By Agathe Kuhn, Senior Policy Consultant at Longevity Partners
On 3rd November 2021, COP26 Finance Day, Rishi Sunak announced plans to make the UK the world’s first net zero aligned finance hub. The announcement came shortly after the UK Government released its roadmap to achieve this ambitious goal.
Greening Finance: A Roadmap to Sustainable Investing sets out the details for the UK’s Sustainable Disclosure Requirements (SDR) and comes at a vital time: the ESG investment market has grown rapidly to $35 trillion in the last year, and with this growth comes a need to provide a common set of standards to financial market participants.
The SDR will introduce a set of disclosure obligations for corporations, asset managers and owners, as well as investment products. Those subject to the new reporting rules will have to disclose information on the environmental impact of financed activities, clearly justify any sustainability claims and lay out transition plans in their Annual Reports. These requirements seek to ensure that investors and consumers driven by sustainability have access to the information they need to make their decisions.
Interoperability with EU and international frameworks is crucial
The SDR is the UK’s take on the EU’s Sustainable Financial Disclosure Regulation (SFDR), which introduced requirements to increase transparency and clarity in the EU’s sustainable investment space.
The UK government should ensure the development of a framework that is compatible with regulatory requirements already in place in the EU. A disconnection between disclosure practices in the UK and the EU would create confusion and additional burden for reporting entities. Whereas coordinated frameworks have the capacity to support financial market participants in this task and accelerate the ESG transition on the continent.
Policymakers should also be particularly wary of differences between the UK and EU Taxonomy frameworks, as these will be used as key benchmarks when conducting disclosure under the SDR and SFDR. The UK’s taxonomy is still in development, but it is positive to see that it will be based on the same six key environmental objectives as the EU’s one.
It is positive to see that the standards to be developed by the newly formed International Sustainability Standards Board (IISB) will be at the core of the SFDR framework. This will provide a baseline for corporate sustainability disclosures and allow investors and financial market participants with global portfolios to compare sustainability performance more easily.
Learn from the EU’s experience
A key challenge in the implementation of sustainable finance disclosure regulations lie in the classification of different funds. The SFDR places funds into three categories based on their green credentials: Article 6 (no green credentials), Article 8 (light green funds with some ESG credentials), Article 9 (dark green funds with strong ESG credentials). The SDR draws on this, but expands into five categories, providing two categories for funds transitioning to become more sustainable in the future.
The issue here lies in the definition of these categories. The lack of clarity around definitions of Article 8 and Article 9 funds under the EU Regulation has led to some confusion on the market as well as some potential greenwashing risks. Unclear definitions leave scope for some managers to dress up their funds’ ESG credentials and paint funds a darker shade of green than they should be.
Greenwashing being the main issue that these regulations are seeking to address, the UK government should learn from the EU’s experience and strive to provide a clear and robust framework for the classification of funds on the UK market.
Detailed reporting requirements under the SDR will be developed following a government consultation and enter into force in the next 2 to 3 years. This period gives experts the opportunity to inform the decision-making process and should be capitalised on by industry leaders and future reporting entities. We must learn from the lessons of the EU SFDR implementation and build on those to create a framework that enables the UK financial market to transition.
The SDR is hugely important in the UK’s ambitions to become the world’s first net zero finance hub, for reducing greenwashing within the sector, and for our wider green ambitions. We are in a green financial revolution. We must get it right.