ESG Regulatory Essentials

June 2024 — Issue 13
 

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.

Since the last edition of ESG Regulatory Essentials there has been a lull in new publications from financial services (FS) regulators, reflecting political activity in both the EU and UK. In the UK, the period of sensitivity in the run up to a General Election means that regulators typically refrain from publishing new consultations or contentious final policies. This has extended to publications such as the eighth edition of the Regulatory Initiatives Grid. The recent EU elections will change the composition of the European Parliament and impact the appointment of the next European Commission. The autumn will bring greater clarity on forward-looking ESG/sustainability policy priorities for financial services in both jurisdictions. 

However, prior to the start of the election campaigns there were several developments of note. 

Greenwashing continues to be high on the regulatory agenda. The FCA's Anti-Greenwashing Rule came into effect on 31 May and the three European Supervisory Authorities (ESAs) published final reports on the risks of greenwashing and their supervisory approaches. 

The IFRS Foundation and EFRAG have collaborated on a report highlighting areas of interoperability in their respective sustainability standards. Meanwhile, the UK government has issued an update on its Sustainability Disclosure Requirements (SDR) framework (not to be confused with the FCA's SDR for asset managers). The update confirms expected timelines for consultations on initiatives such as the UK Green Taxonomy and Sustainability Reporting Standards (SRS), but it is possible that there could be changes to both the timing and content of policy under a new government. 

ESMA has published its guidelines on using ESG or sustainability-related terms in fund names and the European Commission has summarised the feedback it received as part of its consultation on amending the Sustainable Finance Disclosure Regulation (SFDR). 

Turning to ESG risks, the G7 has published a high-level framework for insurers and governments entering into public-private insurance programmes (PPIPs) to manage the financial risks of climate change. The European Systemic Risk Board (ESRB) has responded to EIOPA's consultation on the prudential treatment of environmental and social risks, and the Bank for International Settlements (BIS) has launched a new project with the Monetary Authority of Singapore to develop a climate risk platform that can assist central banks in assessing material entity-level and systemic climate-related financial risks.

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

In this issue:

• Greenwashing
• Reporting and disclosures
• Wealth and asset management
• Climate and environment-related financial risk 
• Other

Greenwashing

FCA Anti-Greenwashing Rule 

The FCA's Anti-Greenwashing Rule (AGR) came into effect on 31 May 2024. The regulator has published Finalised Guidance (PDF 393 KB) for firms to assist them in complying with the AGR. For more information, see the article above. 

ESAs issue final reports on greenwashing 

The European Supervisory Authorities (ESAs — EBA, EIOPA and ESMA) have published their final reports on greenwashing in the financial sector. The reports reiterate the ESAs' common definition of greenwashing, and each authority provides a forward-looking view of how sustainability-related supervision can be enhanced.

The EBA (PDF 1129 KB) notes that the existing legislative and regulatory framework already provides key foundations to address greenwashing in the banking sector. It offers recommendations:

• At both entity- and product-level to ensure that sustainability claims are accurate, substantiated, up to date, fairly represent the institution's overall profile or the profile of the product, and are presented in an understandable manner.
• That National Competent Authorities (NCAs) pursue their planned and ongoing efforts to identify and monitor greenwashing risk within the remit of their respective prudential supervision and/or conduct supervision mandate.
  

ESMA (PDF 1630 KB) commits to further action, including:

• Future supervisory action on ESG disclosures for issuers, investment managers and investment service providers. This could align the EU approach with the UK's SDR, although the extent of alignment is not yet clear.
• Development of indicators to support the monitoring of greenwashing risks.
• Continuation of a capacity and resource building programme, including around supervisory technology.
• Creation of additional guidance for national regulators as part of the ESMA supervisory handbook.
  

EIOPA observes that the existing supervisory framework does not set explicit standards for greenwashing in the non-life sector, thus increasing risk when compared with the life sector. It:

• Explores ways to categorise sustainability features of non-life products and what non-life sustainability disclosures could look like (neither are policy proposals at this stage).
• Suggests four principles for NCAs to consider when monitoring and supervising an insurer's sustainability claims.

