‘Disclosures aren’t everything,’ was how Sacha Sadan, director of environment, social and governance at the Financial Conduct Authority, opened a panel discussion on converging sustainability regulation at OMFIF’s Sustainability Policy Institute symposium. ‘It’s about doing things. It’s about impact.’
This point is one which many operating within the ESG finance area need to come to terms with. Regulators and investors alike are relying too heavily on more robust information-sharing and transparency to solve the challenge of sustainable financing and climate-risk mitigation.
The European Union’s ground-breaking Sustainable Finance Disclosure Regulation was designed to improve transparency in sustainable financial markets. Since March 2021, it has imposed mandatory ESG obligations for financial institutions operating within its jurisdiction. Its reception was largely positive and seen as an important step towards growing ESG and sustainable investing within the EU.
But the rollout of the SFDR has been marred by the misuse of the regulatory framework. ‘It was a disclosure regime and ended up being used – a lot of the time – as a labelling regime,’ explained Sadan. By assigning numerical values to different kinds of institutions, it became hierarchical: ‘If you use numbers like [article] six, eight and nine… those in commercial product marketing will all want a nine, and not a six.’
During the panel, Carlo Funk, head of ESG strategy for Europe, Middle East and Africa at State Street Global Advisors, concurred, noting that even the European Securities and Markets Authority publicly stated that the SFDR is often incorrectly used as a quasi-labelling regime. ‘It is still being used incorrectly,’ he warned.
For many investors, disclosures are predominantly seen as a way of facilitating exclusions of ‘dirty’ companies or sectors from their portfolios. According to the panellists, this is counterproductive. ‘Exclusions are important… but you can’t avoid huge swathes of industry,’ added Sadan. ‘You need oil and gas to change. You can’t just exclude them and hope that they change.’ If interpreted as punishing transition laggards, capital will not be channelled to the ‘dirtier’ industries, which need financing the most.
Regulators are coming to terms with these ‘bumps in the road’ experienced by the SFDR. In the UK, the FCA is ‘trying very hard not to have hierarchy,’ Sadan emphasised. By creating a typology of ‘focus, improve and impact’, the FCA hopes to facilitate investment to a wider variety of companies and include a broader range of sustainability considerations, such as transition finance.
At the global level, the International Sustainability Standards Board of the International Financial Reporting Standards Foundation is working to harmonise disclosure and reporting standards internationally. ‘The further you can get in prevision of disclosures, the better capital markets can allocate capital correctly,’ explained Lee White, executive director of the IFRS Foundation. ‘This will lead to impact.’
In addition, the Network for Greening the Financial System has a working group dedicated to climate-related financial disclosures. Co-chaired by Marcus Mølbak Ingholt, senior lead climate economist at Danmarks Nationalbank, the working group now includes 64 representatives from 35 institutions around the world. These developments in harmonising reporting and disclosure among jurisdictions are paramount to driving the sustainability agenda forward.
But even a perfect disclosure framework will not suffice to both mitigate climate risk and ensure capital is allocated to decarbonising the economy. In this context, it is worth reiterating the purpose of disclosure and reporting regimes – disseminating information. Companies’ disclosures and reporting on carbon emissions and exposure to fossil fuels are the building blocks of incorporating sustainability considerations into financial and economic decision-making.
Proper data is needed to ensure that investors are informed about the risks and opportunities of climate change. But, while disclosures are a keystone of sustainable finance, this information alone will not enable us to meet our climate goals. Disclosure and reporting regimes are no panacea. Regulators and policy-makers urgently need to move beyond reporting initiatives to include pricing-in climate risk, facilitating capital allocation to sustainable and transition projects. Quantifying climate risk – through a generalised system of carbon pricing – will better inform what is needed to combat the crisis. Measures like these would provide a striking way of producing what climate activists want – impact.
Taylor Pearce is Senior Economist at OMFIF.
This discussion took place at OMFIF’s 2023 SPI symposium held on 22-23 March. View all of the SPI symposium sessions here.