Global ESG regulatory summary and outlook for 2023

Two MiFID II ESG product governance amendments came into force in August and November of 2022. Ultimately the amendments will require firms to specifically take into accounts ESG factors throughout their product governance processes. The amendments will be particularly impactful for firms providing ESG focused products and are expected to result in enhanced ESG disclosure for such products. 

The two amendments relate to:

1. Sustainability preferences being integrated into suitability assessments.
2. Sustainability objectives and factors must be integrated into product governance. 

MiFID firms must also ensure that including sustainability factors in the advisory process does not lead to greenwashing or mis-selling. 

The following requirements are applicable as from 1 January 2023:

• the pre-contractual documentation of SFDR, the Annex II (for Article 8 Funds – those that promote environmental or social characteristics) and Annex III (for Article 9 Funds – those that have a sustainable investment objective) of the Regulatory Technical  Standards (“RTS”), which apply to all new funds and all funds which are open ended.
• the website disclosures in accordance with Article 10 apply to all Article 8 & 9 funds regardless as to whether the fund is open or closed ended.
• periodic reporting which started to apply on 1 January 2023 for all financial reports of products which are Article 8 or 9 which will be prepared and published in 2023, and this is irrespective of the reference period.
• and finally, the Principle Adverse Impact (“PAI”) disclosure publication at entity level is due on 30 June 2023.

On 2 December 2022 the Luxembourg regulator, the CSSF, issued FAQs in relation to the SFDR. The main points are set out below:

• where the portfolio management function has been delegated by a Luxembourg IFM, the latter remains responsible for the website disclosure requirements of Article 10 SFDR in relation to the relevant financial product for which it acts as Financial Market Participant (“FMP”).
• for Article 8 funds applying an exclusion strategy as a key element of the ESG strategy, the CSSF would expect the strategy to be detailed enough to allow investors to understand how the fund’s environmental and/or social characteristics are being met – for an Article 9 fund, the CSSF confirmed that an exclusion only strategy is not acceptable. 
• minimum thresholds disclosed by Article 8 or 9 funds will be considered as binding commitments of the investment strategy of the fund.

The feedback from CSSF suggests that SFDR and the review of the contractual annexes will be quite stringent. We can expect that greenwashing scrutiny will increase.

Demand for ESG products by European investors is expected to continue to grow.

We expect that the European Commission will start working on a comprehensive assessment of the implementation of SFDR. This will include both workshops within the industry and some public consultations. There will also be a new Q&A from the European Commission which will provide some clarification on some of the points raised by the European Supervisory Authorities back in September of last year. 

The European Securities and Markets Authority (“ESMA”) consultation paper on fund names has some similarities with the SEC’s proposed rule in setting an 80% threshold for those funds with ESG terms in their names.  ESMA will review responses from market participants (deadline for responses is 20 February 2023) and then issue its final report. It is expected that ESMA will provide a grandfathering period so that FMPs will have time to comply with the new requirements. This could potentially lead to funds downgrading from Article 8. 

Towards the end of 2023, it is expected that the European Supervisory Authorities will publish final regulatory technical standards on the PAI framework.

In December 2022, the Corporate Sustainability Reporting Directive (“CSRD”) was published in the Official Journal of the EU. It aims to address shortcomings on transparency and disclosure of non-financial information. By 2024, it will apply to listed companies with over 500 employees (which already fall under the Non-financial Reporting Directive (“NFRD”)). By 2025, it will also apply to large non-listed companies which meet 2 out of the following 3 criteria:

• 250 employees
• 40 million in turnover 
• 20 million in assets.

We expect CIMA and the Cayman Islands Ministry of Finance to issue more guidance around ESG.  In the interim, we recommend that operators of Cayman funds take steps to ensure that there are appropriate frameworks, policies and procedures in place to address ESG-related risks.  CIMA has made it clear that responsibility for ESG compliance is with those charged with governance, thus having directors on the board with the requisite skill set and knowledge of ESG related-risks is essential. 

