Despite Setbacks, ESG Regulation Has Made Several Positive Shifts

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by Eric Burdon,

Deutsche Bank

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Last month, on 22 April, we marked the 53rd annual Earth Day as a day to celebrate the planet as we move towards protecting it further. While it’s a day for companies to talk about their ESG initiatives, it's also a day to reflect on how we’re tackling climate change in general. When it comes to ESG, a lot of this focus is on the world of finance and regulations, and since the 52nd annual Earth Day, a lot has changed.

ESG Is A Firm Belief

While from a public standpoint the term 'ESG' isn’t so prominent and is perhaps paraphrased by 'sustainable economy' or 'sustainability reporting standards', it’s a movement that has gained both firm traction and expanded scope in the corporate world.

Today, investors and businesses are seeing the environmental, social, and monetary benefits of becoming more ESG-friendly over the long-term. Climate neutrality is now less something scientifically posited, rather the major challenge for businesses to step up to in the coming decades.

Climate change mitigation means more than 'change', it is an opportunity for change. Reporting obligations, supply chain retooling, climate related financial disclosures, all additional responsibilities, yes, but the emerging business model sees the risks related to not adapting. The belief is becoming more firm that value can be much broader than previously tabulated, that compliance requirements are tough, but will ultimately affect net turnover.

Regulations = Transparency

The more serious companies understand that their current profits may suffer in the short-term due to change, but that was always the case. Whether small and medium enterprises or large companies, sustainability matters affect the bottom line, because to begin reporting means acknowledging transparent data, and that's the starting point where operational waste can be identified, reduced, and net turnover improved.

The mid- to long-term gains from this thinking far outweigh the shorter, rocky road ahead.

The numbers prove this too, as research from Deutsche Bank found that last year, roughly 53% of investors regarded climate change as a factor in their investment decisions. This is in addition to 78% of private and business clients showing concern over the negative influence of climate change on the economy.

ESG Regulation Implementation Ramps Up

ESG regulation has changed dramatically over the past year, though not all movements have been positive. The largest example is in the United States, where the US Republican Party has made it a priority to directly impact investment decisions and pensions.

A famous example now is the move they made in February, when 27 Republican state attorneys general issued a letter to Congress, hoping they would block the implementation of an ESG investing rule.

Then there are smaller efforts, such as that of Florida Governor Ron DeSantis, who banned ESG in his state.

But despite the ongoing issues America is facing with ESG adoption and regulations, regulatory changes globally are showing more promise. Regulation tech firm Regnology points out that the landscape over the past year has changed dramatically. Countries like Canada, Japan, the EU and China are introducing new regulations and requirements. If they’re not, they’re adopting the recommended ones the ISSB provided.

Sustainable Finance Disclosure Regulation (SFDR)

Beyond that, there is also the SFDR, which the European Parliament adopted and formed under the Corporate Sustainability Reporting Directive (CSRD). Those regulations were taken up in 2022 and applied as of 1 January of this year. To further reinforce these regulations, all financial market participants have to use standard disclosure templates by the end of 2023. These standards include the Green Asset Ratio, the proportion of banking assets aligned with the EU Taxonomy regulation.

All in all, the EU has set a precedent for regulations, and more ESG standard-setters are bound to emerge regardless of the anti-ESG movements' efforts. The European Union will, in the meantime, be the testbed for change, and the European sustainability reporting standards will come under close scrutiny. 

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More Regulation Testing

Likely what we will see moving forward are more ambitious regulations. As more people join in, there’ll be more testing. Those at Regnology believe some of the main changes are "climate stress tests", how effectively financial institutions cope with the seismic pressures the effects of global warming will continue to levy on economic systems. 

Beyond that, it’s not out of the question to expand the criteria and consider other objectives, such as pollution prevention. There’ll also be more crackdowns on greenwashing, finding ways to mitigate loopholes, and solving other clunky issues that are bound to emerge with the initial implementation of regulations.

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More Reasons To Be Hopeful

Despite what’s happening in the United States, all around the world, people are embracing ESG in some form, or have been doing so for some time. While the EU mandates reporting on ESG for large companies as of 2023, China mandated this reporting in 2022, and Malaysia started in 2016. Other countries, such as Canada and New Zealand, will soon be incorporating these mandates. 

As a result of government involvement in ESG, we’re seeing this movement spread beyond the shareholders as a broadening base of stakeholders begins to understand what constitutes, or will constitute, ESG and sustainable thinking in general. They are starting to understand some of the issues with old business models, like shareholder interest, and how that’s created more problems than solving them. 

Between the activist shareholders who want companies to be more ESG-friendly and the growing awareness of stakeholders, there are bound to be further changes seen in ESG in the coming years. Again, the single common thread will be change. 

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Takeaway

So, as sustainability disclosure becomes commonplace boardroom discussion under reporting scope objectives, financial and sustainability information become intertwined under the same business model, or as environmental objectives become part of the sustainable investments conversation, change will have happened in, say, a decade's time. Perhaps then, we will look back and see its origin point in the advent of regulated reporting standards. 

Perhaps then we will shudder at the thought of 'business as usual'. One can only hope.

Questions? We have answers at our FAQ.

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