August 2023 — Issue 8

This is a regular publication from KPMG's EMA Financial Services Regulatory Insight Centre, providing key updates on the latest ESG regulatory developments impacting financial services firms in the UK and the EU.

The start of the traditional summer break has not stopped regulators and standard setters from releasing significant ESG updates — some in response to existing deadlines or mandates and others in support of new initiatives.

Shortly after publication of the June edition of ESG Regulatory Essentials, the European Commission issued its 2023 Sustainable Finance Package. There was a lot in here for Financial Services firms to unpack, from expansion of the EU Taxonomy to new proposals on regulating ESG ratings providers. On the theme of taxonomies, the Green Technical Advisory Group (GTAG) recently published recommendations for the UK government on streamlining and increasing the usability of `Do No Significant Harm' criteria when developing the UK's Green Taxonomy. 

There have also been significant developments on ESG reporting and disclosures. Publication of the FCA’s policy statement on Sustainability Disclosure Requirements (SDR) has been delayed from Q3 2023 to Q4 2023. The International Sustainability Standards Board's (ISSB's) IFRS S1 and S2 and the first package of European Sustainability Reporting Standards (ESRS) have been finalised. Both sets of standards represent major milestones in the disclosure of sustainability risks, and attention now turns to their application. The UK Government has announced that it will develop Sustainability Disclosure Standards (UK SDS) by July 2024, based on the ISSB standards. Companies in scope of the EU Corporate Sustainability Reporting Directive (CSRD) must ensure they are in a position to deliver their ESRS-aligned disclosures to the relevant timeline. 

Transition plans are in the spotlight. The UK Transition Plan Taskforce (TPT) has released a status update, confirming that its final disclosure framework will be delivered in October 2023. The Network for Greening the Financial System (NGFS) published a stocktake on firms' transition plans to date and set out ways in which they could be used to enhance prudential regulation. And, in the spirit of practicing what they preach, the Bank of England (BoE) and Financial Conduct Authority (FCA)/Payment Systems Regulator (PSR) have published their own plans.

The supervisory toolkit around greenwashing is expanding in line with continuing regulatory concerns. The three European Supervisory Authorities (ESAs) have agreed a common definition of greenwashing and reaffirmed their commitment to understanding the drivers of this risk and effectively supervising it. ESMA has launched a common supervisory action with EU regulators on sustainability-related disclosures and the integration of sustainability risks, and also issued a statement that standardises firms' sustainability-related disclosures in prospectuses.  

On climate-related financial risk, the EBA is consulting on its data template for use in the `Fit for 55' exercise — the one-off climate scenario analysis that the European Commission asked all three ESAs to conduct. And EIOPA has been considering why the take-up of natural catastrophe insurance has been low amongst both individuals and businesses. 

Product governance and sustainability characteristics remain in focus. ESMA has launched a call for evidence on the integration of sustainability preferences into the suitability assessment and product governance arrangements under MiFID II, which will interest wealth and asset managers as they seek to understand best practice.

For more information on these and other updates, read on.

EU Sustainable Finance Package

European Commission publishes new measures to strengthen its sustainable finance framework 

In June, the European Commission published a new package of measures designed to build on and strengthen the foundations of the existing EU sustainable finance network. For more detail, see our article above.


GTAG report on UK Green Taxonomy `Do No Significant Harm' criteria

The GTAG has published a report on streamlining and increasing the usability of the Do No Significant Harm (DNSH) criteria within the UK Green Taxonomy. The GTAG found that there has been a near global adoption of DNSH in taxonomies under development internationally, and that the market strongly supports the concept. However, it notes that DNSH criteria as drafted in the EU have been challenging because they are overly repetitive, difficult to measure and ambiguous in their drafting. 

In order for the UK government to include DNSH criteria in its own Green Taxonomy more effectively, the GTAG recommends that it should:

  • Confirm the purpose of, approach to and definition of DNSH in the UK Green Taxonomy — this should be set out in the autumn 2023 consultation. 
  • Enable companies to disclose the extent to which they meet DNSH criteria, if their activities are not fully taxonomy aligned. 
  • Establish functional design parameters for the drafting of DNSH criteria. 
  • Streamline the EU DNSH criteria, but this should not weaken the scientific basis for criteria or overall ambition level for the UK Green Taxonomy. 
  • Ensure that guidance to complement DNSH reporting is produced by a single authority. 
  • Advocate for this new approach to DNSH via bilateral and multilateral discussions to position the UK as a leader in the debate on Green Taxonomy harmonisation. 

The consultation on the UK Green Taxonomy is expected in autumn 2023. 

