Recent policy developments and implications for those in sustainable finance – mainly focused on updates from within the UK and EU

• Creation of UK Transition Plan Taskforce and Review of UK Green Finance Strategy

Other announcements and publications

• European Commission consults on ESG ratings and sustainability factors in credit ratings
• European Financial Reporting Advisory Group (EFRAG) consults on draft sustainability reporting standards under Corporate Sustainability Reporting Directive (CSRD)
• Bank of England publishes results of its first exploratory scenario exercise on climate risk (CBES)
• European Banking Authority (EBA) launches discussion on the role of environmental risks in the prudential framework
• European Supervisory Authorities (ESAs) propose Regulatory Technical Standards (RTS) on integrating sustainability indicators into Simple, Transparent and Standardised (STS) securitisation disclosure frameworks
• UK Financial Conduct Authority (FCA) publishes final rules to boost diversity transparency for boards and executive managers
• Securities and Exchange Commission (SEC) proposes legislation changes to prevent misleading or deceptive fund names
• Financial Stability Board (FSB) publishes consultation on supervisory and regulatory approaches to climate-related risks

What to look out for?

• UK Green Taxonomy consultation
• FCA discussion paper and feedback statement on ESG in capital markets and ESG ratings
• FCA proposal for consultation on Sustainability Disclosure Requirements (SDR)
• Extension of comment period for SEC climate related risk disclosure proposal

Creation of UK Transition Plan Taskforce and Review of UK Green Finance Strategy

The UK government has announced the launch of the Transition Plan Taskforce (TPT) [1], to develop a “gold standard” for climate transition plans in the UK. The TPT has been given a two-year mandate by the Treasury to deliver the best practice recommendations. The requirement to publish climate transition plans will form part of the wider Sustainability Disclosure Requirements (SDR) outlined in the government’s Greening Finance Roadmap in October 2021 and will build on the guidance of the Taskforce on Climate-related Financial Disclosures (TCFD). Initially, certain firms will be required to publish transition plans that take into account the government’s net-zero commitment or provide an explanation if they have not done so. As standard, the government and regulators will move towards making it mandatory for firms to publish their transition plans, and at COP26 the UK Chancellor, Rishi Sunak, committed to making this a requirement for certain financial sector firms and listed companies by 2023. 

The TPT will work with international organisations developing standards and best practices to ensure complementarity. Notably, the Glasgow Financial Alliance for Net Zero (GFANZ) is also planning to publish its proposals to support financial institutions in preparing their net-zero transition plans. The announcement is expected in June 2022.

Although there will be a requirement to produce a climate transition plan, there will be no requirement on UK companies and the financial sector to set a net-zero target. The TPT will also prepare detailed sectoral Transition Plan Templates, with associated guidance on metrics and targets.

Shortly following its establishment, the TPT launched a consultation [2] on a sector neutral framework for private sector transition plans. The TPT will develop the initial draft Framework through 2022 which will be published for consultation towards the end of the year with a view to finalisation in early 2023. 

Finally, the UK government has published a call for evidence [3] that will feed into the update of its 2019 Green Finance Strategy. The consultation is looking to gather feedback across a wide range of topics placing a significant focus on energy security alongside achieving environmental objectives in the real economy, greening the financial system and showcasing international leadership in driving sustainability in the global economy. Views are welcomed by 22 June 2022, and the updated strategy is planned for publication in late 2022.

Development of standards around the preparation of transition plans and the review of the UK strategy should be considered holistically. Ultimately, we expect that the UK Green Finance Strategy will incorporate the recommendations, and in the future – requirements, on transition plans. This would likely be done in a way where these transition plans will become a key tool in achieving the strategic objectives on greening the economy and finance to be announced later in the year. 

Investors / Lenders

Availability of standards and best practice on preparation of transition plans will be a pivotal development helping finance providers to, more effectively and efficiently, assess the sustainability profile of the underlying portfolio / borrowing companies. Notably, large organisations have already been taking steps to develop methodologies and internal frameworks on how to assess the adequacy and credibility of transition plans of customers / investee companies operating in most carbon intensive industries, for example mining and oil and gas. However, a combination of different industry frameworks and guidance is being applied on a best effort basis by finance providers indicating that different conclusions may be reached by different investors or banks in relation to the companies seeking finance. A current lack of harmonised standards may also be preventing institutions from upgrading their systems to, in the future, automate the processes associated with the collection of relevant information about company transition plans. 

An important question remains open with regard to who will ultimately be opining on the viability of the transition plans – whether this role will be delegated to third-party assurance providers or whether dedicated body/ies will be created to perform the verification.  

