New and upcoming ESG investment regulation

Governments around the world are clamping down on greenwashing, and that includes the financial sector. Discover the latest ESG investment regulations that may influence your business.

Environmental, Social and Governance (ESG) investment is becoming more and more popular: ESG-related assets under management are expected to grow by 12.9% per year in the next five years, constituting more than one-fifth of total investments by 2026.

But there is no clear definition of what ESG really is, which creates a strong greenwashing risk, with funds potentially branding themselves as ESG without providing any proof that their investments actually generate a positive environmental or social impact.

Because of that, governments have started to draft a flurry of laws to ensure that ESG funds do what they’re intended to: directing finance towards projects with positive environmental and social impacts.

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ESG investment regulation in the U.S.

ESG investment has become a divisive topic in the United States, as conservative states claim that it goes against investor interest and generates higher costs for their local community. In total, 18 states have gone as far as to pass anti-ESG laws, while 10 others have introduced pro-ESG legislation.

However, at the federal level, regulators are taking a strong pro-ESG stance and looking to standardize this activity. The Securities and Exchange Commission (SEC) has proposed rules to enhance climate-related risk disclosures for investors and two rules amendments to prevent misleading or deceptive fund names and enhance disclosures by investment advisers about ESG investment practices. All these proposed regulations could be adopted as early as 2023. The SEC has also set up a Climate and ESG Task Force to identify and penalize greenwashing practices in the ESG investment world. 

Finally, the Inflation Reduction Act (IRA) signed into law in August 2022 supports the ESG principles of assessing, monitoring and improving how sustainable business operations through metrics-based reporting, but also incentivizes ESG investing with the earmarking of US$369 billion for climate change and green energy investment over the next 10 years.

ESG investment regulation in Europe

The European Union is probably the market with the most developed ESG-related financial regulatory framework. ESG activities are currently governed by the Sustainable Finance Disclosure Regulation (SFDR), which came into force in March 2021. The SFDR clarifies which activities meet environmental, social and governance criteria and the impact of all investments on the environment, society and people, and include sustainability reporting rules for issuers and asset managers. 

Other relevant laws include the Markets in Financial Instruments Directive (MiFID II) and the Corporate Sustainability Reporting Directive (CSRD). The latter entered into force in January 2023, requiring large and listed companies to report on sustainability risks and to disclose the percentage of their activities aligned with the EU Green Taxonomy. This is set to help asset managers in making sound ESG investment decisions.

The Action Plan on Sustainable Finance, adopted in 2018, aims to create the rules and guidelines needed to reorient financial flows towards a more sustainable economy. It includes the Green Taxonomy, which defines the activities that can be considered “sustainable” under EU law, a Green Bond Standard and even the development of an EU Ecolabel aiming to set a minimum environmental performance for retail financial products. 

ESG investment regulation in the UK

Financial firms in the UK are still aligned with some of the EU’s regulations, including MiFID II, which recently underwent some ESG-related amendments. Additionally, ESG investment has been governed by a flurry of corporate laws and regulations including the UK Corporate Governance Code 2018, the directors’ duties in the Companies Act 2006, the Listing Rules, the Disclosure Guidance and Transparency Rules, the UK Stewardship Code 2020, the Climate Change Act 2008 (the “CCA 2008”) and the Bribery Act. 

In recent months, the Financial Conduct Authority (FCA) has also increased its scrutiny and oversight of ESG activities. In December 2020, it published a rule requiring commercial companies with a UK premium listing to disclose whether or not they reported climate risks in line with the recommendations of the Task Force for Climate-Related Financial Disclosures (TCFD), and why. A year and a half later, it found that about 90% of these companies made these voluntary disclosures, but that the quantity and quality of data disclosed varied widely. Now, the regulator is working to create a climate disclosure standard to be adopted by the UK government in the near future. 

Finally, a package of new measures, including “sustainable investment labels, disclosure requirements and restrictions on the use of sustainability-related terms in product naming and marketing” is expected to be published by the FCA by mid-2023.

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