2022 ESG round-up and 2023 outlook

Introduction

Another busy year for ESG, in which we’ve seen updates to regulation, greenwashing crackdowns, and progress against a whole range of climate-focused and other metrics and targets. Politicisation of ESG has created a nation-splitting backlash in the US, meanwhile governments and regulators around the world continue to drive policies that bring it further into the mainstream. Controversies and progress, geopolitical turmoil; 2022 was certainly an interesting year for ESG.

Here we look back at ESG trends in 2022, reviewing the key drivers and topic areas we’ve been focusing on with our clients. And then we look ahead at what’s coming down the line in 2023 and how to prepare.

Policy and regulation

Policy and regulation remained at the heart of many ESG discussions this year, as regulators around the world continued to drive the industry towards more consistent and mandatory disclosures and greater clarity on the sustainability of investment products. Amongst our clients we saw a continuing desire to understand the implications of new and updated regulations coming from the EU, the UK the US, and HK. And while there have been challenges, we’ve seen a huge increase in knowledge, familiarity with key concepts and requirements, and appetite to go further.

European Union – SFDR

The EU’s SFDR regime was designed to help investors distinguish between sustainable investment strategies and minimise greenwashing. Despite rapid development in its first years, there remains some confusion in the market. Many are still getting to grips with requirements and evidence for issues such as Good Governance, Principle Adverse Indicators (PAIs) and alignment with the EU taxonomy’s “do no significant harm” principle (DNSH).  

After a flurry of Article 8 and 9 downgrades this year, there’s a move towards more careful and consistent defining of sustainable investments and objectives. Level 2 rules come into force from 1 January 2023 and require disclosures in line with regulatory templates.

UK - SDR

The FCA’s new Sustainable Disclosure Requirements (SDR), currently under consultation, promise to learn lessons from the EU’s experience.  These aim to tackle greenwashing and provide a fund labelling system and framework for fund disclosures based on 3 simple to understand labels: “Sustainable Focus”, “Sustainable Improvers”, and “Sustainable Impact”. It uses TCFD framework to report on climate-related risks and opportunities and will seek to align with the forthcoming ISSB framework in due course.

TCFD disclosures will also be required for UK regulated managers of more than £5bn from 1 Jan 2023. We are also seeing some out-of-scope managers proactively opt in to TCFD reporting in anticipation of inevitable investor requests.

US SEC climate and ESG disclosures

The SEC proposed its own new rules for climate change disclosures this year. These will be aligned to TCFD – for US listed companies (initially) – and ultimately encourage consistent and transparent disclosures. The SEC is also consulting on disclosures for ESG Investment Practices at three potential levels – “integration funds”, “ESG focused funds” and “impact funds”. The proposed rules ask funds to provide more specific disclosures in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue. Again, the goal here is to provide investors with more consistent, comparable, and reliable information on ESG issues.

Whether or not the SEC rules are accepted as proposed remains to be seen, though there is great appetite from investors for standardised reporting, and hopefully these rules will be implemented.

Regulation in 2023

The Goldman Sachs Asset Management case this year shows both how easy it is to fall foul of the rules but also how seriously the regulators are taking the letter of the law. GSAM paid a $4m settlement to the SEC for what amounted to not consistently following their own rules and not sufficiently educating their staff on their own policies. The lesson here is to make sure everyone knows what you’ve committed to and can explain it to investors and other stakeholders. It’s also essential that everyone knows how to use any ESG frameworks, checklists, and other materials and maintains records in line with your policies.

2023 will likely see the emergence of regimes in the US and UK, and possibly elsewhere. Though all slightly different in their language and coverage, their aims are broadly aligned, and the regulators have promised to try to minimise the burden of disclosing against multiple conflicting regimes by mapping them against one another.

We’re hopeful the IFRS’ International Sustainability Standards Board (ISSB) will streamline the standardisation process further and provide everyone with a consistent and comparable framework to operate under in the longer term.

ESG Progress

2022 was a big year for ESG learning and knowledge acquisition. Whether dipping an initial toe or moving to the next stage, it seems levels of knowledge amongst clients and the industry at large are steadily growing and the whole conversation maturing. Where once investors asked if a manager had an ESG policy of any kind, now they’re requesting more detailed information on how ESG is integrated into investment processes and what engagement approaches are in place. They’re also pushing for specific data and metrics, for example on emissions and climate scenario analysis and factors like pollution, biodiversity, and human rights.

Concepts and language are developing too, not least around the technical definitions of sustainable investments needed for regimes like SFDR. We’ve also seen ever more clients getting comfortable and speaking more fluently on climate issues like greenhouse gas (GHG) emissions, Scopes 1-3, carbon neutrality, net zero, energy transition, carbon accounting, offsetting, and scenario analysis.

The Ukraine war, energy crisis and other geopolitical issues have caused some to further question ESG’s validity, and the highly political backlash in the US has indeed stymied progress in some places. However, despite these influences, we’ve seen an ever-increasing interest in developing ESG policies, accessing and analysing climate and other data, and disclosing against frameworks like TCFD. For those in scope for SFDR, we’ve noticed a greater interest in moving towards Articles 8 and 9.  

ESG progress in 2023

Progress has been brisk this year and we’re expecting more of the same in the coming one. With better understanding across the board, investors will be asking for more detailed responses on ESG issues and evidence to back it up.

The FCA’s Sacha Sadan told the PRI conference community to be clear and authentic, to use normal language and to be specific in what you’re actually doing – seems like good advice. Despite the ongoing alphabet soup, we’re hopeful that 2023 could be a year for increased standardisation, clarity on policy, and even more progress on ESG. Moving on from climate is another area we expect to see advancement, both towards more nature-focused and supply chain related issues on the environmental side, but also towards more stringency on human rights and other measurable social aspects.

The current backlash to ESG from some quarters won’t disappear overnight but as climate impacts intensify and regulators, investors, and corporates increasingly assess those risks and take action accordingly, it seems like the direction of travel is naturally forming. Though there may continue to be obstacles through 2023, the longer-term outlook is positive, and most are quietly preparing.

2022 has been a challenging year; economically, environmentally, and geopolitically.  While 2023 may not be a marked improvement, significant progress is being made in standardised reporting and data convergence efforts. 

2023 milestones include the return of UNPRI reporting (May-August), final rules from the FCA on SDR and expected progress from the SEC on ESG regulation.

We look forward to continuing the journey with you.