ESG View - July 2022

Welcome to the first edition of ESG View - a summary of key EU and UK legislative and industry developments in environment, social and governance (‘ESG’) matters. This update includes an introduction from our Global Head of ESG, Sonali Siriwardena, updates on the Sustainable Finance Disclosure Regulation (the gift that keeps on giving!), Supply Chain Due Diligence and ESG-related consultations. Although this edition leans more towards financial services and it is beneficial for other sectors to be aware of these developments, we will look to dive deeper into other sectors in our upcoming editions. Your feedback on ESG View is always welcome and if you have colleagues who would like to be added to our distribution list, do please let us know here.

1. Welcome to ESG View, Sonali Siriwardena – Partner, Global Head of ESG

I recently joined Simmons as Global Head of ESG after over a decade in industry. I moved back into the law as I truly believe policy and regulation can help shape the ESG movement for the better.

Admittedly, it may not feel that way just yet. However, even as we wade through the hazy alphabet soup and fragmentation, there are many reasons to be cheerful. We are united in that our industries must play a proactive role to solve the critical environmental and societal challenges we face today. What’s more, global markets have already made great strides to integrate ESG into business decision making so much so that we now see certain aspects of ESG under challenge: whether that be a discussion on nuclear, a divergence on divestment or a demand for a just transition. These debates are good and necessary for surely they are all part of the evolutionary cycle of the ESG movement.

However, to participate fully in the debate, you need to be aware of what is coming down the tracks. There has been a tsunami of recent activity shaping the ESG regulatory landscape and this pace of change is likely to continue, which is why our fabulous ESG team have created this monthly bulletin. I know it would have been invaluable to me when I was in-house and I hope you will find it as useful!

2. SFDR (Sustainable Finance Disclosure Regulation) - relevant to in-scope asset managers and investment advisory firms

We have seen a flurry of recent activity from the EU on SFDR (which sets out required disclosures in relation to funds and discretionary mandates depending on their investment objective). As a reminder, SFDR Level 1 requirements applied from 10 March 2021 on a principles-based basis. Additional detailed entity and product level 2 disclosures (adopted in April 2022) are due to apply from 1 January 2023.

We want to flag THREE important EU publications, which have developed the industry’s understanding of how SFDR applies in practice.

Commission Q&A (17 May 2022):

• What: The Commission published a new Q&A document in response to ESA’s questions, which are particularly relevant to investment managers and advisors - several answers materially change the prevailing understanding on how SFDR applies.

• Scope: The Q&As cover the following key topics (a) Principal Adverse Impacts (PAI)s at product level; (b) application to MiFID investment advisors; (c) exemption for insurance intermediaries; (d) good governance; and (e) closed products. See here for our briefing note but we outline a couple of key points below.

• Welcome news: The industry has welcomed the Commission’s (unexpected) view that you can validly comply with the PAIs at product level, without needing to comply with the PAIs at firm level, and firms are adapting their approach in response. This also assists with helping products meet anticipated “sustainability preferences” for end investors under the MiFID2 changes.

• Less welcome news: the Commission’s clarifications on when Taxonomy-alignment disclosures are required (i.e. for any article 8 product promoting environmental characteristics) materially widens the operational burden of Taxonomy disclosures.

ESMA’s supervisory statement (31 May 2022):

• What: Whilst ESMA’s supervisory statement is aimed at EU regulators, it is interesting for investment managers and their funds, as it sets out ESMA’s views on supervisory practice for their disclosures and fund documentation. Our detailed briefing note here provides a useful summary.

• Welcome news: There is clarity on:

  • how national regulators will assess compliance with SFDR, including through the use of helpful checklists to assist with verification of compliance with disclosure requirements, and examples of where disclosures may stray into greenwashing (at one end of the spectrum) or may be insufficient (at the other end).
  • what will be areas for supervisory enforcement action, including severely misleading disclosures (including a discrepancy between what the fund actually invests in, and what was disclosed), no integration of sustainability risks, and article 9 products making significant non-sustainable investments.

• Surprising news: There is a detailed discussion on when fund names may stray into greenwashing, outlining limits on the use of ESG terminology such as “sustainable” and “impact” in fund names. Firms will need to check fund names against this guidance and consider changing fund names if necessary.

ESAs’ clarifications document (2 June 2022):

• What: ESAs’ Clarifications on the Level 2 RTS contain useful guidance on (a) principal adverse impact (PAI) disclosures; (b) pre-contractual and periodic financial product disclosures; (c) Taxonomy disclosures; and (d) "do not significantly harm" (DNSH) disclosures.

