Policy in practice: sustainable finance

06 September 2023

In our latest policy in practice podcast episode, David Gauke, Rachel Richardson and Gavin Haran discuss all things sustainable finance.

They review the current landscape and significant policy developments from the last few months including;

  • the impact of the ISSB,
  • UK & EU taxonomy and disclosure requirements,
  • greenwashing concerns, and
  • the future of “ESG”.


David Gauke: Hello. This is David Gauke, head of public policy at Macfarlanes and welcome to the latest in our policy in practice podcasts. I'm delighted to be joined by Rachel Richardson, head of ESG at Macfarlanes, and Gavin Haran, head of policy in our asset management team and we are turning once again to the issue of green finance sustainability. We last looked at this in May where we did a podcast, which is available on Macfarlanes’ website, where we covered the Government's updated green finance strategy and we touched on sustainable finances as part of that, but a lot has happened since then and what we aim to do today is unpick a few elements of the complex landscape we find ourselves in today, so we want to look at what are the significant developments over the course of the last few months, because there's been quite a bit and I want to start off with Rachel, I'll ask you about this, the International Sustainability Standards Board (ISSB). Tell us a little bit about that. What is it? And what's happening?

Rachel Richardson: Good question. There's been a lot of coverage on it and it's useful to unpick that a little bit to kick off the podcast.

Well, the ISSB, you've already defined it, it's the International Sustainability Standards Board, so, it is the Board itself. It was launched at Cop 26 in November 2021 and it's actually the organization itself that is creating the sustainability related standards. It is not the standard itself. However, many people refer to the ISSB as the actual standard or standards that they're producing and, for the purposes of this podcast we might as well just do the same because that’s what people understand.

So, the ISSB board is actually part of the of IFRS Foundation, and the IFRS Foundation is the International Financial Reporting Standards Foundation, which will be very familiar to probably the majority of our listeners.

So, technically speaking, when people are talking about the ISSB standards, they're actually talking about two standards that we've got.

There's the IFRS S1, and S1 covers sustainability generally, and then there is also the IFRS S2, which covers climate specifically. But I think we will move to a world in which people refer to S1 and S2, rather than just the ISSB. But I suppose the most important thing to get across in terms of what it is, is it really is intended to be a global baseline for sustainability reporting. So, its aim is to provide something for everyone around the world.

David Gauke: So, is this a sign that we’re getting there when it comes to global coordination on sustainable finance? Or is this just another organisation and going to cause confusion and complexity? How positively do you think we should view the development of the ISSB and the production of its standards?

Rachel Richardson: Well, I think the answer is yes and yes, I think we do need another standard or standards, as it more accurately would describe it. Sustainability factors have become a really important part of investment decision making processes and that the landscape of the reporting frameworks is really fragmented at the moment.

In producing their standards, the ISSB really do hope to streamline some of that reporting for investors and what they've done when they've done it, is that they have incorporated the aspects of existing frameworks and disclosure regime. So, for example, anyone who has read a TCFD report or in fact, prepared one, or even read the still draft, TNFD (the nature equivalent of TCFD) they'll recognize the four familiar pillars that you report against so governance, strategy, risk management and metrics and targets. And S2 as well, so we had S1 and S2 and S2, which relates specifically to climate, that also requires scenario analysis, so really similar to what you do when you prepare a TCFD report. So, there's streamlining there.

There are also quite a few additional requirements over and above what you have to do when you report against TCFD, and we won't go into that in any particular detail, but there's things like reporting on how a business uses carbon offsets and there's requirement for Scope 3 reporting, for example.

On the sort of global coordination part of the question, a really good example of that is that IOSCO has come out, and they have recommended that the 130 member jurisdictions, that actually represent, regulators representing 95% of the world's financial markets, they have recommended that their members consider the ways in which they can adopt the ISSB standard, so that does represent a really good global coordination effort there in that recommendation, and, in fact, lots of countries have come forward and said that they are intending on making it mandatory, including the UK, of course.

David Gauke: So, there's quite a lot of momentum there, Rachel, really behind this?

