In this month’s ESG Market Alert, we cover:

• Creation of UK Sustainability Disclosure Standards
• SEC subpoenas fund managers over ESG disclosures
• EU dilutes EFRAG draft standards but introduces a tough carbon import tax
• Market Practice Update: Internal governance structures to handle ESG reporting

Creation of UK Sustainability Disclosure Standards

On 2 August 2023 the UK Department for Business and Trade announced its plans to create UK Sustainability Disclosure Standards (“SDS”) by assessing and endorsing the global corporate reporting baseline of IFRS Sustainability Disclosure Standards. The SDS will be based on the IFRS standards to ensure that the disclosed information can be compared globally. They are expected to only divert from the global baseline if absolutely necessary for UK specific matters.

The SDS, which are expected to be developed by July 2024, will set out corporate disclosures on the sustainability-related risks and opportunities that companies face. They will form the basis of any future requirements in UK legislation for companies to report on risks and opportunities relating to sustainability matters, including those arising from climate change.

Following implementation of the SDS, decisions to require disclosure will be taken by the FCA in respect of listed companies and by the UK government in relation to UK-registered private companies and limited liability partnerships.

SEC subpoenas fund managers over ESG disclosures

The U.S. Securities and Exchange Commission (“SEC”) enforcement division has sent subpoenas to several asset managers this month in relation to their ESG marketing. Amongst the SEC’s areas of inquiry is the repurposing of conventional investments as ESG funds.

These subpoenas come after the SEC, in March 2021, formed a task force dedicated to identifying misconduct in climate and ESG investment disclosures. In 2022 the SEC brought cases against leading financial institutions and, although no cases have been filed yet this year, a German asset manager settled an ESG investigation involving the SEC and other regulators for €21 million in July 2023.

The growing scrutiny of ESG investing is not limited to the United States and Europe. Recently, the Australian Securities and Investments Commission fined a global investment advisor for making ESG misstatements including that its global bond fund excluded fossil fuel issuers while in reality the fund held debt from several oil companies.

EU dilutes EFRAG draft standards but introduces a tough carbon import tax

In line with the Corporate Sustainability Reporting Directive, which outlines the obligation for companies to use standards to fulfil their legal sustainability reporting obligations, the Commission is adopting common standards, the European Sustainability Reporting Standards (“ESRS”), which will help companies to communicate and manage their sustainability performance more efficiently. The ESRS are based on technical advice (draft standards) which the European Financial Reporting Advisory Group (the “EFRAG”) submitted to the Commission in November 2022. The Commission made a number of modifications to the draft standards submitted by EFRAG including phasing-in certain reporting requirements, giving companies more flexibility to decide exactly what information is relevant in their circumstances and making some of the proposed requirements voluntary.

The approved ESRS focus on corporate ESG reporting and will be mandatory for use by companies that are obliged by the Accounting Directive to report certain sustainability information. The ESRS cover climate change, biodiversity, and human rights, and aim to inform investors about the sustainability impact of the companies in which they invest.

While the EU has diluted the requirements proposed by EFRAG, it has introduced reporting rules for the Carbon Border Adjustment Mechanism (“CBAM”), the EU's carbon tax on imported goods. Under these rules, companies must collect embedded emissions data from imported products starting October 2023 and reporting by January 2024. CBAM aims to prevent carbon leakage by aligning EU carbon prices with non-EU countries and importers must buy CBAM certificates to bridge price differences. The rules require reporting on product emissions, including origin, production site, and main emission sources, and will initially target carbon-intensive sectors.

Market Practice Update: Internal governance structures to handle ESG reporting

Recent trends in the market suggest that organisations believe that a robust ESG reporting program will lead to competitive advantages. A recent report commissioned by Workiva Inc., the 2023 Global ESG Practitioner Survey, confirmed that 90% of the organisations surveyed considered that having a strong ESG reporting program in place would give their companies a competitive advantage in the next two years. Notably, according to the survey, these benefits have already been realised for companies that have been reporting on ESG for five years or longer.

The Workiva Inc. survey further suggests that a large number of organisations have implemented frameworks to address ESG issues. The survey polled more than 900 professionals with knowledge of ESG reporting at their respective organizations. 71% of the ESG practitioners surveyed say three or more teams contribute to ESG reporting and 74% report that their companies have appointed at least one employee to manage ESG reporting (6% higher than last year).

Despite a clear increase in ESG-specific structures within organisations, companies are experiencing a growing demand to formalise their ESG policies and strengthen their ability to report on ESG financial metrics. This emerging trend was confirmed by a recent survey conducted by Deloitte, who found that only 45% of professionals surveyed are confident in the ability of their company’s financial reporting team to report on ESG financial metrics.

The demand for a more formal ESG reporting system is reflected in the creation of a new role, an ESG controller, which has become increasingly common in corporate organisations. An ESG controller is responsible for integrating ESG issues into the management systems of an organisation and ensuring that a company complies with all applicable ESG reporting obligations. The ESG controller role is likely to continue to gain traction as the scope of ESG regulations on reporting expands and becomes more complex across jurisdictions.