The US Securities and Exchange Commission’s decision to pare back its long-awaited climate-risk disclosure rules suggest the blowback against the environmental, social and governance (ESG) movement is gathering strength. The reality is ESG reporting demands are only growing. For many investment managers, the obvious answer is to turn to their fund administrator for help … provided they are up to the job.
SEC row back won’t diminish ESG reporting demands
The SEC rule initially included a Scope 3 requirement obliging certain large companies to report on the emissions generated across their entire value chains by their suppliers and customers. That requirement has been shelved amid fears of a legal challenge and, the SEC says, to mitigate “the associated costs of the rules.”
The SEC also narrowed the reporting requirements for Scope 1 (direct greenhouse gas emissions from a company’s own operations) and Scope 2 (indirect emissions from companies’ energy use) activities of larger SEC-registered businesses to emissions they deem “material” to investors — allowing companies to decide whether they need to disclose that information. Small or emerging companies won’t have to report their emissions.
Yet despite the softening, the rules may be trumped by requirements elsewhere. As a recent Financial Times column observed: “in the green audit world the tale is more of a regulatory “squeeze to the top” now: as reforms are unleashed in one jurisdiction, they are spreading to other regions in surprising ways, threatening to hit unwary companies.”
In keeping with other EU regulations, the new Corporate Sustainability Reporting Directive (CSRD) – with its disclosure demands for Scope 1, 2 and 3 emissions and broader ESG metrics – will raise the global bar and introduce an extraterritoriality component. Big companies will have to apply the new rules for the first time in the 2024 financial year, for reports published in 2025. Listed SMEs and non-EU companies that generate over €150 million in Europe will have to report sustainability information in time too. Reports must be filed in accordance with the rigorous European Sustainability Reporting Standards (ESRS).
The CSRD follows the EU Sustainable Finance Disclosure Regulation (SFDR), with its requirement for asset managers and other financial markets participants to be more transparent about how they integrate ESG risks into their investment decisions and the ESG credentials of their products. As PwC noted at the time of implementation in 2021, “[l]arge swathes of the UK industry are caught by this EU initiative, largely by virtue of managing EU products or marketing products to EU clients. And for those not strictly in scope, we are seeing many clients take the strategic decision to align themselves with SFDR in response to market pressures.”
The FT column similarly pointed to California’s bill, signed last autumn, which requires all companies with more than $500 million in annual revenues to provide extensive climate reports by 2026, and those with more than $1 billion revenues to include Scope 3 reports by 2027. “Since most large American entities touch the Golden State, this will suck 8,000 companies into the net, according to Crunchbase estimates,” the article noted. And given the expense of running different systems for different regions, companies will tend to set up their reporting capabilities to meet the toughest rules.
Investor push for ESG transparency
The new rules are all being framed with an eye to giving investors the information to assess what impact companies have on people and the environment so they can determine the financial risks and opportunities, and make appropriate investment decisions. Which is a key point.
Even without the regulatory imperative, investors are increasingly ESG-conscious. As such, they are demanding ever greater transparency on a slew of ESG factors – be that asset managers appraising portfolio targets, or institutional/retail investors weighing which traditional and alternative funds to invest in. Transparency has thus become essential to building and maintaining trust between fund managers and their investors at every stage of the fund lifecycle. Gaining client trust in turn supports ongoing demand for firms’ funds.
Fund administrators at the ESG sharp end
Meeting these transparency expectations takes two critical elements: complete, accurate data to measure and analyse the impact and performance of investments; and reporting tools able to deliver the information on key ESG metrics to end users at speed, scale and in a format and channel they want.
Which is where fund administrators can come to the fore.
One of the biggest factors holding the ESG sector back has been a lack of common definitions, clear standards and appropriate high-quality underlying data. Disparate third-party data sources have proliferated to meet the need. But the “lack of data standardization across third parties and publicly available tools makes it challenging for investors to get a clear picture of exposure and ensure alignment with their climate change commitments,” noted Cerulli Associates.
Fund administrators that can aggregate the swathes of incoming ESG-related data, standardise it into usable formats, check the quality, extract relevant components, and create and distribute compelling investor, regulatory and management reports will add real value to their clients.