Updates and amendments to the EU Taxonomy

As part of the sustainable finance package, the European Commission provided updates on and amendments to the EU Taxonomy. A new Delegated Regulation, the Environmental Delegated Act, was approved in principle alongside amendments to existing Delegated Acts. The announcement included:

  • Technical screening criteria (TSC) for the remaining four EU Taxonomy objectives. 
  • DNSH criteria for the remaining four objectives. 
  • Clarification of disclosure obligations for the additional activities.
  • Expansion of the economic activities contributing to climate change mitigation and adaption, particularly in the manufacturing and transport sectors.

For more information, see our article above.

Reporting and disclosures

European Commission adopts the ESRS

At the end of July, the European Commission adopted the ESRS, which will be used to report sustainability information by companies subject to the Corporate Sustainability Reporting Directive (CSRD). For more information on the standards, including preparing to report against them, see the link above. 

ISSB finalises IFRS S1 and S2

The ISSB has published its much-anticipated sustainability standards: IFRS S1 on General Requirements for Disclosure of Sustainability-Related Financial Information and IFRS S2 on Climate-Related Disclosures. For more information on the standards and next steps to get ready for reporting against them, see the link above.  

IFRS comparison of ISSB climate-related disclosures and TCFD recommendations and guidance  

The IFRS has published a staff paper on the differences between the ISSB's IFRS S2 on Climate-Related Disclosures and the TCFD's core recommendations and guidance. The paper finds that, overall, IFRS S2 is in line with the TCFD's recommendations. However, IFRS S2 often goes further than TCFD in seeking either additional specificity to build on the work of the TCFD or in adding new requirements that are not in the TCFD recommendations or guidance. 

Examples of additional specificity in IFRS S2 include more detailed information on: 

  • Oversight of climate-related risks and opportunities; 
  • Where these are concentrated in the business model and value chain; and 
  • Disclosure of transition plans. 

Examples of additional requirements of IFRS S2 that are not in the TCFD recommendations include: 

  • Criteria for when quantitative and qualitative information is required when disclosing risks and opportunities;
  • Additional disclosures on the processes to identify and assess opportunities; and 
  • Additional disclosures on financed emissions when disclosing scope 3 GHG emissions. 

Companies should familiarise themselves with the differences between TCFD-aligned reporting and the requirements of IFRS S2 and consider how they will meet the additional requirements under the new standard. 

EFRAG response to ISSB consultation on future priorities

The European Financial Reporting Advisory Group (EFRAG) has published its draft response to the ISSB's proposed agenda priorities (to be finalised ahead of the ISSB's 1 September 2023 deadline). EFRAG provided technical advice on the development of the ESRS and has been mandated to ensure that the ESRS and ISSB are interoperable. EFRAG:

  • Recommends that the ISSB clarify its overall direction of travel, including the universe of sustainability-related topics that it will cover — the ISSB is still considering whether to prioritise nature- or social-related risks in its agenda. The ESRS cover a broad range of topics and EFRAG is likely to face challenges in aligning the two sets of disclosure requirements. 
  • Recommends that the ISSB explicitly integrate investors' interests in impact materiality. 
  • Disagrees with the broad definition of biodiversity proposed by the ISSB as it risks becoming all-encompassing. EFRAG suggests that the ISSB align itself with the definition developed by the Taskforce on Nature-related Financial Disclosure (TNFD). 
  • Has significant concerns about the distinction between standards on human capital and human rights, as separating these topics may perpetuate misunderstandings about their inter-relation.

UK government to develop UK Sustainability Disclosure Standards

The UK government's Department for Business and Trade announced the development of UK Sustainability Disclosure Standards (UK SDS). The UK SDS will set out corporate disclosures on the sustainability-related risks and opportunities that companies face and will form the basis of any future requirements in UK legislation or regulation around disclosure of this information. They will be based on IFRS S1 and IFRS S2. 

The Secretary of State for Business and Trade will consider endorsement of the ISSB's standards to create the UK SDS by July 2024. UK endorsed standards will only divert from the global baseline if absolutely necessary for UK-specific matters. 

NGFS stocktake of financial institutions' transition plans

The NGFS, a group of central banks and supervisors committed to sharing best practices on climate and environmental risk management in the financial sector, published a stocktake of firms' transition plans to date. For more information, as well as an overview of the existing regulatory requirements for transition plans, see the article above. 

TPT update on transition plan disclosure framework

The UK Transition Plan Taskforce (TPT), created by HM Treasury (HMT) to develop a gold standard for transition plan disclosures, published a status update in July. The update summarised responses to the TPT's earlier consultation, noting that respondents `strongly endorsed' the proposed Disclosure Framework and supported the `commitment to building international consistency and coherence'. Respondents also called for further transition plan guidance and examples, which the TPT is considering as it finalises its work. 

The final TPT Disclosure Framework will be released in October 2023, after which the FCA is expected to clarify its transition plan disclosure expectations. 

