ESG Compliance and Green Disclosure Obligations
In recent years, Environmental, Social and Governance (ESG) considerations have rapidly evolved into a core compliance obligation driven by several key global regulatory changes. ESG compliance is no longer focused on the provision of corporate social responsibility initiatives. Instead, firms are now required to quantify and report on their ESG impacts in a similar way to traditional transaction reporting.
Key Regulation Changes for ESG Compliance
The introduction and evolution of several key frameworks have resulted in key changes to the ESG regulatory landscape:
- International Sustainability Standards Board (ISSB): Establishes a global baseline and informs the development of most national and regional regimes for sustainability disclosure requirements.
- Corporate Sustainability Reporting Directive (CSRD): Expands the scope of sustainability reporting within the EU, introducing “double materiality”, which requires firms to report on how sustainability issues affect their business (financial materiality) and how their business impacts the environment and society at large (impact materiality).
- Sustainable Finance Disclosure Regulation (SFDR): The EU’s anti-greenwashing transparency framework requires firms to classify their products under Articles 6, 8 or 9 and disclose how they integrate sustainability risks.
- European Sustainability Reporting Standards (ESRS): The detailed and mandatory “rulebook” for the CSRD specifies the reporting taxonomy that firms must use for their disclosures.
- Sustainability Disclosure Requirements (SDR): Implemented by the Financial Conduct Authority (FCA) for entity-level and product-level disclosure requirements for UK firms, designed to combat greenwashing and build trust in UK markets.
What are the Main ESG and Green Disclosure Challenges for Firms?
There are several key challenges that firms may encounter when trying to meet all ESG disclosure requirements. The most common issue is that ESG data can be particularly hard to quantify and verify, especially as it relates to societal impacts or environmental factors. ESG regulations often have complex and unique reporting requirements, which means firms will need to develop new data collection and validation processes. All reporting carries the potential risks of accidental greenwashing through inaccurate or incomplete disclosures, which can result in compliance penalties but can often be hard to identify or avoid.
How can Firms Build a Robust ESG Compliance Framework?
The rising expectations for ESG compliance present a good opportunity for firms to prepare for enhanced disclosures with a proactive and structured approach. Firms should take the following steps now to prepare for further evolution in regulations:
- Establish clear internal governance: Define specific roles and assign clear lines of accountability for ESG data collection, verification and reporting.
- Invest in RegTech: Identify technology gaps with existing systems and implement RegTech solutions designed to manage ESG data and automate reporting.
- Correct product classification: Ensure the accurate classification of all financial products under the relevant frameworks, such as Article 6, 8 or 9 of the SFDR.
ESG is now an equally important part of regulatory compliance monitoring and should be considered in the same way as traditional financial reporting. Firms must invest in the systems and processes required to adapt to these evolving reporting standards, as failure to do so presents two significant risks. As stakeholders become increasingly interested in ESG compliance as a key metric, firms that prove to be reluctant to adapt could be seen as less attractive for global investment or for hiring top talent. Additionally, non-compliance with evolving ESG regulations will lead to severe financial penalties and significant reputational damage as financial services consumers become more aware of the impact of sustainable investing.
