ESG on the Move: Tracking the Shifting Global Rulebook

The concept of responsible investing, the precursor to ESG, dates back several decades. Socially Responsible Investing (SRI) gained traction in the 1970s and 1980s, driven by ethical concerns and social movements. However, the formal integration of environmental, social, and governance factors into mainstream investment and corporate practices began to solidify in the early 2000s. The term "ESG" itself gained prominence following the United Nations Global Compact's initiative in 2004.

Initially, ESG considerations were largely voluntary, with companies adopting sustainability practices and reporting based on their own discretion or in response to stakeholder pressure. However, as the financial materiality of ESG factors became increasingly evident – impacting risk management, operational efficiency, innovation, and reputation – the demand for more standardized and mandatory frameworks grew.

Several key milestones mark the evolution of ESG regulations:

• Early Disclosure Initiatives: Organizations like the Global Reporting Initiative (GRI), founded in 1997, aimed to provide frameworks for companies to voluntarily report on their environmental, social, and governance performance. These early initiatives laid the groundwork for broader ESG awareness and reporting.
• The Rise of Mandatory Reporting: The late 2010s and early 2020s witnessed a significant shift towards mandatory ESG reporting in various jurisdictions. The European Union's Non-Financial Reporting Directive (NFRD), implemented in 2018, required large public-interest companies to disclose information on environmental, social, and employee matters, respect for human rights, and anti-corruption and bribery.
• Focus on Climate-Related Disclosures: The Task Force on Climate-related Financial Disclosures (TCFD), established in 2015, provided recommendations for companies to disclose clear, comparable, and consistent information about the risks and opportunities related to climate change. While initially voluntary, the TCFD framework has been increasingly adopted or incorporated into mandatory regulations globally.
• Regulatory Focus on ESG Ratings: Recognizing the growing influence of ESG ratings on investment decisions, regulators have started to pay closer attention to the methodologies and transparency of ESG rating providers. Initiatives are underway in several regions to bring ESG rating activities under regulatory oversight.

TRACKING THE PULSE OF GLOBAL POLICY CHANGES

The current landscape of ESG regulations is diverse and rapidly evolving, with different regions and countries adopting varying approaches. Some key trends and regulations include: 

Europe: The European Union has been at the forefront of developing comprehensive ESG regulations. Notable initiatives include:

• Corporate Sustainability Reporting Directive (CSRD): Building on the NFRD, the CSRD, which came into force in January 2023, significantly expands the scope and detail of sustainability reporting requirements. It applies to a wider range of large companies, including non-EU companies with significant activity in the EU, and mandates reporting according to more detailed standards, including a "double materiality" perspective, considering both the company's impact on people and the environment and how sustainability issues affect the company financially. The first set of companies will need to apply the new rules for the first time in the 2024 reporting year, for reports published in 2025.
• Sustainable Finance Disclosure Regulation (SFDR): Implemented in March 2021, the SFDR aims to increase transparency on sustainability risks and impacts within the financial services sector. It requires financial market participants to disclose how they integrate sustainability risks into their investment decisions and provide information on the sustainability characteristics or objectives of their financial products.
• EU Taxonomy Regulation: This regulation establishes a classification system ("taxonomy") to define which economic activities are environmentally sustainable. It aims to channel investments towards green activities and prevent "greenwashing." Companies covered by the CSRD will be required to disclose how and to what extent their activities are aligned with the EU Taxonomy.
• Corporate Sustainability Due Diligence Directive (CSDDD): This proposed directive aims to hold companies accountable for their impact on human rights and the environment across their value chains. It would require companies to identify, prevent, mitigate, and account for adverse sustainability impacts in their own operations, their subsidiaries, and their business relationships. The directive is expected to be implemented in the coming years.
• Carbon Border Adjustment Mechanism (CBAM): Introduced to address the risk of carbon leakage, CBAM imposes a carbon tax on imports of certain carbon intensive goods into the EU from countries with less stringent climate policies. This mechanism indirectly incentivizes higher environmental standards globally.

United States: While the US does not have a federal mandate for comprehensive ESG reporting, there is increasing regulatory focus, particularly from the Securities and Exchange Commission (SEC):

• SEC Climate-Related Disclosures: In March 2024, the SEC finalized rules requiring public companies to disclose climate-related information, including greenhouse gas emissions (for large companies), climate-related risks, and their governance and risk management processes related to climate change. These rules aim to provide investors with consistent and comparable information to make informed decisions. However, these rules are currently facing legal challenges.
• State-Level Initiatives: Several US states, like California, have introduced their own climate disclosure requirements, often going beyond the federal proposals
• Focus on ESG Investing: The Department of Labor has issued guidance clarifying that retirement plan fiduciaries can consider climate change and other ESG factors when making investment decisions.

United Kingdom: The UK is also actively developing its ESG regulatory framework:

• Taskforce on Climate-related Financial Disclosures (TCFD) Alignment: The UK government has mandated TCFD-aligned disclosures for a wide range of companies, including publicly listed companies, large private companies, and financial institutions.
• UK Sustainability Reporting Standards (SRS): The UK is working towards implementing its own Sustainability Reporting Standards, which are expected to be aligned with the International Sustainability Standards Board (ISSB) standards.
• Modern Slavery Act 2015: This act requires large businesses operating in the UK to publish a statement outlining the steps they have taken to ensure that slavery and human trafficking are not taking place in their supply chains.

