ESG
Impact of ESG regulation
The first significant impact of ESG regulations will be felt in 2021 with the EU SFDR, requiring asset managers, private banks, pension funds and others to categorise financial products into light green, dark green and everything else. Firms in Europe will reassess their product ranges and many will look to create ESG versions of existing products to fit within the new green categories and to be ready for an anticipated surge in demand. This demand is expected to be further stimulated by changes to the MiFID suitability assessments.
SFDR Level 2 measures will be finalised during the year causing firms to re-work their initial compliance programmes once details are clarified. UK firms will follow with close interest as the FCA is expected to consult on mandatory TCFD disclosures for asset managers and others, coinciding with the UK hosting COP 26 in November 2021. Outside of Europe, regulators such as the Hong Kong SFC are considering mandatory climate-related risks requirements and other jurisdictions are expected to explore greater regulation of ESG products.
ESG as a driver for transactions
ESG is featuring in M&A across the globe and across all sectors. It’s a driver for M&A - people wanting to buy in ESG 'good' businesses or capabilities and dispose of ESG 'poor' assets. It is generally seen as too slow or too difficult to do this organically. We are also seeing ESG featuring in the standard M&A process. Even where there isn’t an ESG target, it is being factored into pricing discussions and needs to form part of the due diligence process.
2021 will see a further increase in demand for sustainable finance products. It has already been high on the agenda, but given the events of 2020, sustainable investments and investments with impact and fit for a corporate culture become even more important and will have to be matched by the sell-side.
This will not only mean environmental driven investments but we expect to see a rise in investments driven by the social component of ESG and stakeholders will look out for that.
Impact of ESG regulation
We know that the S and the G can create greater challenges for organisations. The breadth of the possible issues and the lack of a clear taxonomy can make it more difficult for firms to get a clear sense of what good looks like. Market leaders in 2021 will be looking to drive their own agenda here with a resurgence in the focus on BLM and equality, and heightened scrutiny of the purpose and behaviours of boards. Human capital and governance issues will continue to move rapidly up the investor and board room agenda. Firms wanting to position themselves as leaders in this space in 2021 will be looking to establish their own measures of best practice and their own goals with regard to talent management, diversity and inclusion, staff engagement, corporate purpose, culture, reward and remuneration and tax practices. An audit of what is already in the toolbox, by way of data, policies, training and other initiatives, is an important first step for firms looking to spot and address the gaps and promote the most positive narrative. From a governance perspective, information flow, metrics and senior management accountability will remain a key focus cross-sector.
Mitigating ESG risks
An increasing ESG focus brings risks as well as opportunities. Green and ethical financial products are proliferating and will continue to do so. Investors will expect greater focus on ESG issues in their investment profile.
However, the increasing responsiveness of the market to climate and wider ESG issues, combined with new financial disclosure obligations and requests for transparency from regulators and investors alike, will increase the risk for claims based on the greenwashing of financial products and breaches of investment mandates. This is particularly so given the uncertainty that remains around the criteria by which products qualify as socially responsible or ethical, and how those criteria are translated into investment decisions. There may also be exposure to claims in relation to directors' liabilities and reporting.
Beyond reporting risks, there is also increased litigation activity in relation to a company’s own ESG performance – for example its environmental impact, human rights record and the suppliers it deals with.
The COVID-19 crisis has highlighted the need to build resilience across all sectors. Corporate culture and proper, responsible, governance are in the spotlight. Companies need to understand their own ESG risks which may impact on values. Understanding where ESG litigation, regulatory and conduct risks may arise for businesses will become increasingly important.