Issuers / Borrowers 

Whilst the work on the transition plans is ongoing, companies should not wait until that work is fully completed. On that basis issuers / borrowers will need to evaluate where they stand now with regard to their carbon footprint. This, on its own is not a straightforward exercise, especially when it comes to evaluating Scope 3 emissions. This requires understanding of available methodologies, assessment of data gaps and consistent engagement with business relationships. The earlier companies begin the assessment, the easier it would be to then build a transition plan that would be viable from both ‘business continuity’ and ‘environmental and social sustainability’ perspectives. The Taskforce will produce a set of templates setting out both generic and sector-specific disclosures and metrics that will further help issuers from all sectors with their disclosures.

For corporate issuers this has clear and specific implications that may support its alignment with the eventual EU Green Bond Standard.

Whilst other disclosure programmes focus on backwards looking data, transition plans will require forward looking elements, including but not limited to: short, medium and long-term targets; specific actions for climate mitigation and adaptation; capex plans; specific sectoral considerations such as fossil fuel phase-out plans and plans for scaling up new investment areas. This may require companies to carefully consider how this disclosure ties into their other revenue / business forecasts they are making to the market (and ensure this is done in an appropriate way). Furthermore, listed UK companies in scope of the eventual 2023 regulation that already have transition plans, may have to update them to align with the eventual template and that these plans should be aligned with the TCFD and will need to be independently verified and made publicly available. These UK corporates that may want to issue an EU Green Bond (EU GBS) will also have to consider how their transition plan meets those eventual requirements. Along with the EU GBS other jurisdictions have proposed similar rules even if they are not explicit in requiring a transition plan. For example, in the US, the SEC’s proposed rules ask for disclosures on a company’s processes for identifying, assessing and managing climate-related risks and to the extent possible details on a transition plan. 

UK: Bank of England publishes results of its first exploratory scenario exercise on climate risk (CBES)

The Bank of England (BoE) has completed its first exploratory scenario exercise on climate risk (CBES), involving the largest UK banks and insurers – with the results published [4] on 24 May. The CBES included three scenarios exploring both transition and physical climate risks. Two possible routes to net-zero by 2050 have been considered: an ‘Early Action’ (EA) scenario and a ‘Late Action’ (LA) scenario. A third ‘No Additional Action’ (NAA) scenario explored the physical risks that would begin to materialise if governments around the world fail to enact policy responses to global warming. The CBES also included an exercise to explore climate litigation risk facing general insurers, separate from the three scenarios. The results of the exercise will not be used to set capital requirements rules but they will help inform future policy action by the UK regulators and Government. The Bank of England will continue to work with banks and insurers to improve climate risk management, for example by disseminating best practice, and supporting initiatives to help fill data gaps.

For banks, loss projections were focussed on the credit risk associated with their lending activities, with an emphasis on detailed analysis of risks to large corporates. For insurers, the focus was on changes in the value of invested assets and the impact on insurance claims.

Key findings included

• Climate risks captured in the CBES scenarios are likely to create a 10-15% drag on the profitability of UK banks and insurers.
• Projections made by banks and insurers suggest overall costs will be lowest with early, well-managed action to reduce greenhouse gas (GHG) emissions and so limit climate change.
• Some climate costs that initially fall on banks and insurers may ultimately be passed on to their customers. In particular, in the NAA scenario, households and businesses vulnerable to physical risks would be especially hard hit.
• Government’s public climate policy will be a key determinant of the speed and shape of the transition in the global economy. 
• Projections of climate losses are uncertain; scenario analysis is still in its infancy and there are several notable data gaps. 

Future focus areas highlighted by the BoE’s report

• The need for more data on, and understanding of, customers’ current emissions and transition plans. 
• The need to invest in modelling capabilities and doing more to scrutinise data and projections supplied by third-parties.
• The need to consider more deeply how to respond strategically to different scenarios, including thinking through the implications of different paths for climate policy.

The results of the CBES should be considered by both financial and non-financial sectors as, despite many lessons to learn still, the findings give a clear indication that significant incremental losses are inevitable, whilst might still be bearable from the systemic financial stability perspective. The losses would only increase if little or no action is taken to prevent and adapt to climate change consequences. Also, the Bank of England was clear that whilst it may not be up to prudential regulators to reduce carbon emissions in the economy, any outcomes from the lack of action in this space threating financial stability will be handled according to the Bank’s objectives and supervisory powers.

