Converging Environmental, Social and Governance (ESG) frameworks

In a nutshell:

• Various countries regulators and policy makers are beginning to chart out more ambitious ESG regimes with wider-ranging consequences.
• Fragmented ESG standards are bound to create more significant adoption challenges.
• It is vital that standard setting firms engage with the efforts to develop harmonized global standards to ensure both the challenges and the opportunities their users will face are fully considered.

 Amongst this rapid expansion, one issue looms large: the need for harmonized global ESG standards. This is not simply a case of ensuring that ESG regulation meets the political commitments and shifting market attitudes underpinning its development as well as adoption; it has a tangible impact on the ability of the financial industry to follow, work within and benefit from the ESG framework. As the framework expands, fragmented standards will present ever more significant challenges.

Examples include:

• investors (including asset managers) being unable to compare investments on a “like for like” basis between different jurisdictions; however that is changing, India is making it mandatory (FY 2021-22) to make non-financial disclosures by way of a tabulated data driven approach with the new SEBI’s Business Responsibility and Sustainability Reporting framework 2020
• challenges associated with global financial institutions implementing effective group governance and risk management controls; for many multinationals there is a real worry of which ESG standards are endorsed across jurisdictions they operate in and what shall be the cost-benefit of adopting too many of such standards.
• a greater risk of jurisdictional arbitrage, with product providers potentially choosing jurisdictions perceived as having less rigorous standards, which may contribute to the risk of “greenwashing” (i.e. overstating ESG performance); and
• greater difficulty incentivizing desired behavior (e.g. through tax and other fiscal incentives) where there is insufficient clarity around the treatment of ESG products and investments.

Shareholders, Investors and other stakeholders need a clearer picture of how companies are managing sustainability today and planning for the future.

Alphabet curries

To the uninitiated, such disclosures standards are quite puzzling and heavily abbreviated – TCFD, GRESB, CDP, SDGs, PRI, SASB, CDSB, IIRC and the list goes on. 

The current position reflects the failure of a single global body to set effective ESG standards. At present, standards are derived from a number of different sources, ranging from those produced by international bodies such as the Task Force on Climate-related Financial Disclosures (TCFD – established by the Financial Stability Board at the request of the G20) through to regional and national regulations and private industry guidelines.

This has resulted in an “alphabet curries” of standards, with three common themes:

• multiple standards which often take divergent approaches;
• a lack of common definitions for sustainable activities; and
• the lack of a coordinated approach to avoiding “greenwashing” and ensuring investor protection.
• Compounding this problem is the various rating agencies who have their own fragmented and divergent approach to ESG Metrics evaluation.

Moving towards global standards

Pressure has been mounting from both the financial industry and broader stakeholders to improve the clarity and consistency of the current standards. In the last few years, a number of initiatives have emerged with a view to achieving this objective, but many are limited in sectoral or geographical scope.

The development of global standards will require an authoritative global platform with the ability to co-ordinate numerous stakeholders. There are two obvious candidates for this:

• the TCFD, whose 2017 recommendations continue to be the most influential and widely endorsed standards, but which are generally thematic and principles-based. Given its remit, its primary role may be to consolidate the wide number of existing initiatives and provide the leadership required to agree global standards; and
• the IFRS Foundation, which has existing expertise in setting global standards through its work on IFRS, and which is currently considering establishing a Sustainability Standards Board. There are reasonable expectations that IOSCO and the IASB to be closely involved with these efforts.

While the “who” question remains open, a broader consensus is emerging that the output should be a global framework that balances the need to ensure clarity and consistency with the ability for users to develop more detailed standards and best practice guidelines.

Engaging in the debate

In the view of the growing push for global standards, financial institutions as well as corporations should be asking themselves how they can most effectively engage in the debate. Those that want to actively participate in shaping the new standards will need to consider how they can best make their voice heard. In most cases, this will mean identifying the most appropriate route for engagement – whether directly through relationships with regulators and policy makers, participation in industry associations, or through existing initiatives. To contribute effectively, firms will need to look to their own experiences to identify both the challenges and opportunities presented by a move to global standards.