The TPT will also publish sector-neutral guidance in October 2023 and will consult on sector-specific guidance later in the year for finalisation in early 2024. 

UK regulators publish their transition plans

The BoE published its transition plan in July 2023, shortly followed by the FCA and PSR's joint plan. The regulators all noted that they had published their plans to demonstrate that hold themselves to the same standards they expect of regulated firms. 

Most emissions from the BoE and FCA/PSR are indirect scope 3 emissions, meaning all three bodies will work towards influencing suppliers and staff to reduce these emissions. 

ESAs agree a common definition of greenwashing

The three ESAs — EIOPA, the EBA and ESMA — published reports on their common understanding of greenwashing. They define it as 'a practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services', which 'may be misleading to consumers, investors, or other market participants'. 

The ESAs agree on the importance of supervising greenwashing risks. EIOPA has started to integrate greenwashing into its supervisory activities. The EBA notes that although regulatory and legal frameworks exist to tackle greenwashing, more experience is needed to understand how effective they are and what their shortcomings are. ESMA is investigating how to use artificial intelligence (AI) tools to support its supervision of ESG-related disclosures and has also launched a common supervisory action (see below). All three ESAs will continue to research the drivers of, and supervise, greenwashing risk, and will report again in May 2024. 

ESMA's insights into expected sustainability disclosures in prospectuses

ESMA has issued a statement to National Competent Authorities (NCAs) aimed at standardising sustainability-related disclosures included in prospectuses under existing prospectus legislation and listing rules. The statement includes expectations on the following:

  • Sustainability-related disclosures in equity prospectuses and consistency with non-financial reporting;
  • Prospectuses relating to non-equity securities with a specific ESG component or objective; and
  • Consistency of sustainability-related disclosures in prospectuses and advertisements.

The statement relates only to the applicable disclosure requirements under the Prospectus Regulation and does not introduce any new, additional disclosure requirements. Any future disclosure requirements that may be introduced to the Listing Act will not be affected by this statement.

FCA review of the sustainability-linked loans market

The FCA has written to heads of ESG and sustainable finance outlining its concerns around the sustainability-linked loans (SLL) market. SLLs fall outside the FCA's regulatory remit, and these findings do not give rise to regulatory requirements. However, the FCA is concerned that the operation of the SLL market may impact the integrity of the overall sustainable finance market. The FCA's key findings are that: 

  • Most banks include SLLs in their calculation of sustainable finance KPIs, which are used for internal and external reporting and risk management disclosures. However, the classification of SLLs varies amongst banks and there are questions over the robustness of SLL classification.
  • Borrowers may be disincentivised from seeking an SLL due to the higher costs of arranging the loan and need for negotiation resources, especially given the relatively small savings on margin. 
  • The SLL market is not achieving the scale that the FCA considers possible. Banks should therefore work to drive the uptake of SLLs.
  • Potential conflicts of interest exist, particularly where banks emphasise relationships over robust and ambitious targets.

Some of the deficiencies identified in the FCA's review are addressed by the recently-published Sustainability-Linked Loan Principles. The letter demonstrates the FCA's willingness to reach beyond its direct remit and seek new ways of promoting transparency and market integrity in the ESG/sustainability space.

Data and ratings

European Commission consults on the future regulatory regime for ESG ratings providers  

The European Commission is consulting on a potential new regulatory regime for ESG ratings providers. This follows an earlier consultation published by HMT in the UK in March 2023. For more information on the Commission's proposal, see the article above. 

EBA gathering data on ESG risks

The EBA has made a formal decision to collect quantitative ESG data from large, listed institutions' pillar 3 disclosures. National Competent Authorities (NCAs) will be required to collect this data and submit it to the EBA twice a year (with the first submission due in June 2024 based on data as at 31 December 2023). This data collection exercise is temporary and will be discontinued once a supervisory reporting framework on ESG risks will be in place. Nonetheless, the exercise should serve as a reminder to firms that supervisors will review and form judgements on their pillar 3 disclosures — including in the supervision of ESG risks.

Climate-related financial risk

EBA consults on data template for its `Fit for 55' one-off scenario analysis 

The EBA is consulting on a template to gather data for its `Fit for 55' one-off climate risk scenario analysis. The template asks for data on credit risk, market risk, real estate risks (both physical and transition) and interest income. Stakeholders have until 11 October 2023 to submit their responses to the consultation.

The template will be used as part of the one-off scenario analysis that all three ESAs are conducting, as requested by the European Commission in March 2023. The exercise will assess the resilience of the EU's financial system as it works to meet the Commission's climate targets. The ESAs will develop severe but plausible scenarios: one to focus on climate-related risks that could materialise in the near term, and a second to combine climate-related risks with other stresses. Results of the exercise are due by end Q4 2024/no later than Q1 2025. 