UK: FCA finalises proposals to boost disclosure of diversity on listed company boards and executive committees

The FCA finalised rules [5] that mandate listed companies to disclose targets on the representation of women and ethnic minorities on their boards and executive management. This disclosure would support availability and comparison of data that can help investors to track progress specifically in these areas of ESG. With this, the FCA aims to increase transparency and enhance market integrity around diversity and inclusion. 

The ‘comply or explain’ statement targets are as follows:

• At least 40% of the board should be women.  
• At least one of the senior board positions (Chair, Chief Executive Officer (CEO), Chief Financial Officer (CFO) or Senior Independent Director (SID) should be a woman.  
• At least one member of the board should be from an ethnic minority background excluding white ethnic groups (as set out in categories used by the Office for National Statistics).

On a related note, the Bank for International Settlements (BIS) published a paper [6] Diversity and inclusion – embracing the true colours in financial supervision. This paper examines emerging regulatory approaches on the diversity and inclusion (D&I) practices of financial institutions. It finds that there has been noticeable progress in improving firms' D&I practices internally within their organisations as well as externally in dealings with customers. The report states that D&I regulatory approaches on corporate governance, conduct of business and disclosure vary across jurisdictions and that most of the progress thus far has focused on gender diversity. Against this background, it is proposed that international standards and guidance on D&I might be helpful to accelerate the pace of progress, broaden the scope beyond gender and, more generally, enhance the safety and soundness of firms and the financial sector. 

EU: European Commission consults on ESG ratings and sustainability factors in credit ratings

The European Commission launched a targeted consultation [7] (with feedback due on 6 June 2022) on the functioning of the ESG ratings market in the EU and on the consideration of ESG factors in credit ratings.

This consultation follows the publication of the renewed sustainable finance strategy in 2021 where the Commission gathered preliminary feedback on the quality and relevance of ESG ratings for investment decisions, on the level of concentration in the market for ESG ratings and need for action at EU level. Stakeholders indicated that better comparability and increased reliability of ESG ratings would enhance the efficiency of this fast-growing market, helping the progress towards the objectives of the EU Green Deal.

This consultation also seeks views from market participants on the use of other types of tools that can be offered by sustainability-related providers, including research, controversy alerts, rankings, and others.

The consultation will directly feed into an impact assessment that the Commission will prepare in 2022 to assess in detail the impacts, costs and options of a possible EU intervention. Notably, in February 2022, the European Securities and Markets Authority (ESMA) also published a call for evidence which, amongst other matters, looked at possible costs of supervision if these ESG service providers become subject to supervision.  ESMA’s work will also feed into the impact assessment by the Commission.

Based on the results, the Commission may propose an initiative (legislative or not) to foster the reliability, trust and comparability of ESG ratings by early 2023. 

EU: EFRAG consults on draft sustainability reporting standards under CSRD

EFRAG is seeking views [8] from constituents on the first set of European Sustainability Reporting Standards (ESRS) under the CSRD. The future standards will include 3 categories. 

1. Cross-Cutting Standards – intended to be applicable to all sustainability subject matters, including general principles, strategy, governance and materiality assessment of impacts, risks and opportunities.
2. Topical Standards – sector-agnostic disclosure requirements (Environment: Climate Change, Pollution, Water and Marine Resources, Biodiversity and Ecosystems, Resource use and circular economy; Social: Own workforce, Workers in the value chain, Affected Communities, Consumers and end-users; Governance: Governance, risk management and internal control; Business Conduct), and
3. Sector-Specific Standards – these standards are not included in the consultation and are still being developed by EFRAG’s Technical Expert Group.

These draft standards, organised in exposure drafts (EDs) also take account of disclosures required under other EU legislation and proposals, including the Sustainable Finance Disclosure Regulation, Article 8 of the Taxonomy Regulation together with obligations under the proposed Corporate Sustainability Due Diligence Directive. The EFRAG indicated that international sustainability reporting initiatives were also considered along with the recent SEC proposal on climate-related disclosures. The EFRAG is gathering feedback on the EDs by 8 August 2022 and is due to submit the first set of draft ESRS to the Commission by November 2022. 

EU: ESAs proposed RTS on integrating EU SFDR PAIs into STS securitisation disclosure frameworks 

The European Supervisory Authorities (EBA, European Insurance and Occupational Pensions Authority (EIOPA), and ESMA), known as ESAs, are consulting on draft Regulatory Technical Standards (RTS) setting out the content, methodologies and presentation of information in respect of the sustainability indicators in residential mortgage and auto loan / lease assets in traditional and synthetic STS securitisations [9]. The proposed draft RTS aim to facilitate disclosure by the originators of the “principal adverse impacts” (PAIs) of assets financed by STS securitisations on ESG factors (i.e. environment and society), to a large degree integrating metrics introduced by the Sustainable Finance Disclosure Regulation (SFDR) and the EU Green Taxonomy. 

