Despite being outside the EU, there are many firms marketing their wares around the EU's Sustainable Finance Disclosure Regulation. Dr Andy Sloan of Guernsey Green Finance discusses ESG regulations to understand why.
My favourite line when explaining Guernsey's Brexit status was always "we're a third country today, we were a third country yesterday, we'll be a third country tomorrow." So why am I writing about an EU Regulation?
With the growing global concern surrounding the achievement of the Sustainable Development Goals (SDG) by 2030, financial markets players are increasingly interested in understanding how organisations manage their material environmental, social and governance (ESG) opportunities and risks, and how they deliver ESG-positive impact. Views in this area have matured significantly. ESG-related information has moved from a "peripheral" to a "core" part of finance, across all sectors.
The rhetoric about ESG is far removed from reality of reporting. We need to keep it simple and straightforward to avoid being burdensome, particularly when global standard-setters cannot agree on what the core metrics are yet.
Legislators or regulators have been a primary source of stakeholder pressure for considering ESG risks and opportunities, but in the process their actions can be contrary, creating confusion with the multitude of players and standards. At the last count, more than five supranational bodies, including the Sustainable Accounting Standards Board, the World Economic Forum, and the Financial Stability Board, were competing to create a single global set of standards, measures and metrics.
ESG lacks the simplicity of climate change: limiting the rise in global temperatures. Reducing CHG emissions. Net zero by 2050.
ESG factors and measure are by comparison complicated and complex, there is no one right way to incorporate ESG.
So how does the Sustainable Finance Disclosure Regulation (SFDR) measure up on this basis? Writing in 2020 in Funds Europe, I said that as an industry, financial services "must guard against costly complexity. There is a simple measure – carbon content of the portfolio, and its path to zero. Yet still the propensity is to over-engineer. The EU Taxonomy is a great illustration of the case in point. The concern with the EU Sustainable Finance agenda is its application in practice, and the likely granularity of the approach to implementation, which may well end up with a Mifid II degree of complication".
The European Supervisory Authorities (ESA) has recently weighed in with a 200-page final report on the Regulatory Technical Standards. However, at the core are just 14 standard measures, nine of them environmental. But these are wrapped in an awful lot of bureaucratic and administrative requirements, and the non-environmental metrics are clearly of the "work in progress" variety.
Investors' need for trusted, transparent product was the rationale behind our creation of the Guernsey Green Fund, the world's first regulatory regime, a simple, straightforward notification and disclosure regime, aligned with international standards, designed to provide investors with confidence from a regulatory wrapper. In a similar vein, our Green Principles for Private Equity, described at the time by market commentators as simple ESG principles, provided a straightforward guide to investing, aligned with the climate change agenda.
Private markets and the private equity sector in particular need the comfort and confidence of a robust investment product, aligned with global standards, without the cost and complication of overly granular prescriptive rules. Personally, I don't think the EU's SFDR will successfully meet these criteria despite the fact that at its core, it's just nine environmental indicators plus another five to cover off S and G. Its MIFID II type administrative complexity.
Will it become the VHS of standards? Difficult to say. I think the 20 core KPIs of the World Economic Forum's 2020 paper 'measuring stakeholder capitalism, towards common metrics and consistent reporting of sustainable value' have a fighting chance to make the grade at a global level. But frankly ensuring firms are aligned, that is good governance, culture, practice and portfolios really ought to be a matter of principles. Is that too "old school" for 2021?
John Glen, Economic Secretary to HM Treasury, announced last June that the UK did not plan to incorporate the EU's regulatory technical standards. This was then confirmed by Chancellor Rishi Sunak, at the UK's New Green Horizon Summit (which Guernsey Green Finance supported) when he also announced that the UK planned to develop its own green taxonomy.
SFDR reporting is not due for another two years, and it is on a comply or explain basis, if you have fewer than 500 employees or a turnover of less than £500 million. It is going to be interesting to see if any Guernsey managers feel the need to comply at that point.
Being at forefront of development of green and sustainable finance here in Guernsey, we are fortunate to have an established sustainable finance community. Many firms provide sustainability reporting and advisory services. PE managers, owners of private capital in particular, and their advisers can be confident of finding the right advice - SFDR or not.
For more information about Guernsey's finance industry please visit www.weareguernsey.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.