Rachel Richardson: Yeah, there is a lot of momentum, but there is also a lot of duplication, or some people might just say that isn't duplication. So, for example, we also have European Sustainability Reporting Standards, and that's a standard which will sit alongside CSRD, which is EU regulation. Now, they have been streamlined with the ISSB standards, and we understand that a document is being prepared to help firms that have to disclose under both. However, they still maybe likely have to report through both initiatives, and in an economic environment where resources are pretty stretched, that is still relatively difficult; we haven't come together as well as perhaps we could. But also what they've managed to do with the ISSB is they've taken on the TCFD’s functions; they manage the SASB standards, which many of our listeners will be familiar with, and also they've managed to achieve that the CDP, the carbon disclosure project, next year for companies that disclose, they will be altering their reporting frameworks to include the requirements of IFRS S2. So, this convergence is happening. We've also got things like the Transition Plan Task Force Disclosure Framework that's working its way through and that's also building on the work of the TCFD and the ISSB, so both of those include a recommendation to prepare a transition plan and what the Transition Plan Taskforce is aiming to do is to help businesses achieve that and put that together. But one more point before we move on, is that the ISSB is really trying to streamline investor reporting and there are people that criticize the ISSB for being an example of what we call single materiality. So, their focus is on sustainability risks and opportunities as they affect the underlying business that's reporting or the underlying fund that's reporting. They're not trying to deal with the risk that that business or fund might have in relation to climate or a particular biosphere, or the environment more generally, they're subtly different. And they're criticized for that. But that's not their intention. They're not trying to do both there.

David Gauke: Gavin, did you want to just come in on that.

Gavin Haran: Yeah, very briefly. I think to Rachel's point, the whole ISSB structure is sort of setting an institutional framework whereby you can consolidate all the more prominent various standards which are out there. So organisationally that's important as well, and the backing of IOSCO is important in a regulatory sense, because the way IOSCO works essentially, it's an umbrella organization for all of the world's securities regulated. And to vote on something, typically it has to be unanimously supported.

So, you reach a kind of baseline level which regulators across the world, or security regulators at least, can all agree on. So I think it's fair to say, your question around global coordination, there's a lot of regulatory backing, I think, for that. And that's quite important. Obviously, from an issuing company perspective, you want to access, to fundraise capital from all over the world. Similarly, from an investment perspective, you want to be able to invest in companies all over the world. So having a global baseline is quite important. But I suppose more of a question for you, David, politically, the environment is somewhat fragmenting, not just in respect of ESG, but obviously certain elements of scepticism about international organizations and the role they will play. If something like the ISSB is adopted by jurisdictions as a mandatory standard that will typically involve some sort of legislative change. And that process is beginning in the UK now. Now, could a similar process happen in the US? I don't really know but it'd be interesting, David, to hear your thoughts on the on the politics. Because I think on the regulatory level you could say technocratically, things are moving, but that doesn't necessarily mean the politics will move along with it.

David Gauke: Yeah, I mean, there's an interesting debate that's clearly going on in this country about various environmental pieces of legislation. Following the Uxbridge and South Ruislip by election, and the arguments over the ULEZ, the ultra low emissions zone, there does seem to be a bit of a tone coming from the Government that it's perhaps prepared to step away from some environmental legislation when that, for example, is seen as undermining people's living standards, at times where the cost of living pressures are considerable, is that a potential dividing line? And if you look forward to the next general election, saying Labour are going to bring in these charges, these levies, these taxes, whatever it might be to achieve a particular objective, and the Conservatives will protect voters from such things. I'm not sure how much that will have a kind of direct read across on some of these areas, because it just seems to me that they're quite remote from the immediate concerns of voters. So yes, if you've got something where somebody is going to be paying £12.50 a day to drive their car where they live, that's something that immediately resonates. If you're trying to have a go at international standards on the basis that that's not the sort of thing that we do, it just doesn't seem to me it's likely to cut through in the same way and you'll only go down that route if you are absolutely taking a “We don’t believe in all this climate change stuff. It’s a hoax”, that type of thing, which is not where the Government is. I think there are other parts of environmental policy where perhaps, there is more uncertainty than there was. But it's hard to see, as far as I can see, that there's much of a kind of electoral argument for saying of the rest of the world is adopting this particular standard and we’re not. Particularly given really what the purpose of this is. And it’s about making sure that you’ve got common standards and transparency. It’s hard to see why this would really be a runner. So I don’t see the UK stepping away from an international consensus and, as Rachel has been saying, it does appear that there is this international consensus that is being built. So that’s my view. But, Gavin, can I come back to you and just ask about what’s been happening on the regulatory front of the last few months? We’ve talked about the ISSB and global initiatives, but if we’re looking at it domestically in the UK, where are we with the UK regulators?

