Companies around the world are facing a moment of truth regarding the sustainability of their operations. Driven by a combination of regulation, investor and/or peer pressure, the ESG agenda has morphed into sustainable finance regulations that are rapidly permeating all areas of economic activity.
This is primarily a consequence of the climate emergency, which requires an unprecedented funding effort to re-engineer the global economic system. The Financial Stability Board estimates global investment of $1 trillion per year is required, while the European Commission estimates that at least an additional €180 billion per year is needed in Europe.
But the Covid-19 pandemic and the subsequent need to achieve a fair economic recovery (under the theme of ‘build back better’) have also highlighted the social and governance dimensions of sustainable finance underpinning the EU’s policy-making. To some extent these aspirations are not new. The integration of ESG factors in the investment process has been championed by a proactive community of institutional asset managers and asset owners for the last 15 years (led by the UN-backed Principles for Responsible Investment). What is new however is that regulation is helping embed these expectations across the financial system and, by implication, the broader economy.
Multiple and cross-cutting regulatory requirements are becoming interwoven with competitive pressures, investors’ agendas, and broader reputational risk. The level of granularity and scrutiny around climate in particular means that reliance on high level CSR-style narratives that may have been deployed in the ESG space is no longer an option. Adapting to these new and multiple pressures will often dovetail for individual companies with a wholesale review of their corporate strategy and purpose.
The first elements of the EU sustainable finance agenda (proposed in 2018) have already enacted into law (albeit without their detailed rules or implementing legislation which is still under construction). The fact that the primary legislation is already in place however, has important implications both in terms of the extraterritorial reach of these laws (the so-called ‘Brussels effect’), and how that will evolve as sustainable finance regulations in other countries are developed and come online, as well as substantive lessons that can be learned by other jurisdictions regarding the design and scope of their own statutory requirements.
While the EU has long been a first mover on sustainable finance, this is increasingly becoming a global agenda. The G7 Finance Ministers meeting in June agreed ‘to move towards mandatory climate-related financial disclosures that provide consistent and decision-useful information for market participants and that are based on the Task
Force on Climate-related Financial Disclosures (TCFD) framework, in line with domestic regulatory frameworks.’ They also acknowledged the need to agree ‘a baseline global reporting standard for sustainability,’ so that these disclosures yield consistent and decision-relevant information.
The finance sector is under pressure to redirect capital and put it to more sustainable uses. This in turn has put the spotlight on companies and how they are responding to these pressures and navigating this complex and fraught business environment.