As the UK prepares for the Brexit transition and establishes itself as a hub for sustainable investing, there will be regulatory changes concerning ESG. The authors of this article argue that firms and asset managers must keep up-to-date with developments to ensure compliance. 

The following article, written by a team at Evolution Partners (see more details on the firm below) is a "five-minute read" on the ever-present subject of environmental, social and governance-driven investing, aka ESG. And it takes an unusual tack: how will the rules and processes for ESG be affected by the UK's departure and independence from the European Union? 

Like it or not, Brexit is a fact and talks, as at the time of writing, continue between the UK and Brussels on the shape of any relationship between the UK and EU. Looking through the fog of COVID-19, it is important to see how this change will influence areas such as ESG investing. 

To consider the implications are Tej Dosanjh - partner at Evolution, and colleagues Rachel Smith (analyst) and Hannah Smyk (analyst). The editors of this news service are pleased to share these views and invite readers to respond. The usual editorial disclaimers apply to views from outside contributors. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

ESG and Brexit
ESG. It’s the word of the moment, with searches for the term increasing by 50 per cent on some websites. (1) To achieve positive environmental, social and governance outcomes, investors and asset managers are abiding by rules and regulations that are set by external governing bodies, such as the EU.

Brexit. Another buzzword that has implications for all types of businesses. One of these implications is regulatory change, creating a complex regulatory minefield for UK businesses as we approach the end of the transition period.

ESG and Brexit. Bringing these two terms together, it becomes clear that the changing regulatory ecosystem post-Brexit will affect the way in which ESG issues are moderated in the UK. But what exactly do firms need to look out for? This five-minute read will demystify the impact of Brexit on ESG regulations as things currently stand, providing an insight into the future of ESG in the UK.

So, why are we asking this?
As the 31 December deadline looms, it is becoming more and more important for businesses to understand what ESG regulations they will need to follow post-Brexit. The European Commission has established an EU Action Plan for Financing Sustainable Growth, which covers four legislative proposals: taxonomy, disclosure and duties, benchmarks, and sustainability preferences consultations (2018). (2)

These oversee three key areas:

-- Reorienting capital flows towards sustainable investment;
-- Mainstreaming sustainability into risk management; and
-- Fostering transparency and long-termism in financial and economic activity.

To achieve these goals, the EU has introduced three regulations.
 

Consider the key dates. The UK will leave the EU in the period of limbo between when the taxonomy regulation and the SFDR were introduced, and when they will come into force. 

So, where does this leave UK firms in terms of their ESG regulatory obligations?

Where does the UK stand?
Initially, the UK agreed to onshore these three regulations, meaning that they would all be retained post-Brexit as UK domestic law, regardless of the Brexit outcome. However, this onshoring fell through following the prorogation of the UK Parliament in 2019. (3) Now, the UK is only onshoring the parts of EU law that are already in force before the end of the Brexit transition period.

As the taxonomy regulation and SFDR do not come into force before this date, they will not automatically become UK domestic law or apply to UK firms post-Brexit. 

In a recent turn of events, on 9 November the Chancellor Rishi Sunak announced that the UK would implement its own green taxonomy. This will be based on the EU taxonomy but will be reviewed to ensure its suitability for the UK market. (4)  

In addition, he announced that the UK government will introduce more robust environmental disclosure standards. These will exceed the “comply or explain” approach and make TCFD-aligned disclosures mandatory across the economy by 2025, with some requirements coming into force by 2023. This will make the UK the first country in the world to make climate risk disclosures obligatory.

These rules and regulations will apply to a wide range of businesses, including “listed commercial companies, UK-registered large private companies, banks, building societies, insurance companies, UK-authorised asset managers, life insurers, FCA-regulated pension schemes and occupational pension schemes.” (5)

These recent announcements demonstrate that the UK government intends to divert from the EU taxonomy and regulations and implement its own versions. These measures, combined with the UK’s proposal to issue its first Sovereign Green Bond in 2021, will position the UK at the forefront of green finance. 

What can firms expect going forwards?
Uncertainty still remains with regard to the specifics of the UK’s proposed taxonomy and disclosure regulations. But these latest developments offer investors and asset managers some guidance in terms of how to navigate Brexit uncertainty and anticipate new regulatory requirements:

-- The UK will impose a different taxonomy from the EU.

