Sustainable finance fundamentally refers to the channelling of finance flows towards green and/or social initiatives. We saw a whole host of sustainable finance-related developments in 2021 – many of which will continue to dominate in 2022.
Lucy Dwyer, Associate Director for Sustainable Finance and ESG Strategy, unpacks five sustainable finance topics to watch out for in 2022.
1. Alignment to the EU Taxonomy and the SFDR
Central among the trends will be financial institutions seeking to show their funds’ alignment with Article 8 or Article 9 of the EU’s Sustainable Finance Disclosure Regulations (SFDR). This will place renewed pressure on firms to understand the EU Taxonomy.
The EU taxonomy, formally adopted in 2021, was designed to reduce the risk of greenwashing of financial products by providing a classification system; an activity that is ‘taxonomy aligned’ is considered sustainable under the EU Green Deal. Supporting guidance for classifying whether goods or services support climate change adaptation and mitigation was published late in 2021 (and has been applicable since January 2022) and further guidance is expected later in 2022 for the remaining four objectives, namely water, circular economy, pollution, and biodiversity. This expansion will widen the scope of what is considered sustainable, allowing more companies to be eligible for the taxonomy. More broadly, we expect there to be more focus on social impact and the just transition especially given the economic climate and rising energy costs.
2. ESG-linked products are on the rise
In addition to increasing numbers of funds of real assets aligning with sustainable goals, there is an increased focus on debt products. 2021 saw an exponential increase of sustainable debt issuance, totalling $960 billion, according to the Environmental Finance Bond Database; up 61% from 2020. We expect continued growth but also continued scrutiny to avoid greenwashing. Inconsistencies in labelling, reporting, and data disclosures are driving fragmentation of this market as institutions create their own innovative approaches. Market participants, therefore, need to work to instil consistent standards of performance metrics and sufficiently ambitious targets to ensure the integrity of the sustainable debt market.
The ISSB has the goal of cutting through disclosure confusion and providing investors and capital markets participants with consolidated information on a company’s sustainability-linked risks and opportunities, allowing them to make informed decisions.
3.The development of standards is moving at pace
Perhaps the most exciting development for standards in 2021 was the launch of the International Sustainability Standards Board (ISSB), signalling a shift toward a global reporting standard and away from the existing ‘alphabet soup’, including Sustainability Accounting Standards Board (SASB) and Task Force on Climate-related Financial Disclosures (TCFD). We expect a draft of these standards in the second half of 2022, accelerating the move to a global standard. Prototypes are already available on the ISSB website, providing stakeholders with a good idea of how to report on sustainability-linked risks and opportunities.
Also of note is the Corporate Sustainability Reporting Directive (CSRD), which was proposed in April 2021. A draft of the first set of CSRD standards is expected to be agreed on by EU Institutions in the second half of 2022. This will broaden the scope of entities the current EU directive covers and increase the level of detail of non-financial information that companies must report on, including the concept of double materiality and reporting in line with the EU Taxonomy and SFDR.
In March 2022 we also saw the launch of the beta version of the Taskforce for Nature-related Financial Disclosures (TNFD). The TNFD recommends disclosures for financial services and corporates that capture nature-related risks, such as biodiversity loss and ecosystem degradation. This will come into force in 2023 but in preparation, and considering the complex nature of the topic, it will be prudent for organisations to start considering now how they might expand their data models and processes to capture relevant data.
Overall, we expect to see advancement in companies’ non-financial reporting activities in preparation for these developments.
We expect to see an acceleration of companies seeking to understand their climate risks and planning ways to mitigate, adapt and strategise on how these impacts will affect the future of their business.
4. The US is catching up with Europe
On the 21st of March 2022, the U.S. Securities and Exchange Commission (SEC) announced a new measure that will require U.S. listed companies to report detailed disclosures on climate risk and greenhouse gas (GHG) emissions and voted in favour of the proposal 3 to 1. The proposed rule for climate risk disclosure aligns with the Task Force on Climate-Related Financial Disclosures (TCFD) framework and the Greenhouse Gas Protocol.
This new measure marks the biggest shift in U.S. corporate disclosure policy since the post-2008 financial crisis. It will bring additional transparency to shareholders weighing climate risk and greenhouse gas emissions exposure in their investments. The U.S. follows over 30 regions that have already taken action to mandate climate risk disclosure.Depending on the company’s filer type, the rules will take effect as soon as the fiscal year 2023 (to be filed in 2024).
5. Active ownership – stewardship – will continue to increase.
Shareholder action is on the rise, and there is increasing pressure on boards to upskill on ESG matters and be held accountable. For example, May 2021 saw the ousting of two of Exxon’s board members for failure to do enough to address climate change, and, in March 2022, a landmark case was announced against Shell’s directors for failing to prepare the company for net zero.
Investors have an important role to play to prepare companies for the risks of climate change as part of their fiduciary duty to assess long term value drivers. We expect to see an increase in investor scrutiny of company transition plans and resultant voting – either for the plans themselves or the company directors.
Finally, given the situation in Ukraine, there has been a rapid refocus on what is defined as an ethical or responsible investment, beyond a high ESG score. The need to ween off Russian oil may also stimulate markets to focus more on green investments.
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