EIOPA research on consumer reluctance to take out natural catastrophe insurance 

EIOPA published a staff paper exploring the reasons for the limited uptake of natural catastrophe (NatCat) insurance in the EU. Building on previous studies, the paper explores so-called `demand-side' barriers that can prevent consumers from buying NatCat insurance. It also proposes possible consumer-tested solutions to overcome these barriers. 

The barriers for people and businesses to buy NatCat protection include: 

  • Income levels and the perceived unaffordability of coverage.
  • Lack of clarity in terms and conditions.
  • Previous negative experiences with insurance claims.
  • The misperception of the risks of a NatCat event.
  • High expectations about state intervention in case of a catastrophe.
  • The perception that the process of buying insurance is demanding.

Potential solutions for bridging the NatCat protection gap include:

  • Increasing risk awareness, for instance through public or independent tools monitoring the level of risk in regions. 
  • Targeted messages at `teachable moments' (e.g. prior to buying property).
  • Better comparison and greater standardisation of products regarding coverage, exclusions and pricing structures.
  • Simpler and more consumer-friendly purchasing processes, including via digital channels.
  • Premium reductions for implementing risk mitigation measures.

There are no immediate next steps, but this paper will be of interest to insurers and reinsurers, including those in the London market, working on initiatives to address NatCat protection.

TPR review of defined contribution schemes 

The Pensions Regulator published the findings of its defined contribution (DC) scheme survey. It found that action on managing the financial risks of climate change was widespread among the large schemes and master trusts. However, few small and micro schemes had devoted time or resources to this. Trustees should consider the findings and where necessary take action to address compliance or knowledge gaps.

Wealth and asset management

ESMA call for evidence on MiFID II sustainability requirements

ESMA has published a call for evidence regarding the integration of sustainability preferences into the suitability assessment and product governance arrangements under MiFID II. ESMA hopes to better understand the evolution of the market, how firms apply the rules, and the experience of investors. It will assess the responses along with National Competent Authorities. 

The call for evidence is not a consultation and does not propose any specific changes to the guidelines. There are 36 questions in total, covering the following areas (amongst others): 

  • How firms are implementing the requirements.
  • Whether there are aspects of sustainable investment that retail investors struggle to understand, and any relevant education initiatives.
  • How clients respond to questions on sustainability preferences and the type of sustainable investment definition they opt for.
  • How clients' preferences are considered in the context of considering Principal Adverse Impacts (PAIs).
  • How firms have mapped their products' ESG features against clients' sustainability preferences, and whether ESG rating or scoring systems have been used.
  • How firms apply sustainability concepts to MiFID II financial instruments that are outside the scope of SFDR (e.g. shares).

Stakeholders have until 15 September 2023 to respond to the call for evidence. 

ESMA common supervisory action (CSA) to assess disclosures and sustainability risks

In July 2023, ESMA launched a CSA with EU National Competent Authorities (NCAs) to assess EU asset managers' compliance with SFDR, the Taxonomy Regulation, and the 2022 sustainability amendments to the UCITS Directive and AIFMD. Until Q3 2024, NCAs will undertake supervisory activities and share information with ESMA. The CSA will:

  • Assess whether asset managers adhere to applicable rules and standards in practice;
  • Gather further information on greenwashing risks in the investment management sector; and
  • Identify further relevant supervisory and regulatory intervention to address any issues.

Asset managers should have regard to ESMA's May 2023 supervisory briefing to understand existing expectations.

Other standard-setter updates

European Commission consultation on CBAM reporting obligations

The EU Carbon Border Adjustment Mechanism (CBAM) is a central policy tool in the EU's fight against climate change and has been designed to fight carbon leakage. On 13 June, the European Commission launched a public consultation seeking feedback on its draft Implementing Regulation for the EU CBAM during its transitional phase, which will run until the end of 2025. 

The draft Implementing Regulation outlines reporting obligations and information required from EU importers of CBAM goods, as well as the provisional methodology for calculating embedded emissions released during the production process of CBAM goods. 

The consultation closed on 11 July, with the Implementing Regulation to be formally adopted by the European Commission later this summer.

Review of the Shareholder Rights Directive (SRD2)

In July, ESMA and the EBA published a report with their assessment of the implementation of SRD2 (responding to a request from the European Commission). SRD2 was originally introduced to further improve the stewardship of companies by increasing shareholder engagement, and to encourage investors to adopt a long-term focus, including consideration of social and environmental issues.

ESMA and the EBA found that whilst the framework for proxy advisers (firms that offer research, advice or recommendation services) is robust overall, certain improvements could be made. ESMA has proposed introducing a registration mechanism for proxy advisers, and regarding the wider investment chain, it considers more can be done to introduce a common definition of a “shareholder”. In addition, it has suggested some wider technical improvements. These findings will inform the Commission’s upcoming assessment of SRD2 and a potential review.

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