Regulating ESG
The glut of reporting systems, frameworks and rating agencies causes confusion for both ESG watchers and participants and we need to achieve a greater alignment of expectation, disclosure and approach.
Is more legislation the answer? Regulation and better standards are on the way as a result of initiatives by both government and the private sector. Calls are increasing for mandatory disclosure.
Sector initiatives
Initiatives to try to standardise ESG reporting have emerged organically in several sectors. There is no doubt that peer participation encourages a race to the top but there is concern over equality of application, and achieving a level playing field will be crucial.
While voluntary initiatives encourage compliance, the risk is that companies could be benchmarked against peers whose operations are subtly different or that do not have the same level of disclosure.
Regulatory frameworks
In some industries existing regulatory frameworks have been extended to take in these organic initiatives. One example is financial services where institutions are increasingly expected to focus on ESG-related disclosures in their filings.
The pressure for this is becoming intense. In February Allison Herren Lee, the acting chair of the US Securities and Exchange Commission, directed the Division of Corporation Finance "to enhance its focus on climaterelated disclosure in public company filings".
She also said it must update its climate change disclosure guidance, which dated back to 2010.
Lee later confirmed that the SEC had "begun to take critical steps toward a comprehensive ESG disclosure framework".
Regional regulation
Other regional initiatives include the EU regulation on sustainability-related disclosures in the financial services sector. This sets transparency requirements and directs companies to make a risk assessment as part of their investment analyses.
The bloc also has plans for enhanced disclosure in non-financial sectors, as well as mandatory due diligence to cover human rights, environmental issues and governance.
Many industries have cautioned against a standard that reduces flexibility. In this regard, legislation that adopts indicative measurements may help address the concerns, especially across sectors and with businesses of varying sizes.
A "one size fits all" approach tailored to any one region is unlikely to work given the global nature of business. Worldwide harmonisation may be an ideal but it is not an immediate solution.
Covid-19 has put ESG in the spotlight – where it is likely to stay. But the potential weaknesses in measurement and reporting, together with the possibility of exploitation and manipulation, highlight that it is not just individual companies’ ESG credentials that are under scrutiny. More work is needed on the self-regulation of the "ESG industry" itself.
The UK Competition and Markets Authority’s current investigation into alleged greenwashing by ESG rating agencies is an important step in trying to bring order and structure to the industry.
In our view it is inevitable that regulation of ESG standards will follow.
White & Case LLP has partnered with the Financial Times on the publication of its Moral Money Forum reports, which explore key issues from the ESG debate. This article has been reproduced with permission from the Financial Times.
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