ESG Regulatory Essentials

Progress toward wider adoption of ISSB standards 

The ISSB has welcomed consultations on the adoption of its sustainability-related standards in several jurisdictions. Consultations are in progress in Canada and Japan, with deadlines of 10 June and 31 July respectively. Australia, Singapore and Malaysia have recently conducted consultations, and Brazil, Costa Rica, Sri Lanka, Nigeria and Turkiye have already confirmed adoption of the standards. The UK government is expected to endorse the ISSB standards as part of the creation of UK Sustainability Disclosure Standards (SDS) by July 2024. 

 ISSB 2-year workplan

On 23 April, the ISSB will vote on topics to include in its future workplan. A staff working paper, which considers responses received in the now-closed public consultation, will form the basis for ISSB board discussion. The paper recommends that nature and human capital issues be added to the workplan, and suggests rejecting proposals to include human rights, reporting integration and other sustainability-related themes. 

TPT publishes final set of transition plan resources 

The TPT has published its final set of sector-specific guidance including considerations for banks, asset owners, asset managers and insurers (the latter in a separate document covering several sectors) when disclosing their transition plans. The guidance is intended to be used as 'internationally recognised best practice'. 

The TPT also published several papers from its working groups, including a report that considers how its approach to climate transition planning could be applied to nature objectives and makes recommendations for the UK government, regulators and policymakers. 

While the TPT guidance and working papers are non-binding, the FCA will consult in 2024 on how to integrate the output into its disclosure requirements. Companies and firms should therefore consider how to apply the guidance to pre-empt any formal regulatory requirements. 

EFRAG request for input to transition plan implementation guidance 

EFRAG is preparing guidance to support companies in making the transition plan disclosures required under the CSRD (in line with ESRS E1). It is seeking input from a diverse group of companies, including financial services firms, on a variety of practices and challenges related to disclosing transition plans. Engagement will take place throughout April and May, with a deadline of 23 April 2024 to express interest in participation. 

EFRAG releases first set of technical Q&As on ESRS

EFRAG has published a first set of explanations on the ESRS Q&A platform to assist firms in making appropriate disclosures under the CSRD. The explanations are provided where the content of the ESRS already provides an appropriate answer, but the need has arisen for signposting or non-technical clarification. They create no new obligations and do not form new technical standards. Firms can use the explanations alongside the ESRS to understand how and what to disclose.  

TPR publishes review of pension schemes' climate-related disclosures 

TPR has published a review of the climate-related disclosures made by occupational pension schemes with more than £1 billion in assets under management. It identifies examples of good practices as well as areas for improvement across the disclosure pillars of governance, strategy, scenario analysis, risk management, and metrics and targets. Pension trustees should review the findings and consider how to incorporate the suggested improvements in future disclosures. 

FCA anti-greenwashing guidance

The FCA has published final guidance for firms to meet their obligations under the its anti-greenwashing rule. From 31 May, the anti-greenwashing rule will require all communications to clients in the UK made by FCA-authorised firms about sustainability-related financial products and services to be ‘fair, clear and not misleading’, and to be consistent with the sustainability characteristics of the product or service. The rule will only apply to communications to users in the UK, and financial promotions approved for communication to persons in the UK. Notably, since its original consultation, the FCA has clarified that firm-level disclosures and the claims firms make about themselves are outside the scope of the anti-greenwashing rule. However, these add to the overall picture of firms and, as such, should be considered by them when assessing how users are likely to understand their sustainability-related claims. Firm-level disclosures and claims are subject to other expectations and rules, including those of the CMA and ASA.

PRA Business Plan reaffirms focus on climate-related risks 

The PRA's 2024/25 Business Plan reaffirmed its commitment to managing the financial risks of climate change as part of its strategic priority to `be at the forefront of identifying new and emerging risks and developing international policy'. In 2024, the PRA will publish thematic findings on banks' processes to quantify the impact of climate risks on expected credit losses, and will commence work on updating SS3/19 for banks and insurers. 