• Helpful news: Overall, the paper helpfully provides additional colour and worked detailed examples to assist with interpretations and broadly either confirmed adopted market views or reduced regulatory burden. In particular, it confirms the mandatory and optional use of PAI indicators, beyond entity-level PAI reporting. This includes the DNSH test for sustainable investments (mandatory), as sustainability indicators for periodic reporting (optional), and for product-level PAI reporting (optional). There’s also helpful clarifications on when look-through is required for indirect exposures when doing PAI reporting.

  Regarding the DNSH test, the ESAs’ Clarifications confirms (our longstanding view) that firms must use all the mandatory PAI indicators, but set their own subjective thresholds for harm.

3. Supply Chain Due Diligence: the next frontier – relevant cross sector

• What: The Commission has published its long awaited proposal (‘Proposal’) for a directive on corporate sustainability due diligence (‘DD’). It is a significant regional development as it introduces cross-sectoral mandatory obligations on companies to implement robust processes to manage human rights, governance and environment risks within their own business and value chains.

• Scope: It applies to companies incorporated within the EU, but also to non-EU companies which are active in the EU regardless of where they are headquartered.

• Timing: The legislation is not expected to come into force until 2024/25. However, many firms are already evaluating and adapting their own DD processes and internal governance obligations against the proposed standards. We have a detailed briefing note on key steps that firms should be considering in preparation.

• What does this mean for UK firms? Although it is not yet clear how many UK firms will fall within the scope, based on the Proposal many will be caught if they are generating significant turnover in the EU (through a branch) or because they are exporting goods to EU companies that are in scope. The UK government announced it is carefully monitoring the EU’s Proposal’s, but that it doesn’t plan to replicate the same requirements. However:

  • Large UK companies already publish annual transparency in supply chain statements according to the Modern Slavery Act, and are encouraged to disclose due diligence approaches in this context. Recent FRC findings on listed companies’ Modern Slavery Reporting, indicated that more work needs to be done and the government has also committed to strengthen s54 Modern Slavery Reporting and will publish its new strategy in H2 2022.
  • The UK is considering DD disclosures in the context of the international standards being developed by the International Sustainability Standards Board (ISSB) to harmonise ESG reporting and intends to bring forward proposals to adopt the ISSB's standards for use by UK businesses this year.

4. Power to the People: ESG consultation round-up

Finally, here are a few notable ESG policy consultations in flight that are currently open for comment. Such engagement is a great opportunity to influence the direction of travel for ESG matters.

• Relevant for Asset Managers: The International Sustainability Standards Board’s exposure drafts aim to harmonise the current mix of disclosure standards. They are still open for comment either directly or through industry bodies.

• Relevant for Banks: Aiming to align global practices and standards on net zero, the Glasgow Financial Alliance for Net-Zero (‘GFANZ’) has published for consultation its Report on Recommendations and Guidance on Net-zero Transition Plans for the Financial Sector which will run until 27 July 2022. The report builds on existing ISSB and TCFD requirements and encourages consistency in approaches to transition planning across the financial sector. GFANZ will publish an updated report, containing final recommendations and guidance, in autumn 2022, before COP27. Firms may wish to respond to the report - link to response.

5. How can we help you?

We have a variety of ESG-focused resources to help you navigate the fast-changing ESG policy landscape:

• ESG Global Solutions Horizon Scanning Tool (Our Trackers): Our ESG Global Solutions is a customisable tracker tool which captures all key ESG regulatory developments in an easy to access format. Updated quarterly, ESG Global Solutions provides a single repository of accurate and up to date information.

• SFDR Article 8 pre-contractual disclosure RTS template guidance document: containing guidance, interpretative views, framework language and template form disclosures

• Diversity & Inclusion (D&I) toolkit: The D&I Toolkit is an easy to use set of documents and templates created by our cross-practice team of lawyers, that will help an organisation on its D&I journey. The toolkit covers topics such as positive action, diversity audits, data collection and analysis.

• Clean Energy Tool: an online database providing access to reliable legal and regulatory renewable energy data across 40+ jurisdictions. This can help you speed up analysis and make investment decisions.

As always, if you have any questions on the above topics or on ESG more generally, our dedicated ESG Team is at hand to support you so please do not hesitate to reach out to us.