The UK government has announced its intentions to introduce its own green taxonomy. The ways in which this new taxonomy may differ from the EU taxonomy could be informed by the UK’s current relation to certain ESG factors.

A 2016 Sustainalytics report (6) on the impact of Brexit on nine sectors of ESG in the UK found that most areas of ESG, such as climate change, health and safety, and corporate governance, would not be negatively impacted by Brexit. In many cases, these issues are already ingrained in UK policy and legislation (such as the 2008 Climate Change Act), or exceed EU requirements. However, this report found that the UK struggled to comply with the recycling and air pollution rules set by the EU, and that standards in these areas are likely to weaken post-Brexit. The newly established UK Green Technical Advisory Group could propose a taxonomy that places less emphasis on these variables.

Consequently, if the UK were to impose a taxonomy that had lower standards for air pollution, a UK firm/fund that would have gained low ESG ratings using the EU’s taxonomy due to its air pollution levels could receive a higher ESG rating post-Brexit.

It is likely, however, that the UK taxonomy will largely be aligned with the EU taxonomy in order to avoid compliance issues for UK asset managers who are operating in the EU. This approach is suggested by the UK government’s intentions to join the International Platform on Sustainable Finance (IPSF), a working group co-led by the EU and China. (7)

-- The UK government will run more robust disclosures.

The UK joint regulator and government TCFD taskforce has already published its roadmap towards implementing mandatory climate-related financial risk disclosures. (8) This means that firms will no longer be able to choose between complying or explaining a lack of compliance; the UK has set the standard for climate risk disclosures. (9)

If the EU does not follow suit in making climate risk disclosures mandatory, this could cause a divergence between disclosure regulations - something that fund managers operating in both the UK and EU need to look out for.

Key takeaways
The UK’s next steps in sustainable finance are still uncertain, however the Chancellor’s recent statement has provided some clarity in this area and sets up the UK as a global centre for sustainable finance. Additionally, partaking in initiatives such as the IPSF will help to bridge potential UK-EU divisions in the ESG space, post-Brexit. 

As the UK prepares for the Brexit transition and establishes itself as a hub for sustainable investing, we can expect to see a number of regulatory changes concerning ESG. Firms and asset managers must keep up to date with developments to ensure compliance. 

ESG is here to stay, so it’s time to move with it. 

Footnotes

1 https://www.fundecomarket.co.uk/help/searches-for-esg-funds-increase-rapidly-with-sustainability-issuesdominating

2 https://www.unpri.org/sustainable-financial-system/explaining-the-eu-action-plan-for-financing-sustainablegrowth/3000.article

3 https://assets.contentstack.io/v3/assets/blt3de4d56151f717f2/blt76669b75d92911de/5efca0f18304ac0dbc4a5e3e/EU_ESG_-_SFDR_Key_Requirements_June_2020.pdf

4 https://www.gov.uk/government/news/chancellor-sets-out-ambition-for-future-of-uk-financial-services

5 https://www.gov.uk/government/news/chancellor-sets-out-ambition-for-future-of-uk-financial-services

6 https://www.longfinance.net/media/documents/Sustainalytics_ESG_Spotlight_Brexit_2016.pdf

7 https://www.ipe.com/news/international-sustainable-finance-forum-starts-taxonomy-work-gainsimf/10048486.article

8 https://www.gov.uk/government/publications/uk-joint-regulator-and-government-tcfd-taskforce-interimreport-and-roadmap

9 https://www.businessgreen.com/news/4023000/rishi-sunak-uk-issue-green-bond-require-firms-discloseclimaterisk?utm_medium=email&utm_content=&utm_campaign=BG.Daily_RL.EU.A.U&utm_source=BG.DCM.Editors_
Updates&utm_term=&utm_medium=email&utm_term=50%20to%2099&utm_term

About Evolution Partners
Evolution Partners is a boutique management consultancy with a presence in Hong Kong, Paris, London and Sydney. It concentrates on the financial services sector, providing strategy, technology, regulatory, operations, innovation and governance advisory, and consulting services to CEOs and executives in the investment banking, retail banking, wealth management and insurance segments.