EIOPA consults on recalibrated natural catastrophe parameters in the standard formula 

EIOPA is consulting until 20 June on proposed changes to the natural catastrophe (nat cat) parameters of the standard formula (SF). Having last assessed the parameters in 2018, EIOPA is proposing amendments to multiple perils: flood, hail, earthquake, windstorm and subsidence. It will monitor the impact of other perils such as wildfire, coastal flood and drought to make a future assessment on their potential inclusion in the nat cat SF parameters. 

EIOPA is also adding countries previously excluded from the parameters as a result of the increased severity and frequency of nat cat events in Europe. 

EIOPA has affirmed its commitment to ensuring the continued protection of policyholders and the stability of the EU's insurance market, noting that it is important for insurers' capital requirements to reflect the expected impact of climate change.

IAIS consultation on climate risk supervisory guidance 

The International Association of Insurance Supervisors (IAIS) has launched its third consultation on proposed changes to guidance in its Insurance Core Principles (ICPs) to better incorporate climate risk. The first and second consultations were conducted in 2023 and were covered in previous editions of ESG Regulatory Essentials. The fourth and final will take place later in 2024 covering issues including supervisory reporting and public disclosures. The IAIS will respond to each consultation at the end of the project.

The current consultation closes on 19 June and proposes the following changes to ICP guidance: 

• ICP 15 (regulatory investment requirements): additions are made to ensure that insurers consider climate risk holistically in investment risk assessments — e.g. how climate change has been factored into ratings and over what time horizon, considering climate change risk in traditional risk categories such as credit, market, reputational and strategic risk, considering how climate change may impact asset-liability matching especially for liabilities with a long duration etc. 

• ICP 16 (enterprise risk management [ERM] requirements): ERM frameworks must consider climate risk and other emerging risks, incorporating elements such as varying time horizons and scenario analysis. Analysis on an insurer's exposure to climate-related risks over the short, medium, and long term should be included in the ORSA.

BCBS discussion paper on climate scenario analysis 

The Basel Committee on Banking Supervision (BCBS) has published a discussion paper on the role of climate scenario analysis in strengthening the management and supervision of climate-related financial risks. It is seeking stakeholder feedback until 15 July, before issuing additional materials that complement the work of the Financial Stability Board (FSB) and the Network for Greening the Financial System (NGFS). The key areas of focus are:

• Risk identification
• Risk management processes
• Internal and supervisory capital and liquidity assessments 
• Assessment of business model resilience and business strategy building 
• Constraints for the application of scenario analysis and stress testing
• The key features and usage-specific considerations of climate scenario analysis

BoE bulletin on measuring climate-related financial risks using scenario analysis

The BoE has published a bulletin focusing on how firms can use scenario analysis to quantify physical and transition risks. The bulletin considers the extension of macro-climate scenarios to undertake granular asset-level analysis of financial risks, using sovereign and corporate bonds as well as residential mortgages as examples. It also explores how scenario analysis outputs can be applied to firms’ existing financial modelling toolkits.    

ECB updates modelling guidance for climate and environment-related risks

In February, the ECB published its final revised guide to internal models together with a feedback statement. The guide clarifies the rules for banks' internal models and covers topics including credit risk, market risk and counterparty credit risk — the ECB notes that, where relevant and material, institutions should include climate-related and environmental risk drivers in the internal models approved for use for the calculation of credit and market risk own funds requirements.

ECB working paper on bank climate commitments and lending and engagement activities 

The ECB has published a working paper that evaluates the impact of banks' voluntary climate commitments on their lending behaviour. The ECB used data on bank lending from 19 European countries and found that:

1) Many banks have signed up to green initiatives,  particularly larger banks. However, at a global level, larger banks tend to lend more to “brown” sectors (e.g. mining) than banks which do not sign up.  

2) There was no evidence of divestment by climate-aligned banks from targeted sectors. 

3) Climate-aligned lenders have a slightly higher rate of entry into new relationships with firms in high-emissions targeted sectors. 

4) Companies borrowing from Net-Zero Banking Alliance (NZBA) banks are not more likely to themselves set a decarbonisation target. 

Overall, the results cast doubt on the efficacy of voluntary climate commitments for reducing financed emissions, whether through divestment or engagement. This aligns with recent efforts by governments to improve the credibility of net zero commitments.