Gavin Haran: Yeah, quite a lot has happened since May, given it was only a few months ago you wouldn't have thought there'd be quite so much movement, but there has been. I think, first of all just to continue that point around, where does this quite, to use the term again, technocratic initiative fit in with the politics? I suppose one area where we have seen some delay, and it does fit in with the politics, is around the creation of an environmental taxonomy in the UK. And what an environmental taxonomy would do is designate certain activities, certain types of business as environmentally friendly and green, and therefore able to attract sustainable finance as the find.

Now we've been waiting for quite a while for this to happen in the UK, and there've been certain amounts of delay. The EU has gone ahead with its taxonomy and its rules are pretty much finalised around how the definitions work for each of those types of business. The controversy in the EU has been the definition of nuclear power and also liquid natural gas, as environmentally friendly, and that has led various environmental organisations, including Greenpeace I believe, correct me if I'm wrong Rachel, to sue the European Commission on the basis that those activities shouldn't be defined as environmentally friendly.

The UK has come out in favour of nuclear already, I assume, natural gas would be something that UK would define as environmentally friendly, because the country has such a large dependence on it. But if you were to go down a different route to try, and if you like, nudge investment more towards renewables for instance, that would have a real effect on people's energy bills. Conversely, if you did put more of a reliance on nuclear natural gas, etc. the UK Government runs the risk of being sued potentially, as the European Commission has. And we've seen similar court action happen in the UK by the High Court, for instance, in terms of the Government's Net Zero planning. Rachel might want to talk a little bit more about that. So, I think the taxonomy that's one that's been delayed, and that's one we're still watching for.

The other big thing on the UK front in regulatory terms is the second delay to the sustainability disclosure requirements, the FCA’s rules around it’s sustainable finance regime which have been delayed until Q4 this year, and that’s because, quite positively, the FCA are revisiting some of the feedback they received in respect of their draft rules.

We understand they’re going to look at the labelling regime. So labelling investment funds, investment products, and the criteria that would qualify to have those labels attached to a product and also the marketing rules and naming rules for products. So we can go into a bit of detail about where that might come out although admittedly, it's a bit speculative at the moment. But the important point there is, there is a bit of a hold, in the UK in terms of sustainable finance while people are waiting for these rules to be finalised, and understand whether they will qualify for things like the labels under the new regime. In the EU we've had the SFDR, the sustainable finance disclosure regulation, in place for a while now. We've had reviews going on at the national level, for instance, in terms of how things are being implemented - Ireland, Luxembourg. We've got a review of the rules going on at the EU level in terms of how the disclosures will work, and I think the important point there is that the EU's in a position actually where it’s going back and revisiting its rules. There have been criticisms, for instance, around the lack of a fundraising regime in the EU, and the French Regulator, for instance, is pushing for a more fundamental review.

Now, the likelihood of that happening, I think, is quite high, but I don't think we're going to see anything tangible come out in terms of proposals until probably early next year, and that's partly because ESMA and the ESA’s are due to give some of their feedback from European Commission by November this year. So I'm kind of throwing out dates there, but I think the important point is, change is likely to happen, but it's not going to be immediate.

Other things I should just mention, in the meantime we've got ESMA's guidelines on funds names, and this is a sort of stopgap method, trying to find what an ESG product looks like in the absence of having regulatory rules around it through the SFDR. Those guidelines are likely to come in around October this year.

We've got two more big developments happening in the EU in the meantime: the Corporate Sustainability Reporting Directive which Rachel alluded to, and again Rachel might want to talk about the details on this, but this is a mandatory reporting regime which will begin to take effect for the largest companies from early next year. Now, that's quite a tricky thing, because the standards are just in the process of being finalised or just about finalised now, and national governments haven't adopted this in their own rules until June next year. But you've got something of a bit of a rush to try for those larger companies at least a bit of a rush to try and get things in order for this new reporting regime.

