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ESG regulation is changing: your guide to what’s coming up

As we’re increasingly seeing and feeling the effects of climate change, social inequality and poor corporate governance across the world, regulators are taking steps to reform and move forward ESG-related legislation, expanding the scope of ESG regulation and introducing greater clarity for businesses and investors.

Over the next 12 months we’re set to see a number of new pieces of legislation introduced in the UK and EU, as well as significant changes to existing rules.

Here, we share some of the key changes coming down the line that will impact fintech and financial companies:

Taskforce on Nature-related Financial Disclosure (TNFD) framework

The TNFD has been developing a risk management and disclosure framework for organisations to report and act on evolving nature-related risks. The aim is that by following the framework, businesses will facilitate a shift in global financial flows away from nature-negative outcomes and toward nature-positive outcomes.

It will not be mandatory for businesses to follow the TNFD framework initially, but this may change for some businesses in the future.

The beta framework has been published, with final recommendations being published in September 2023.

Find out more:

International Financial Reporting Standards S2 (IFRS S2) — Climate-related Disclosures

An addition to the UK’s International Financial Reporting Standards, the objective of IFRS S2 is to require entities to disclose information about its climate-related risks and opportunities that is useful to users of general purpose financial reports in making decisions relating to investing in the entity. Businesses will be required to disclose information about climate-related risks and opportunities that could reasonably be expected to affect the entity’s cash flows, its access to finance or cost of capital over the short, medium or long term.

IFRS S2 was issued in June 2023 and applies to annual reporting periods beginning on or after 1 January 2024.

Corporate Sustainability Reporting Directive (CSRD)

This update to EU legislation requires companies to report regularly on the effect of their activities on people and the environment.

The aim is to place sustainability reporting on an equal footing with financial reporting, responding to the increase in demand for information on the part of the investment community and providing access to reliable and comparable data.

The directive introduces more detailed obligations regarding the impact that companies have on the environment, human rights and social matters, based on common standards in line with the EU’s climate objectives.

Reporting will be required for the 2024 financial year for companies already subject to the EU Non-Financial Reporting Directive (NFRD).

EU Sustainability Reporting Standards (ESRS)

On 31 July 2023, the European Commission adopted a Commission Delegated Regulation with the first set of the long-awaited European Sustainability Reporting Standards (ESRS)

The ESRS create a common framework for sustainability reporting and support the operation of the EU Corporate Sustainability Reporting Directive 2022 (CSRD)

The ESRS significantly expands the scope of EU sustainability reporting.

Under the new rules, over 50,000 companies will be required to provide sustainability disclosures, up from around 12,000.

The ESRS is aimed as a major update to the 2014 Non-Financial Reporting Directive (NFRD) and introduces more detailed reporting requirements on company impacts related to the environment, human rights, social standards, and sustainability-related risks.

The proposed date of application is 1 January 2024 for businesses already subject to the Non-Financial Reporting Directive.

Sustainable Finance Disclosure Regulation (SFDR)

In April 2023, the EU Commission opened a consultation on a number of changes to the SFDR Level II rules, including:

  • extending the list of social indicators for principal adverse impacts (“PAIs”);

  • improving the definitions, methodologies, metrics and presentation for various PAI indicators;

  • extending disclosures (and related reporting) under the “do no significant harm” (“DNSH”) principle;

  • introducing new disclosures regarding greenhouse gas (“GHG”) emissions reduction targets; and (v) proposing changes to the templates for pre-contractual and periodic disclosures.

There is no current date for application, the consultation closed in early July and the results will soon be published.

FCA delays SDR policy statement until Q4 2023

In a further delay to the announcement of the final Policy Statement relating to the Sustainability Disclosure Requirements (SDR) and investment labels, the Financial Conduct Authority (FCA) now intends to publish the final rules in Q4 2023.

The SDR aims to ‘help the UK’s asset management sector thrive by setting standards that improve the sustainability information consumers have access to’.

DRWG consults on draft code of conduct for ESG ratings and data product providers

On 5 July 2023, the ESG Data and Ratings Code of Conduct Working Group (DRWG), the International Regulatory Strategy Group (IRSG) and the International Capital Market Association (ICMA) launched a consultation on a draft voluntary code of conduct for ESG ratings and data product providers. The code intends to enhance the consistency, transparency and accountability of ESG ratings and data. The code is intended to be internationally operable given that it is based on IOSCO principles. The consultation closes for responses on 5 October 2023. The DRWG intends to publish the final code at the end of 2023.

Changes to MSCI ratings (not linked to regulatory changes)

While not a change to regulation, in May 2023, changes to the MSCI’s Fund ESG Ratings methodology were introduced, aiming to raise the requirements for a fund to be assessed as “AA” or “AAA” rated, as well as to improve stability in Fund ESG Ratings and add transparency through simpler attribution analysis.

This means the distribution of the fund ratings will shift, and approximately 31,000 funds will see one-time downgrades as a result.

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