GARP survey on nature risk management at financial firms   

The Global Association of Risk Professionals (GARP) has published its first global survey of nature-related financial risk management across financial services firms. The survey of 48 firms (37 banks, seven asset managers and four insurers) found that:

• There is a growing regulatory focus on nature risks.
• Boards at nearly half of the firms had oversight of nature-related risks and opportunities.
• C-suite executives at around two thirds of the firms were accountable for nature-related risk assessments and management efforts.
• However, nature risk is relatively new for many firms and maturity levels on strategic engagement are relatively low.
• Only 17 per cent of the firms were using metrics, targets or limits to address drivers of nature-related risks.
• Availability of data and models were firms’ greatest short-term concerns, and nature scenario analysis was not widely used.
• Staff training on nature-related risk is increasing.

GFI report on nature degradation 

The Green Finance Institute (GFI), with input from other scientific and financial experts, has published a report quantifying the impact of nature degradation on the UK’s economy and financial sector: an estimated 12% loss to GDP and up to 4–5% loss in the value of banks’ domestic portfolios ‘in the years ahead’. The GFI notes that these estimates are likely to be conservative, indicating that nature-related risk will impact not just the economy but potentially also financial stability. 

For FS firms, the GFI recommends integrating nature within transition plans and working with clients to support their transition. For central banks and regulators, it recommends:

• Advancing disclosures of nature-related risks and impacts in the UK; and 
• Broadening supervisory statements on climate to explicitly include environmental risks and incorporating aspects of environmental degradation into exploratory scenario exercises.

ESMA consultation on ESG factors in credit ratings  

In response to a request by the European Commission, ESMA is consulting on amendments to explicitly include ESG factors in the Credit Ratings Delegated Regulation and technical annex. Proposed changes include:

• Inclusion of reference to 'ratings outlook'
• Clarification of the term 'methodology' 
• Integration of ESG factors
• Information to be included in a methodology

The consultation closes on 21 June, after which a report will be delivered to the European Commission. 

ESMA consultation on external reviewers under the EU Green Bond Regulation

Following finalisation of the EU Green Bond Standard (EU GBS) in December 2023, ESMA is consulting on rules for the authorisation of external reviewers of instruments issued under the EU GBS. The rules cover requirements for technical competencies, ethics and independence, outsourcing arrangements and procedures for providing registration information. The consultation closes on 14 June 2024, with final RTS to be submitted by 14 December 2024.

ESMA call for papers for its 2024 Research Conference

ESMA has announced a call for papers ahead of its 2024 Research Conference, which will focus on issues such as the impact of environmental risks on EU financial market players, the short- and long-term risks in the transition to a sustainable economy, and existing micro- and macro-prudential toolkits to address the challenges of a riskier macroeconomic environment. ESMA invites papers by 30 May on:

• Modelling environmental risk exposures and impacts: climate stress testing, transition risk, physical risk, and biodiversity risk. 
• Measuring and understanding ESG factors: ESG metrics, disclosure and reporting standards, AI models, greenwashing in the financial sector, retail investor perception of ESG characteristics, and ESG factors beyond environmental aspects. 

HMT consultation on UK carbon border adjustment mechanism

The UK government is consulting on the introduction of a carbon border adjustment mechanism (CBAM) which would equalise the carbon-related tax burden for imports and UK products. The UK CBAM would impose a tax on carbon emitted in the production or manufacture of imports where these have not already been taxed at the same level as if produced in the UK. The proposed UK CBAM follows the EU model already in operation, including a phased implementation that would prioritise the most carbon-intensive imports. The scheme does not directly affect financial services firms but may have a downstream impact.

UK Treasury Committee recommends amendments to FCA/PRA D&I proposals 

In March, the House of Commons Treasury Committee published a report on 'Sexism in the City'. One of the Committee's recommendations was that regulators drop their plans for extensive diversity data reporting and target setting (outlined in CP18/23 and CP23/20), as the requirements would be costly for firms to implement and could result in many firms treating them as a `tick-box' compliance exercise. The Committee recognised that lack of diversity is a problem but noted that boards and senior leadership of firms should take greater responsibility for improving diversity and inclusion. It also recommended that the thresholds for gender pay gap reporting should be lowered to include most financial services firms, including hedge funds and smaller firms.