Reporting and disclosures (see also 'Wealth and asset management')

HM Treasury (HMT) update on UK economy-wide Sustainability Disclosure Requirements 

Before the UK General Election was announced, HMT published an update (PDF 221 KB) on the implementation of its economy-wide Sustainability Disclosure Requirements (SDR) framework. This should not be confused with the FCA's SDR for asset managers, which is one of the five components of the government's framework. To note, there may be changes to these timelines and to policy priorities following the election:

• UK Sustainability Reporting Standards (SRS): these were formerly referred to as the UK Sustainability Disclosure Standards (UK SDS) and will be created following UK endorsement of IFRS S1 and IFRS S2. The government will consult on the draft UK SRS in Q1 2025 and, once final, they will be used by the FCA to consult on introducing reporting requirements for UK-listed companies. In Q2 2025 the government will also consult on disclosure requirements against the UK SRS for UK companies that do not fall within the FCA's regulatory perimeter.
• Transition plans: the government will consult in Q2 2024 on how the UK's largest companies can most effectively disclose their transition plans. The FCA is expected to consult on transition plan disclosures for listed companies at the same time as it consults on implementing the UK SRS.
• FCA SDR: in Q3 2024 the government will consult on whether to broaden the scope of the FCA's SDR to include funds under the Overseas Funds Regime. This could require legislative change in 2025, followed by a separate FCA consultation to make rules for overseas funds. 
• UK Green Taxonomy: the government reaffirmed its commitment to developing the UK Green Taxonomy and to consulting 'some time in 2024'. There would be a two-year voluntary application period before exploring mandatory disclosures.
• Nature: the government encourages companies to engage with the TNFD UK National Consultation Group. It welcomes the ISSB's new research priorities on biodiversity, ecosystems and ecosystem services and its announcement that future standards could reflect nature-related risks and opportunities.
  
  

Interoperability guidance for sustainability standards 

The IFRS Foundation (responsible for the global IFRS S1 and IFRS S2 standards) and EFRAG (which developed the European Sustainability Reporting Standards [ESRS]) have collaborated on a report highlighting areas of convergence and consistency in the two reporting frameworks. The report clarifies areas of alignment in disclosure requirements and suggests actions for firms to ensure compliant reporting under both regimes. Highlights:

• There is divergence around materiality approaches, but the presentation and location of disclosures are broadly aligned. 
• For non-climate-related topics, the ISSB standards require entities to use their own judgement to provide reasonable information to users. 
• The ESRS are significantly more prescriptive, with reporting requirements across a broad range of sustainability topics. They set out numerous specific disclosures relating to a wide variety of sustainability issues that are outside the specific scope of IFRS S1 and IFRS S2. Firms that identify individual sustainability factors as material for disclosure under IFRS S1 may be able to leverage the ESRS requirements to meet their disclosure obligations.
• Both frameworks include tapers and reliefs, but these do not always match one-for-one. Firms should ensure that they qualify for relief under the applicable framework.
• In respect of climate-related disclosures there is a high degree of alignment in the two sets of standards. Almost all the IFRS disclosures relating to climate are included in the ESRS. 

ESAs joint opinion on review of SFDR

The ESAs EBA, EIOPA and ESMA) have published a joint report containing recommendations to the European Commission to improve the SFDR. These include recommendations to reduce the risk of greenwashing for products which fall outside Articles 8 and 9, and improvements in how information is presented to investors. There has been speculation on the extent to which the review of SFDR might lead to greater alignment with the UK's Sustainability Disclosure Requirements (SDR). However, the report advises that consumer testing is needed before product categorisation labels or other indicators are introduced.

TNFD and EFRAG publish correspondence mapping

The TNFD and EFRAG have published a granular mapping between the TNFD disclosure framework and the European Sustainability Reporting Standards (ESRS) which underpin the CSRD. The TNFD’s 14 core disclosure recommendations are reflected in the ESRS. The TNFD’s four pillars have also been adopted by EFRAG, although some adaptation was required to ensure that the concept of ‘double materiality’ required under CSRD is preserved.

Wealth and asset management

ESMA guidelines on using ESG and sustainability terms in fund names 

ESMA has published final guidelines on using ESG or sustainability-related terms in fund names. The guidelines (PDF 698 KB) are in addition to the SFDR requirements and aim to prevent greenwashing by providing more detailed expectations for fund managers. Depending on the ESG or sustainability terms used in a fund name, ESMA has created three buckets of funds, each with their own requirements:

• Funds using sustainability-related terms
• Funds using environmental- or impact-related terms
• Funds using transition-, social- and governance-related terms 

The guidelines will apply three months after they have been translated into all EU languages and published on ESMA's website, with a transition period for existing funds. 