In some key respects, these draft RTS diverge from the SFDR in order to take into account the specific characteristics of securitisation products and the relevant legal framework. The paper focuses on the following subsections: 1) the means and format of disclosure; 2) sustainability policies of the originators and the criteria for selection of the assets in the pool; 3) selection of PAI indicators to be reported in the annual principal adverse sustainability impacts statement.

The consultation paper suggests that it may be appropriate to facilitate the ability of originators of different types of securitisations to provide information on PAIs on sustainability, and thus ESAs seek views on proposed indicators for other types of underlying assets, in particular corporate debt, commercial real estate and trade receivables.

The closing date for responses to the consultation is 2 July 2022.

EU: EBA launches discussion on the role of environmental risks in the prudential framework

The EBA published [10] a long-awaited Discussion Paper on the role of environmental risks in the prudential framework for credit institutions and investment firms. The Paper explores whether and how environmental risks are to be incorporated into the Pillar 1 prudential framework. It launches the discussion on the potential incorporation of a forward-looking perspective in the prudential rules. It also stresses the importance of collecting relevant and reliable information on environmental risks and their impact on institutions’ financial losses. The consultation runs until 2 August 2022.

The Paper raises the question as to whether the current prudential framework can account for the new risk drivers that are likely to impact on all traditional risk categories, such as credit, market and operational risks. 

The Discussion Paper provides an analysis of the extent to which environmental risks are already reflected in the Pillar 1 own funds requirements via internal and external ratings, valuation of financial instruments and collateral, or scenario analysis.

The Paper takes a risk-based approach to ensure that the prudential framework reflects underlying risks and supports resilience of financial institutions. The purpose of the prudential framework is not to achieve specific environmental objectives. These could be supported by the risk-based framework, particularly if coupled with other policy actions. This message was consistent with the conclusions delivered by the Bank of England (as per above) as part of CBES.

While the Discussion Paper focuses on Pillar 1 own funds requirements, it highlights the need for a holistic regulatory approach and should be seen as part of the EBA’s broader work in the area of ESG risks, which includes transparency, risk management, Pillar 2 supervision and macroprudential capital buffers. The Paper also highlights interlinkages with the accounting framework.

US: SEC proposes legislation changes to prevent misleading or deceptive fund names

The Investment Company Act “Names Rule” currently requires registered investment companies whose names suggest a focus in a particular type of investment (among other areas) to adopt a policy to invest at least 80 percent of the value of their assets in those investments. The proposed amendments [11] would enhance the rule’s protections by requiring more funds to adopt an 80 percent investment policy. Specifically, the proposed amendments would extend the requirement to any fund name with terms suggesting that the fund focuses on investments that have (or whose issuers have) particular characteristics. This would include fund names with terms such as “growth” or “value” or terms indicating that the fund’s investment decisions incorporate one or more ESG factors. 

Under the proposal [12], a fund that considers ESG factors alongside but not more centrally than other, non-ESG factors in its investment decisions would not be permitted to use ESG or similar terminology in its name. Doing so would be defined to be materially deceptive or misleading. For such “integration funds,” the ESG factors are generally no more significant than other factors in the investment selection process, such that ESG factors may not be determinative in deciding to include or exclude any particular investment in the portfolio.

The comment period for the proposal was set at 60 days after the publication in the Federal Register. 

US: FSB publishes consultation on supervisory and regulatory approaches to climate-related risks

The FSB is consulting on its recommendations [13], which aim to assist supervisory and regulatory authorities in developing their approaches to monitor, manage and mitigate cross-sectoral and system-wide risks arising from climate change and to promote consistent approaches across sectors and jurisdictions. 

This is an important milestone evidencing that the US be set to follow other jurisdictions in seeking to integrate climate risk considerations into its supervisory framework. 

FSB’s preliminary recommendations focus on three areas:

• Supervisory and regulatory reporting and collection of climate-related data from financial institutions. Consistent and comparable firm disclosures, based on a global baseline climate reporting standard, provide a good starting or reference point for the future development of regular standardised regulatory reporting requirements. Authorities may also require more granular and specific information for supervisory or regulatory purposes. The report includes recommendations on the identification of authorities’ information needs, reliability of data, use of common definitions and coordination towards common regulatory reporting requirements.
• System-wide supervisory and regulatory approaches to assessing climate-related risks. Supervisory and regulatory risk assessments and policies need to better incorporate understanding of the channels through which climate-related risks to financial institutions may be transferred across sectors or borders. The report includes recommendations on how authorities’ approaches should account for the potential widespread impact of climate-related risks across the financial system, including with respect to use of scenario analysis and stress testing exercises.
• Early consideration of other potential macroprudential policies and tools to address systemic risks. Microprudential tools alone may not sufficiently address the cross-sectoral, global and systemic dimensions of climate-related risks. The report presents some of the early thinking on macroprudential policies and tools that could complement microprudential measures, and trade-off considerations.