Asia-Pacific: The ESG regulatory landscape in the Asia-Pacific region is diverse, with varying levels of development across countries:

• Mandatory Reporting in Some Jurisdictions: Countries like Singapore and Malaysia have implemented mandatory ESG reporting requirements for listed companies, often focusing on specific areas like climate-related disclosures. Singapore, for instance, will align its sustainability reporting with ISSB standards, requiring Scope 1 and 2 GHG disclosures for listed companies in 2025, with Scope 3 disclosures and emissions assurance to follow.
• Market-Driven Adoption: In other countries, such as Japan and Australia, ESG adoption is more market-driven, with stock exchanges and investor groups playing a significant role in promoting ESG disclosure. However, regulatory developments are also underway to enhance standardization and comparability.
• China's Growing Focus: China has been increasingly emphasizing ESG in its national policies, with guidelines for green finance and a growing expectation for companies to disclose environmental and social information.

INTERNATIONAL STANDARDS AND INITIATIVES:

International Sustainability Standards Board (ISSB): Established by the IFRS Foundation, the ISSB aims to develop a global baseline of high-quality sustainability disclosure standards to meet the information needs of investors. Its first two standards, IFRS S1 (General Requirements for Disclosure of Sustainability-related Financial Information) and IFRS S2 (Climate related Disclosures), were issued in June 2023 and are expected to be adopted by various jurisdictions globally. Canada, for example, launched its Canadian Sustainability Disclosure Standards (CSDS) in December 2024, aligning with IFRS S1 and S2.

Task Force on Nature-related Financial Disclosures (TNFD): Following the TCFD model, the TNFD provides a framework for organizations to report on their nature-related dependencies, impacts, risks, and opportunities. While still in its early stages of adoption, it is expected to play an increasingly important role in corporate reporting.

REGULATIONS FOR ESG RATING AGENCIES

Given the significant influence of ESG ratings on investment decisions and corporate behavior, there is a growing global focus on regulating ESG rating agencies to enhance transparency, comparability, and prevent conflicts of interest.

• European Union: The EU has reached a political agreement on a new regulation for ESG rating activities. This regulation aims to make ESG ratings and their underlying methodologies more transparent, strengthen the governance of ESG rating providers, and ensure their independence. ESG rating providers offering services to investors and companies in the EU will need to be authorized and supervised by the European Securities and Markets Authority (ESMA).
• United Kingdom: HM Treasury has consulted on a potential new regulatory regime for ESG ratings providers, which would bring them under the regulatory perimeter of the Financial Conduct Authority (FCA). The proposals aim to improve transparency and promote good conduct in the ESG ratings market, covering a broad range of ESG-linked data and ratings products.
• India: The Securities and Exchange Board of India (SEBI) has introduced regulations for ESG rating providers, mandating that no entity can act as an ESG rating provider without a certificate from SEBI. These regulations also specify transparency and disclosure requirements for ESG ratings, and the methodologies used.
• International Organization of Securities Commissions (IOSCO): IOSCO has also been actively working on recommendations for ESG rating providers, focusing on transparency, good governance, management of conflicts of interest, and robust systems and controls.

What’s Holding ESG Back—And What’s Driving It Forward

Despite the significant progress in ESG regulations, several challenges remain:

• Lack of Global Consistency: The fragmented nature of ESG regulations across different jurisdictions creates complexity for multinational companies and investors. Achieving greater harmonization of reporting standards and regulatory frameworks is crucial.
• Data Quality and Comparability: Ensuring the quality, reliability, and comparability of ESG data remains a significant challenge. Differences in reporting frameworks, methodologies, and the scope of reported information can hinder meaningful analysis and comparison.
• Greenwashing: The risk of "greenwashing," where companies or financial products misrepresent their sustainability efforts, remains a concern. Robust regulations and effective enforcement mechanisms are needed to address this.
• The Role of ESG Ratings: Ensuring the transparency and reliability of ESG ratings is critical. Ongoing regulatory efforts aim to address concerns about methodologies, conflicts of interest, and the lack of comparability among different rating agencies.
• Evolving Scope of ESG: The understanding of what constitutes material ESG factors continues to evolve, with increasing attention on areas like biodiversity, human capital, and supply chain resilience. Regulations need to be adaptable to these evolving priorities.
• Looking ahead, the future of ESG regulations is likely to be characterized by:
• Greater Convergence and Standardization: Increased efforts towards global harmonization of reporting standards, potentially driven by the ISSB and other international initiatives.
• Enhanced Focus on Data and Technology: The use of technology, including AI and data analytics, will likely play a greater role in ESG data collection, analysis, and reporting, improving efficiency and accuracy.
• Increased Regulatory Scrutiny: Regulatory bodies are expected to continue to enhance their oversight of ESG disclosures and rating agencies to ensure compliance and prevent greenwashing.
• Integration of Double Materiality: The concept of double materiality, as seen in the EU's CSRD, is likely to gain traction globally, requiring companies to report on both their impact on the environment and society and the financial risks and opportunities arising from sustainability issues.
• Expansion of Scope: ESG regulations may expand to cover a wider range of companies and sustainability topics, reflecting the growing recognition of the interconnectedness of ESG factors with financial performance and systemic risks.

ALIGNING PURPOSE, POLICY, AND PERFORMANCE

ESG ratings and the regulations surrounding them are at a critical juncture. The evolution from voluntary guidelines to mandatory requirements reflects the increasing recognition of the importance of sustainability in the global economy. While the current regulatory landscape is complex and fragmented, the trend towards greater transparency, standardization, and regulatory oversight is clear. As regulations continue to evolve and converge, they will play a crucial role in driving more sustainable corporate behavior, fostering greater accountability, and enabling investors to make more informed decisions, ultimately contributing to a more resilient and sustainable global economy.