useful to have an internal paper to deal with these enquiries with some consistency.
  3. Act – Where there is an ESG policy, ensure actions follow internal policies, procedures and processes.  There is increasing accountability on performance of the values that is espoused as being values of the business.
  4. Stay Alert – in any case, any business in our sector should stay up to date on the potential impact of new ESG laws and regulation on their business and activities which are coming onstream. The wide-reaching disclosure regulation that will come into force in March 2021 will increase the expectation for ESG integration even for market actors not in scope of said regulation. Any business who deals with market actors who are in scope are likely to be requested to present their ESG credentials for incorporation into their disclosures.  Guideline for the disclosures is expected to be issued only in December 2020.  Firms should be appraising their position on ESG now, so that an existing agreed position can be conformed to the disclosure requirements at the time. 

ESG looks to become a mainstay in our industry for the period to come.[iv] Firms should expect increasing scrutiny from regulators and investors alike, and prepare to invest more into ESG implementation into their business.

 

[i] FT Adviser 30/10/2019

[ii] Financial Times, 10/08/2020

[iii] Financial News 23/07/2020

[iv] EY Sustainable investing report 2017