The FSB is welcoming comments on its recommendations by 30 June 2022. The final recommendations, incorporating feedback from the public consultation, will be published in Q4 2022.

June 2022: UK Government is due to launch a consultation on the UK Green Taxonomy

After several delays, there is an indication that the draft technical screening criteria will be published for public feedback in June. Recent news indicated that the UK Taxonomy of environmentally sustainable activities may include natural gas related activities. Proponents of this development say gas is needed as a transition fuel to replace coal in power generation [14]. However, many sustainable finance specialists say it undermines the push toward renewable energy. If natural gas is included it would fundamentally change the purpose of the taxonomy and may conflict with the UK’s ambitious decarbonisation targets.

June 2022: UK FCA will publish a discussion paper and feedback statement on ESG in capital markets – green and sustainable debt instruments / ESG data and ratings

In the CP21/18 [15] on climate-related disclosure rules for listed issuers, the FCA included a discussion chapter on some ESG issues in capital markets, such as i) issues related to green, social and sustainable debt instruments; and ii) ESG data and rating providers. The FCA will publish [16] key findings from the consultation which will help direct any future regulatory agenda on these topics.

June 2022: SEC extends the comment period for climate-related risk disclosure proposal 

The SEC announced that it will extend the public comment period on its proposed rules regarding climate-related disclosures for investors until June 17, 2022 [17]. The SEC proposed these rule changes that would require registrants to include certain climate-related disclosures in their statements and periodic reports [18]. For example, these would include a company’s greenhouse gas emissions and other quantitative and qualitative disclosures, which are already used or recommended by the TCFD to help stakeholders assess a registrant’s exposure to such risks. The extension allows interested persons additional time to review the proposed rulemaking and prepare their comments. 

July 2022: UK FCA to publish consultation paper on SDR and sustainable investment labels 

Alongside the introduction of SDR (Sustainability Disclosure Requirements) for investment managers, the FCA is working to introduce a sustainable classification and labelling system for investment products. This will help consumers navigate investment products based on their sustainability characteristics and find those meeting their sustainability preferences.

For those looking to discuss any of the above further, please reach out to our authors:

• Tonia Plakhotniuk, Vice President, Climate & ESG Capital Markets 
• Daniel Bressler, Vice President, Climate & ESG Capital Markets, Corporates
• Tyler Mayzes, Analyst, Climate & ESG Capital Markets, Corporates

*For any unfamiliar terms used within this article please refer to our Insights glossary.

References

1. https://www.e3g.org/news/hm-treasury-launches-uk-transition-plan-taskforce/
2. https://www.e3g.org/wp-content/uploads/TPT_Call-for-Evidence_Embargoed.pdf
3. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1074650/green-finance-strategy-cfe.pdf
4. https://www.bankofengland.co.uk/stress-testing/2022/results-of-the-2021-climate-biennial-exploratory-scenario
5. https://www.fca.org.uk/news/press-releases/fca-finalises-proposals-boost-disclosure-diversity-listed-company-boards-executive-committees
6. https://www.bis.org/fsi/publ/insights42.pdf
7. https://ec.europa.eu/info/consultations/finance-2022-esg-ratings_en
8. https://www.efrag.org/lab3
9. https://www.esma.europa.eu/press-news/esma-news/esas-consult-sustainability-disclosures-simple-transparent-and-standardised
10. https://www.eba.europa.eu/eba-launches-discussion-role-environmental-risks-prudential-framework
11. https://www.sec.gov/news/press-release/2022-91
12. https://www.sec.gov/files/ic-34593-fact-sheet.pdf
13. https://www.fsb.org/2022/04/supervisory-and-regulatory-approaches-to-climate-related-risks-interim-report/
14. https://www.bloomberg.com/news/articles/2022-05-16/uk-plans-to-label-gas-as-a-green-investment-to-replace-coal
15. https://www.fca.org.uk/publication/consultation/cp21-18.pdf
16. https://www.fca.org.uk/publication/corporate/regulatory-intitiatives-grid-may-2022.pdf
17. https://www.sec.gov/news/press-release/2022-82
18. https://www.sec.gov/news/press-release/2022-46