Finally, I would be remiss not to mention that CSDDD, and that's the Corporate Sustainability Due Diligence Directive and that's under negotiation at the moment. But I point to this because it's very impactful and it's causing a lot of concern outside of Europe, because what it does is put certain requirements on companies along their supply chains, regardless of where they are anywhere in the world. For instance, the survey of Korean companies quite recently on ESG topics put the CSDDD as their top number one concern, because lots of those Korean companies are serving companies in Europe along their supply chains. So this is a really big one. We don’t know how financial services will be affected yet. But I think over the course of this year we’ll see a lot more from the negotiations which will give us a bit more clarity and what the impacts will be.

And there are, no doubt, other things which I haven't mentioned here. But I think these are the really big developments in regulatory terms at the moment, and obviously looking through to next year.

David Gauke: Well, I mean, really quite a lot there, given it wasn't that long ago we last talked about this. So plenty happening there. And let's avoid getting too much into the details on those points. But I've got a question really for both of you, which is, there's a lot happening in terms of regulation, but what about regulatory enforcement? And the criticism that we all know is often made, “businesses are greenwashing”, “they're making great claims”? How is this being enforced to ensure that there is genuine transparency? And the reality is out there?

Rachel Richardson: There have been some high-profile enforcements in relation to greenwashing in the US and in the in the EU. From my perspective as being traditionally a debt finance lawyer, interesting for me was that at the end of June the FCA sent a letter to regulated firms in the sustainability link loans market, warning them that they'd been observing the market, they'd seen poor standards, they'd notified certain conflicts of interest, So, for example, a desire to please a long-term bank customer, Balancing that alongside what they should be doing, which is keeping high standards in their sustainability performance targets that they're putting within the sustainability link loans. And they really viewed that as a conflict and a potential for greenwashing and leading to some mistrust in the market. So there isn't really much else that they're doing with that letter other than serving a bit of a warning to the market, saying, look, we're watching this, and we want standards to get better. And I think that they probably will.

Loans are written at a certain point in time, and then they are either amended and restated, or they're repaid. And over the duration of the loan, you might find that standards are then improving. So, what you might do on day one, might in say, three years’ time no longer be rigorous and at the high standard that we'd all like. What's worth bearing in mind is that we're actually at the very start of a really young market and standards are constantly being updated whilst the market is progressing. So yeah, to answer your question, there have been some regulatory enforcement around the world, I'd expect once we see some of the regulations coming through that Gavin referred to, so some things like SDR in the UK, when we have a bit more regulation, there might be more enforcement that sit around that.

David Gauke: Gavin, any further thoughts?

Gavin Haran: Yeah, I agree with all of that. And I think the way enforcement is working at the moment is you're starting to see, as Rachel said, a look at the regulations that are in force, and how well they're being implemented, which may or may not be greenwashing, of course, but it goes down to compliance.

The other point, I think, where regulators have started to take action is more on, where is something blatantly misleading and therefore greenwashing. And you've seen, for instance, you have the advertising standards agency in the UK has been one of the leading regulators actually to crack down on advertising that it perceives to be potentially greenwashing.

I think you're starting to see more and more of that, as it becomes clear what could be misleading in terms of environmental claim. With guidance coming out on certain things, such as carbon offsetting, and whether if you go and offset your footprint by planting trees, for instance, how you can express that in a way that doesn't make it sound like you're not really emitting anything at all. So we're starting to see more and more guidance, kind of firming things up. The other thing, for our financial services clients listening to this, that will be of interest - the European Supervisory Authorities have tried to come up with a definition of greenwashing and a lot of the pushback on that initially from certain parts of the industry, was, you can't greenwash unless you intend to greenwash. So in other words, you couldn't inadvertently mislead someone.

Where the regulator seems to be coming out on, that is, that's not what greenwashing is. Greenwashing essentially just means a difference between the claim you're making and the reality of the underlying fact of your investment product or whatever it might be, companies activities. So you can inadvertently greenwash. I think now, we're starting to see more and more clarity around what that looks like as well as new regulations coming into force. As Rachel says, we'll probably see a lot more activity in terms of enforcement, or simply in terms of just striking down claims which shouldn't be made.

Rachel Richardson: And I suppose to prevent greenwashing, you should be as clear as possible and as granular as possible about what you're doing, and then make sure that you do that. Which sounds very easy, but in practice, in a really large organisation that can be relatively difficult.