European Commission feedback report on SFDR consultation 

The European Commission has published a report (PDF 770 KB) summarising feedback on its consultation on amending the Sustainable Finance Disclosure Regulation (SFDR). The results of the consultation will inform the ongoing review of the SFDR regime. 

Most respondents supported the SFDR's objectives but were less positive on whether they have been achieved. Feedback highlighted issues around a lack of clarity on key concepts, data availability challenges and the limited relevance or usefulness of some disclosure requirements. Respondents would like to see a more consumer-focused and internationally consistent set of rules. There is also strong support for better integrating the concept of transition finance into the regime. A large majority of respondents also agreed that the SFDR is being used as a labelling and marketing regime, rather than solely as a disclosure framework.

Climate and environment-related financial risk

G7 framework on public-private insurance programmes 

The G7 published a high-level framework for public-private insurance programmes (PPIP) to help insurers provide adequate protection for natural catastrophe events, which are increasing in frequency and severity. The PPIP framework explores how governments and the insurance sector can work together to fill the protection gap against natural hazards, with measures such as sharing data, sharing catastrophe risk between insurers and government, and actions that can prevent damage from occurring. 

The objectives of PPIPs include supporting the availability and affordability of coverage, leveraging existing capacity in the private (re)insurance market, limiting public sector exposure to natural hazard risks, and encouraging risk reduction and adaptation to prevent moral hazard. 

Features to consider when designing a PPIP include defining the scope of coverage, configuring the role of government depending on the desired aim of the programme, and adopting an appropriate approach to premium setting. 

Advice to EIOPA on the prudential treatment of environmental and social risks 

The European Systemic Risk Board (ESRB) has issued advice (PDF 1093 KB) following EIOPA's December 2023 consultation on the prudential treatment of environmental and social risks. EIOPA will consider this advice alongside other feedback received.

The ESRB highlights several challenges in the Pillar 1 prudential approach to sustainability, such as data and methodological constraints. Nonetheless, it notes that EIOPA may want to consider alternative ways to broaden its existing work on Pillar 1 (which currently focuses on fossil-fuel related investments, adaptation measures and social risks) to include a more granular assessment on sector-wide approaches.

The ESRB also notes that the revised Solvency II Directive has been strengthened to address sustainability risks, and the effectiveness of the new provisions will depend on their sound implementation. Additionally, it recognises that the Solvency II Directive largely relies on micro-prudential instruments, but that targeting the risk profile of individual insurers is not enough as it fails to capture transmission channels, amplifiers and spillovers into the wider financial sector and economy. The advice considers how new tools, such as a systemic risk buffer (SyRB) tailored to insurers, could be used to target sectoral and sub-sectoral exposures that have the potential to lead to systemic risk, sitting within the market risk module of the Solvency Capital Requirement (SCR) standard formula. 

Climate risk platform for financial authorities 

Under Project Viridis, the Bank for International Settlements (BIS) and the Monetary Authority of Singapore (MAS) have developed a blueprint for a climate risk platform that can assist central banks and supervisory authorities asses material climate-related financial risks.  Features of the platform include: 

• Views of financed emissions at institution level as well as system-wide 
• Consolidation of reported and modelled emissions of entities that are key counterparties to financial institutions 
• Mapping the geographical distribution of entities' assets to assess their transition risk exposure arising from changes in carbon pricing policies and exposure to different physical hazards.

The platform will evolve as standards, technologies and methodologies also evolve. Firms will be interested to note how standard setters are using technology, including artificial intelligence (AI), to understand the levels of systemic risk stemming from climate change.

Other

UK and Singapore strengthen collaboration on sustainable finance 

On 8 May (just before the UK General Election announcement), HMT and MAS issued a joint declaration of strategic priorities. Amongst other political and financial issues, this covers commitments for scaling sustainable finance, including transition planning, ESG data and ratings, and sustainability reporting. HMT and MAS are working in parallel to implement their policies on transition plans. Similar voluntary codes of conduct for ESG ratings and data products have been published in both jurisdictions, based on IOSCO's recommendations, and Singapore has committed to developing a formal regulatory regime based on the approach currently being developed by the FCA. Both countries have committed to implementing the ISSB standards and to considering further collaboration.