The Securities and Exchange Commission (“SEC”) proposed rule amendments that would require a domestic or foreign registrant to include certain climate-related information in its registration statements and periodic reports, such as on Form 10-K, including: 

• climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook
• the registrant’s governance of climate-related risks and relevant risk management processes 
• the registrant’s greenhouse gas (“GHG”) emissions, which, for accelerated and large accelerated filers and with respect to certain emissions, would be subject to assurance 
• certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements
• information about climate-related targets and goals, and transition plan, if any. 

The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.

The SEC’s proposing release in May 2022 notes that investment products generally fall along a three-part spectrum:

1. ESG Integration – considering one or more ESG factors alongside other, non-ESG factors in investment decisions such as macroeconomic trends or company specific factors like a price-to-earnings ratio.
2. ESG-Focused – focusing on one or more ESG factors by using them as a significant or main consideration in selecting investments or in engaging with portfolio companies.
3. ESG Impact – strategies with a stated goal that seek to achieve a specific ESG impact or impacts that generate specific ESG-related benefits.

Under the proposed rules:

• Funds that say they consider ESG factors would be required to provide investors with information in the prospectus about the ESG factors they consider, along with the strategies they use. This could include, for example, whether a fund tracks an index, excludes or includes certain types of assets, uses proxy voting or engagement to achieve certain objectives, or aims to have a specific impact.
• ESG-Focused funds would need to disclose details about the criteria and data they use to achieve their investment goals, as well as more specific information about their strategies. These disclosures would enable investors to dig into the details of a fund’s strategy.
• Certain ESG-Focused funds would be required to disclose relevant metrics. For example, most environmentally focused funds would be required to report the greenhouse gas emission metrics of their portfolios, and an impact fund would be required to disclose metrics about and annual progress toward its ESG goals.
• The proposals would also require ESG-focused funds to present information in a standardized, tabular format, enabling investors to quickly identify the types of ESG strategies being used, and to easily compare with other funds.
• In addition, under the proposal, certain investment advisers would be required to disclose similar types of information as registered investment companies regarding their ESG factors and strategies in annual reports and adviser brochures. These disclosures would be tailored to help clients make an informed decision about whether to engage an adviser and how to manage that relationship.

The SEC also introduced a proposed update to the “Names Rule,” in a separate release (Investment Company Names, Investment Company Act Release) clarifying the requirement for certain funds to adopt a policy to invest at least 80% of their assets in accordance with the investment focus that the fund’s name suggests. While the proposed rule does not apply exclusively to ESG funds, it specifically references the use of ESG Terminology in a fund name and states that “the use of ESG or similar terminology in a fund’s name would deceive and mislead investors where the identified ESG factors do not play a central role in the fund’s strategy.”

The SEC’s final ESG funds rule is subject to change and may intersect with the agency’s other rulemaking (e.g., regarding private funds and side letters, among others) in ways that are not yet clear.   The SEC currently has 29 rules in the final states and another 23 in the proposed stage.¹   

For the foreseeable future, the SEC will continue to rely on the on the relevant anti-fraud rules for ESG-related concerns (e.g., greenwashing, misleading advertising, misleading fund names, etc.).  A clear and consistent framework and implementation consistent therewith are key in navigating the current regulatory environment.

1 https://www.reginfo.gov/public/do/eAgendaMain?operation=OPERATION_GET_AGENCY_RULE_LIST&currentPub=true&agencyCode&showStage=active&agencyCd=3235

China announced in its 14th Five-Year-Plan (14th FYP) in 2021, China’s commitment to peak carbon emissions by 2030 and achieve carbon neutrality by 2060.

The Asset Management Association of China (“AMAC”) issued China’s first systematic and comprehensive voluntary standard for China’s asset management industry with respect to ESG.

AMAC has requested asset managers to carry out self-assessment on their green investing practices and submit their self-checking reports to the regulator on an annual basis.

