Sustainability disclosures – opening Pandora’s box?
Partner, Global Co-Head International Trade and Regulatory Law Group
Ming Zee Tee
12 January 2023
The ESG reporting landscape has accelerated significantly in the past five years, with the nature and scale of reporting requirements changing. This article discusses recent trends around entity-level and product-level sustainability disclosure requirements, in both public and private markets.
The below was adapted from a panel discussion during the Responsible Asset Owners Conference on 22 November 2022 between Matthew Townsend, partner at A&O' ESG Group and Greg Brown, partner at A&O's Social Finance and Impact Investment Group, in conversation with Adrienne Lawler, CEO and Founder of Responsible Asset Owners Global Symposium.
More disclosure frameworks, stronger enforcement against greenwashing
An alphabet soup of disclosure frameworks have been introduced, including the EU’s Sustainable Finance Reporting Directive (SFDR) and Corporate Sustainability Reporting Directive (CSRD), the UK Financial Conduct Authority’s Sustainable Disclosure Requirements, further rules from the Task-Force on Climate-Related Financial Disclosures (TCFD), and more. Key factors driving this change include investors' demands for deep data to feed into their sustainability strategies, as well as regulatory-driven change.
Europe has thus far lead the charge in creating frameworks for reporting. However, regional regulators have been quick to follow, with national bodies such as the Hong Kong Exchanges and Clearing Limited (HKEX), Singapore Exchange (SGX) and China Securities Regulatory Commission issuing their own guidelines on ESG disclosures. This will create challenges for businesses operating in multiple jurisdictions, who may be faced with a suite of differing disclosure regimes to comply which.
The Taskforce for Nature-related Financial Disclosures (TNFD) also heralds a new level of reporting obligations. Earlier this month, the TNFD published beta version 2 of its risk-management framework, and intends to publish its final recommendations in September 2023. If businesses are already finding TCFD reporting challenging, the TNFD will certainly be a step up. The science involved in quantifying nature-related risks and impacts is more complex that climate-related risks, and therefore demands a wider spectrum of data and disclosures. This is a space businesses need to keep an eye on.
The heightened standards around ESG disclosure is a double-edged sword. A shift has occurred over the last six months where there is much greater realism over the dash for net zero target-adoption and ambitious transition plans. Boards have become more reflective about making such commitments, in light of greater regulatory concern around greenwashing and enforcement actions in the spheres of ESG-related advertising, product disclosure and climate reporting. The US Securities and Exchange Commission (SEC) is proving active in this space alongside regulators in the UK and across Europe.
Taking a more considered approach when planning for and setting net-zero targets is a good thing. Companies must balance the growing demands and desire to make commitments and set targets with the need to be realistic about the pace and challenges of decarbonising their businesses and supply chains particularly when it comes to their scope 3 emissions.
Sustainability disclosures in the private debt market
Historically, private debt markets such as the loan market have had a much lighter regulatory touch in terms of disclosure, and are driven by market conventions. However, the past few years have seen a growth of green- and sustainability-linked loan products that involve disclosures of ESG data. While these are rightly characterised as market-driven disclosures rather than strict regulatory requirements, they eventually bring market actors to a similar place.
The influence of regulators’ public disclosure requirements on private markets should not be underestimated. This is because most, though not all, borrowers under loan agreements are likely to have a presence in public markets (for instance if they are listed companies, or if they issue public debt). As such, we expect to see a degree of alignment in disclosure standards across the public and private. This movement towards consistency is welcome: one of the main concerns about green- and sustainability-linked products in recent years has precisely been the lack of harmonisation of reporting standards.
However, one key distinction between private and public markets is that loan market disclosures tend to relate to specific ESG Key Performance Indicators (KPIs), agreed as part of the loan product, as opposed to KPIs relating to the borrower's business more broadly (as is common in regulation-driven disclosure requirements under). Private debt documents therefore create a more limited scope of disclosure requirements to their regulatory counterparts.
Data and disclosure concerns
In loan and impact investment markets, there has been a great deal of focus on the quality and reliability of the data and metrics being reported and applied. This scrutiny follows on the heels of regulators' increased enforcement of greenwashing claims (see above). In response, many ESG reporting obligations under loan agreements now contain a degree of third party validation.
Stringent disclosure obligations can also create a barrier to attempts to extend forms of green- and sustainability-linked finance to other parts of the market, such as the SME market. In these segments, borrowers may be smaller, unlisted companies who do not customarily collect and report ESG data as do large, publicly listed companies in their annual sustainability reports. Financiers need to take a proportionate approach to the kinds of information they expect to receive accordingly. In this respect, the flexibility of private debt markets can be useful, as there is scope to adjust disclosure expectations in the loan documentation to reflect what is appropriate for a particular borrower.