ESG Disclosure: Why Only the Development of a Global Standard Can Further Enhance Sustainability Practices in the Financial Sector
Providing environmental, social, and governance (ESG) information is now a fundamental part of companies’ reporting activities. [Editor’s note: Practices differ depending on global region.] Today, investors can have access to a myriad of ESG information. This information, however, is rarely valuable because of its poor consistency and comparability. Setting a single disclosure standard would be a key step toward more comparable and better audited data, which would be more useful and less confusing to investors.
CFA Institute has been exploring the development of a voluntary global ESG standard for investment products. We recently launched a public consultation seeking feedback on the scope, structure, and design of the proposed ESG standard. Stakeholders are invited to provide their input, which will help us develop the first version of this standard, by Monday, 19 October 2020.
In the European Union (EU), ESG disclosure is covered under the Regulation on Sustainability‐Related Disclosures in the Financial Services Sector (SFDR), which was adopted last year. Specifically, SFDR requires financial market participants and advisers to publish information on their policies of integration of sustainability risks in their investment decisions or advice on their website. Investment firms and advisers also must disclose whether they look at the principal adverse impact of their economic activities, or must explain why they do not do so.
Recently, the European Supervisory Authorities (ESAs) jointly produced their draft regulatory technical standards (RTS) on content, methodologies, and disclosures of ESG information, which pertained to the requirements under the SFDR. CFA Institute responded to the public consultation that the ESAs launched to get stakeholders’ feedback on the RTS.
CFA Institute supports the approach that the ESAs have taken on the disclosures that should be included in the description of adverse sustainability impact of investment decisions. The ESAs produced a template on the adverse sustainability statement that financial market participants and investment advisers need to publish on their website. The template looks comprehensive and includes detailed adverse sustainability indicators for climate and environmental issues as well as social and employee, human rights, and anticorruption and antibribery matters.
The metrics that the ESAs have proposed seem to be appropriate for the present time. We emphasize, however, that these should be periodically reviewed as the necessary disclosures that the industry demands are expected to evolve over time. Investors may demand different, or more detailed, types of ESG information in the future. The ESAs, therefore, should reassess the content of the required ESG data and the related indicators regularly so that they remain appropriate.
We believe that future disclosures should be provided on the proportion of ESG data that has been audited and how this has been assured. The EU should have further discussions on how to make the required ESG data more comparable and reliable and to ensure that it is disclosed in a timely manner. The lack of these characteristics and historical data history represents a significant barrier to the increased development of sustainability practices in the financial sector. At present, however, our expectation is not to see perfectly qualitative ESG information, but rather to ensure that the disclosure is improved in the future.
Another aspect that the EU should address is the poor clarity surrounding some of the disclosure requirements in the Regulation and, specifically, between the definitions under the SFDR and the EU Taxonomy Regulations. The SFDR captures not only climate and environmental issues but also social and governance aspects, whereas the scope of the EU Taxonomy concerns only environmentally sustainable activities. The lack of alignment between these two pieces of legislation may mislead investors as products could be marketed as sustainable even though they do not have specific ESG characteristics.
Although compliance with the EU Taxonomy is not mandatory, the required indicators under the SFDR also could include one measuring the proportion of alignment of a financial product or activity with the EU Taxonomy. This may help investors better understand the climate and environmental impact of a product and could facilitate the comparison between two different products.
The SFDR also distinguishes between transparency requirements to be disclosed in precontractual documents and those to be published in periodic reports. The ESAs finds it to be difficult to balance these two types of disclosure. CFA Institute has argued that most ESG disclosures should be made available first for prospective clients in precontractual documents as these investors look for this information when comparing products and making their final investment decisions. These same disclosures also could be provided on the investee companies’ websites, but their inclusion in precontractual documents should be prioritized as this would be more helpful for investors.
The SFDR is a first step toward harmonization of ESG disclosure in the EU. To successfully transition to a sustainable economy, however, the EU needs a single disclosure standard, as well as timely, comparable, and auditable data. The ESAs are now expected to deliver their final RTS on ESG disclosures, which will need to be adopted by the European Commission by 30 December 2020. The requirements under the SFDR will become applicable from 10 March 2021.
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