In 2021 China started the operation of a national emissions trading scheme (ETS), and we would expect this to be a meaningful tool for carbon reduction over time. In 2022, there has been explosive growth in ESG group standards. As of November, China already has six standards in place, including the ESG Reporting Guidelines for Listed Companies, the Guidance for Enterprise ESG Evaluation, the Guidance for Enterprise ESG Disclosure, the General Principle of Enterprise ESG Information Disclosure, the General Principle of Enterprise ESG Evaluation and the Specification of Enterprise ESG Evaluation.

China’s State Council-backed think tank, China Enterprise Reform and Development Society (“CERDS“), alongside a number of major Chinese companies issued “The Guidance for Enterprise ESG Disclosure” effective on 1 June 2022 (“Guidance“). This is China’s first ESG disclosure guideline that covers all companies and industries. While compliance with the Guidance is currently voluntary, it serves as a good starting point for Chinese companies to begin exploring the application of ESG standards adapted for and developed in a local context.

Hong Kong pledges to achieve carbon neutrality by 2050 and has established a Green and Sustainable Finance Cross-Agency Steering Group (“ESG Steering Group”) led by the Hong Kong Monetary Authority (“HKMA”) and the Securities and Futures Commission (“SFC”). The ESG Steering Group aims to position Hong Kong as a leader in green and sustainable finance and help the financial ecosystem transition towards carbon neutrality.

In June 2020, HKMA set out supervisory expectations for governance, strategy, risk management and disclosure of “green and sustainable banking.”  The HKMA introduced a new module to its Supervisory Policy Manual in December 2021 (“GS-1”) to provide guidance on the HKMA’s expectations for banks to develop risk management frameworks in relation to climate risk.

In June 2021, the SFC, following on from guidance it had issued to fund management companies in 2019, added more guidance on enhancing ESG disclosures. All fund managers were required to comply with baseline requirements by 20 November 2022. Requirements are focused on the climate related risks and not wider ESG considerations. 

The SFC and HKMA have teamed with the Stock Exchange of Hong Kong to form a Task Force on Climate-Related Financial Disclosures (“TCFD”). The SFC has set climate risk rules, effective from August and November 2022 and the HKMA issued its own set of climate risk guidelines with a compliance deadline of 30 December 2022.

From 1 July 2020, mandatory ESG reporting obligations that apply to listed companies have incorporated the TCFD recommendations. Listed companies are required to make disclosures in annual ESG reports, which can be part of their annual report or separate. Listed companies that fail to comply with Hong Kong listing rules on ESG reporting could be subject to disciplinary action from the Hong Kong Stock Exchange. 

Singapore updated its National Determined Contribution (“NDC”) to reduce emissions to around 60 million tonnes of carbon dioxide in 2030 after peaking emissions earlier. It has also raised its national climate target to achieve net zero by 2050.

The Monetary Authority of Singapore (“MAS”) established the Sustainable Finance Advisory Panel to help guide MAS on its strategies and initiatives to build a credible and vibrant sustainable finance ecosystem. MAS Guidelines for Environmental Risk Management for Asset Managers (“Guidelines”) was established and became mandatory for all fund managers to comply with this Guideline by June 2022. 

MAS further published an Information Paper on Environmental Risk Management to identify emerging and/or good environmental risk management practices by financial institutions and highlight areas where further work is needed. 

To assist financial institutions, including asset managers, in implementation, Green Finance Industry Taskforce (“GFIT”) published its Handbook on Implementing Environmental Risk Management for Asset Managers, Banks and Insurers in January 2021.

In April 2022 an ABS Environmental Risk Questionnaire (“ERQ”), and ERQ Guide was developed by GFIT. The ERQ is the first industry-standard template that sets a consistent baseline for banks in Singapore to engage their corporate clients on environmental risk issues, gather data points, and identify opportunities to finance the transition to a low carbon economy.

