Differences between regulators hinder SFDR implementation
The flurry of ESG regulation across Europe has posed challenges for in-house counsel on the continent and further afield
Speaking at the IFLR 2021 Corporate Sustainability Summit, industry representatives discussed the lack of standardisation and the potential for greenwashing that could emerge from the Sustainable Finance Disclosure Regulation (SFDR).
One of SFDR’s aims is to create more transparency, so that investors can compare sustainability credentials across different products and decide which one suits them best. However, the inconsistent criteria used across rating agencies for grading investments means such comparisons can’t be made validly. “The ESG ratings are now considered subjective and incomparable,” said Marta Mikliszanka, head of public affairs and sustainability at Polish online e-commerce platform Allegro. “There is a lack of methodology and standardisation because the standards have been developed by each agency individually.”See also: Transparency is key for exchanges targeting sustainability
ESG rating makers and investment firm analysts prepare their own list of risk factors across categories such as environmental, society and corporate governance, Mikliszanka added. Therefore, the assessment of a same company may differ significantly from one rating agency to another. “We are waiting for a more universal understanding of ESG and those ratings,” she said.
Aside from issues related to data interpretation, panellists at the IFLR summit also discussed problems arising at the data collection stage.
“If you map out the data points that are the mandatory indicators for evaluating principal adverse impacts under SFDR, in our experience, it is very rare that information is reported on all 14 for an investee company,” said Kriti Avasthi, general counsel at Emerging Markets Investment Management Limited.
The final draft regulatory technical standards for SFDR says that firms can rely on different sources of data. Where sufficient data isn’t available, they can use estimates and make assumptions, as long as it’s mentioned in the qualitative report.
“If you’re going to enable investors to make more informed decisions about their investments, then this approach is not necessarily the most accurate,” said Avasthi. “What is seen in the report may vary greatly depending on how the data was collected and analysed. It is also very important to understand how things are rated and what weighting is given to different factors.”
Panellists also flagged grey areas and a lack of clarity on SFDR product criteria. “These may not address greenwashing adequately,” said Avasthi. “For example, with the article 8 product criteria, someone could have an article 6 product [no sustainability credentials but considers ESG factors] with criteria that may fall into the article 8 [promoting ESG characteristics] bucket.”
Standardisation, however, isn’t only problematic at EU level – it’s a global issue.
“We’ve looked at European scope, but when you look at investment products, they’re global in nature,” said Ben Pott, head of public policy and government affairs at BNY Mellon. “Funds invest in firms outside the EU, and therefore it’s incumbent upon policymakers to work across jurisdictions and make sure that we have a global framework.”
See also: Why SFDR may split investmentsJan Buechsenstein, co-general counsel and head of compliance and risk at Raisin Deposit Solutions, spoke about the pressures of working with many clients who have created their own ESG frameworks.
“We have been working with a lot of banks and financial institutions throughout Europe,” he said. “Our concern is that we have to develop our own framework at the same time as using and complying with other frameworks developed by our partners. Each of them is different because the regulation is there but it does not provide much detail, particularly on the regulatory standards.”
This, Buechsenstein suggested, has puts an additional burden on his company.
Scheduled for 2022, the EU Taxonomy Regulation is expected to iron out some of these issues in different areas of environmental sustainability. The first rules, which will relate to climate change mitigation and adaptation, are expected in the next two years. Others will follow and are due to cover circular economy and conservation.
“The taxonomy will be about trying to get to the heart of the question – ‘what is green?’,” said Paul Alexander, principal counsel at the European Bank for Reconstruction and Development. “A shift from voluntary to mandatory is what we will be seeing, as well as a lot of intense and difficult discussions about the meaning of ‘green’.”
Although the taxonomy is unlikely to solve all the issues related to standardisation, it should go some way towards helping counsel make sense of the flurry of EU legislation around ESG.