David Gauke: Thank you for that. Now, Rachel, as you're here, I just want to sort of pick up one issue, which is of late there's been quite a lot of negative press about ESG including something just a few days ago in financial news, stating that it is time to dismantle this circus and that ESG has served it purpose. Have you noticed businesses and funds taking a different approach to ESG? Is, this a view that has got some momentum behind it? What are your thoughts?

Rachel Richardson: Look, I think that makes a really good headline and it would make me want to read the article. I think part of that comes from a lack of understanding about what ESG is, and that isn't helped by the fact that ESG isn't defined anywhere, and I don't want to go into the pros and cons of that now, because we will be here all day. But I think some reticence is good and I think that to the extent that people take a step back and say, “what are we trying to do here? Let's get it right before we jump in and do it without a plan”. I think that's where we are seeing and where people will slightly change behaviours.

I think there are articles stating that ESG volumes of investment has gone down. That's no bad thing, either. I think watching this really young market develop is really interesting. It's developing really rapidly. But I think that people will take stock of the regulations across the world, so EU, US, UK and elsewhere. They will work out what is being required, and they will want to take some time to get it right, and that that that goes to the heart of what Gavin was talking about at the beginning of this podcast.

So, I suppose to answer your question, ESG, might sort of, disappear from view as a term a little bit more as we go through the next coming years, and people would just be more clear about what they actually mean rather than using the term ESG. But in terms of central banks and regulators regulating for ESG risks I can't see them taking their foot off the gas, and if they are seeing climate risk as a risk to the functioning of markets and to the economy, they will want to regulate against those risks.

And so, I think there's a mix of response to your question, which is that there will be some reticence, and that's a good thing. And I don't think we're going to see Regulators taking our foot off the gas in relation to ESG regulation.

David Gauke: Thank you very much. And I suppose this brings me to my last question. Which is, we've seen a lot happen in the last four or five months as we've talked about in this podcast, what should we be looking out for in the coming year??

Rachel Richardson: I think going back to some of the things we've already spoken about, we will hopefully see the UK's taxonomy come through at some point within the next 12 months. We will get more developments in relation to SDR that Gavin spoke about. We will probably see additional countries look to take steps to mandate the ISSBB reporting that we also spoke about. And we will hopefully get some clear indication of the dates upon which mandatory ISSB reporting will be there for UK firms as well. We might also this year see consultations from the ISSB on additional further standards. So we talked about S1 and S 2, we might see a consultation on an S 3 and an S 4, and that could relate to nature risk or biodiversity, or human rights related risks.

We'll also see, hopefully, developments from the disclosure framework from the task force on transition planning, which would be good, and hopefully we will see ESG and sustainability related risks become part of the of the opposition and the Government's strategies as we come up to the next election.

Any thoughts from you, Gavin?

Gavin Haran: Yeah, I mean, partially reiterating the things we've mentioned already. So  clearly, I think there will be movement on the SFDR both in terms of monitoring compliance, also quite fundamental reforms, the regime which will be hugely impactful for people. I suppose the other elements we've mentioned CSDR and the reporting regime coming into effect, the SEC's disclosure rule potentially as well towards the end of this year, that's a big one to look for. And I think we've alluded to it, but the task force on nature based financial disclosures - TNFD.

I think we will see the finalized standard and again, that will, like TCFD, I think that's something that's going to be gradually rolled out initially on a voluntary basis, in some cases it will become mandatory as well. So there will be a lot over the coming year, back to your previous question, David, is there a change of approach on ESG? Maybe in terms of the framing and maybe there's been a bit of a wait and see caution in the industry, and that's partly because of the lack of clarity around these rules. What we're seeing over the coming year, I think, is a lot more clarity and a lot more for firms to do.

David Gauke: So, I think one piece of good news we can conclude to our listeners is that there's probably another podcast when we'll get together again and talk through these issues in a few months time. So, Rachel, Gavin, thank you very much for joining me today! Many thanks to our listeners for tuning in to listen to something which is clearly quite a fast moving area, which is why as I say, I think we'll probably return to these topics before very much longer. If you want to look at the Macfarlanes' website you'll see a range of podcasts on various issues. Thanks for listening.