On 28 July 2022, MAS published its circular: CFC 02/2022 Disclosure and Reporting Guidelines for Retail ESG Funds (“ESG Circular”) which took effect 1 January 2023 and sets out MAS expectations on how the existing requirements under the Code of Collective Investment Schemes and the Securities and Futures (Offers of Investment) (Collective Investment Schemes) Regulations would apply to Retail ESG funds.

ESG has received more attention in recent years in Asia and the trend is expected to continue. We will continue to see notable developments in Asia as a whole, including enhancement in the regulatory framework in ESG. Regulators in Asia have been mostly focusing on the “E” aspect of sustainability and we expect the focus will move towards the “S” and the “G” in the coming years. Taxonomies are being created to assist market players in assessing how “green” an activity is, and regulators are starting to implement fund-labelling regulations in a deliberate and future-focused basis. We expect to see improved regional collaboration amongst the Asian regulators to address issues arising from the fragmented nature of ESG legislation in Asia in general. We are also anticipating an improvement in the quality, availability and comparability of data to keep up with the ESG growth and demand in Asia.

Hosting COP 28 is just another step towards the UAE’s adoption of ESG.  As part of the UAE Vision 2021, the country made great strides in driving sustainability forward in alignment with the UN Sustainable Development Goals. Vision 2030 also highlights the importance of sustainability and intends to build a sustainable and diversified, high value-added economy that is well integrated into the global economy, and one that provides more accessible and higher-value opportunities for all its citizens and residents.

1 Refinitiv Eikon Islamic Finance Outlook 2019

• Three sustainable investment labels to help consumers navigate the landscape:
  • Sustainable focus: Products with assets that are environmentally and/or socially sustainable, by ensuring at least 70% of the portfolio meets a “credible standard of environmental and/or social sustainability” or aligns with a specified environmental and/or social sustainability theme.
  • Sustainable improvers: Products that seek to improve the environmental and/or social sustainability of assets over time, including in response to the stewardship influence of the firm.
  • Sustainable impact: Products that have a clear objective to achieve a positive and measurable real-world impact to sustainable outcomes.
• Consumer-facing disclosures to help consumers understand the key sustainability-related features of a product. In the context of the consultation paper, consumers are retail customers. For in-scope products (all authorised funds (excluding feeder funds) and unauthorised AIFs) production of a document to help retail investors to understand a product’s features and objectives. These will be similar to a Key Investor Information Document (“KIID”).
• Detailed disclosures targeted at a wider audience (e.g. institutional investors and consumers seeking more information). These include disclosures that have a similar purpose to the SFDR requirements:
  • pre‑contractual disclosures
  • ongoing sustainability related performance information
  • a sustainability entity report.
• Naming and marketing rules – restricting use of ESG terms for products that don’t qualify to use sustainable investment labels. For example, terms such as ESG and its constituent parts, Climate, Impact, Sustainable, Green, Responsible, Net-zero etc.
• Requirements for distributors to display the sustainable product labels and make the consumer-facing disclosures clearly available for consumers. The FCA’s Consumer Duty will cut across this area, so firms should consider how they manage their implementation of two regimes. Managing each in isolation is not the right approach.
• The FCA will impose an anti-greenwashing rule that applies to all regulated firms. This will bolster existing fair, clear and not misleading requirements, but through a sustainability lens. This rule specifically strengthens existing financial promotion rules and Principle 7.
• Overseas funds are not included in this consultation, but further consultation will come on that as well as pensions. 
• Timeline:
  • Rules likely to come into place on 30 June 2023, including the anti-greenwashing rule, with the labelling and disclosure requirements phased in between 30 June 2024 and 30 June 2026.

Allocators are increasingly looking for sustainable investments. Rather than chasing the market, we have been working with firms to transition their investment products to be sustainable investment products. In addition to thinking about the portfolio of investments, firms must build sustainability considerations into the asset picking process. Their investment governance process and ongoing analysis must consider sustainability. Any client communication must clearly set out the reality of the sustainable nature of the investment product. Embellishment could mislead investors, which would breach long-standing client communication rules.