The government has published its “roadmap to sustainable investing”, laying out a number of new reporting requirements. However, some experts have warned that the plan does not go far enough to make a real difference.
The ‘Greening finance’ report, published on Monday by HM Treasury, stressed the importance of getting greater quantities of accurate information to market participants, arguing that voluntary disclosures are “widespread but often inconsistent”.
“There is a clear need for an effective, government-led sustainability disclosures regime, which enables the flow of comparable and decision-useful information on how companies and financial flows impact — and are impacted by — climate, the environment and broader sustainability factors,” the report stated.
Chancellor Rishi Sunak laid out a new set of sustainability disclosure requirements in a speech in July, building on Task Force on Climate-related Financial Disclosures rules that imposed reporting duties on companies, asset managers, asset owners and the creators of investment products.
It’s all well and good the government releasing papers like this, and giving self-congratulatory forewords at the start, but unless it implements a broad-based carbon tax that fully captures the social cost of carbon, then there’s little incentive to change
Alex Edmans, London Business School
“SDR will use the same framework and metrics across the economy to ensure a clear and direct link from investors, through the financial system to the businesses they are invested in and their relationship with the environment,” the report explained.
“Metrics will be drawn from international standards, where they exist, to support international compatibility.”
The SDR will go further than the requirements set out by the International Financial Reporting Standards Foundation, which, via the International Sustainability Standards Board, aim to establish a global baseline reporting standard, the report explained.
SDR will require “wider information on how firms impact the environment”, and demand disclosure against the UK’s forthcoming “green taxonomy”.
In his foreword to the report, Sunak wrote: “Investors and businesses must have the information they need to understand the full range of environmental risks they face and create.
“That information should be a key component of every investment decision and the strategy of every business. Climate and environmental considerations should be central to the decision-making process of every UK board and every investor’s risk and return calculations.”
David Fairs, executive director of regulatory policy, analysis and advice at the Pensions Regulator, said: “We welcome the roadmap’s ambition to address information gaps by setting new reporting requirements for financial sustainability, so every scheme can properly consider climate and the broader environment in their financial decisions.
“The pensions industry must understand this issue is real and urgent. We need to make a step change to achieve a landscape of sustainable and resilient pension schemes where climate risk is managed and the opportunities from moving to a net-zero economy are taken in the best interests of savers.”
Green taxonomy to provide clarity
The report noted that there is no common definition of what counts as environmental sustainability, with environmental, social and governance ratings often measuring different things and producing incomparable results.
“The lack of common definitions makes it difficult for companies and investors to clearly understand the environmental impact of their decisions and can lead to consumer harms like greenwashing,” it stated.
A UK green taxonomy, building on the EU taxonomy, is designed to provide a standardised way of reporting, thereby making disclosures and measurements less subjective, the report argued.
It has been designed to create clarity and consistency for investors, to improve understanding of companies’ environmental impact and to provide a common reference point.
It sets out a number of environmental objectives, such as climate change mitigation and adaptation, pollution prevention and control, the sustainability and protection of water and marine resources, and the restoration of biodiversity — and aims to underpin each by a set of “detailed standards”.
To be “taxonomy-aligned”, an activity must meet three tests: it must make a substantial contribution to at least one of the environmental objectives, it must not harm any of the other objectives, and it must meet a set of minimum safeguards.
The taxonomy will rely on reported data rather than on projections, such as companies reporting on the proportion of their capital expenditure that is taxonomy-aligned.
“Informed by reliable data from corporate disclosures, providers of investment products will then disclose the extent to which those products are taxonomy-aligned, based on their constituent assets. This will enable investors to identify the investment products which are making a substantial contribution to environmental objectives,” the report explained.
Kate Beech, associate at UK law firm TLT, told Pensions Expert: “A proposed set of standards is a welcomed development on the path towards consistent and transparent reporting.
“A global baseline reporting standard, adopted by the UK, would certainly send a strong message and would go a long way to circumventing greenwashing; however, implementation and enforcement will be crucial. Adopting a set of standards in the hope that investment pressure leads to compliance is likely to eventually lead to improvements, but may not be enough where time is clearly of the essence.
“The governing bodies of pension schemes are being told they need to review the climate-related risks posed by and to their schemes now for reporting next year,” Beech continued.
“This requirement stands alongside other climate-reporting requirements that have recently come into force for schemes with over £5bn in assets and, as of next year, for schemes with over £1bn in assets. It is unclear how these two reporting frameworks sit together and, further, how these sit alongside TCFD reporting.
“Pension schemes need more clarity on how the many reporting requirements relate to one another and the standards they need to adhere to and by when — this clarity is needed now,” she added.
Alex Edmans, professor of finance at the London Business School, told Pensions Expert that the focus on climate risk should not be conflated with climate impact.
“There is still a big disconnect between risks and impact. And, even if companies disclosed their climate impact, there would be little incentive for investors to pay attention to them, as they could simply invest in companies with high climate impact knowing that there’s little risk,” he said.
“It’s all well and good the government releasing papers like this, and giving self-congratulatory forewords at the start, but unless it implements a broad-based carbon tax that fully captures the social cost of carbon, then there’s little incentive to change.”
Stewardship matters
The report also stressed the role of stewardship, listing the various initiatives so far undertaken to encourage greater awareness and accountability, such as the UK Stewardship Code, the Taskforce on Pension Scheme Voting Implementation, and the Financial Conduct Authority’s work in this area.
“The UK’s pensions and investment sectors have made clear that, in order to effectively target and engage with companies on climate change and act as responsible stewards, investee companies must disclose decision-relevant information,” the report stated.
“SDR will ensure that investee companies disclose that information, and government and industry’s stewardship initiatives will lower the barriers to investors acting as effective stewards.
“Therefore, it is the government’s expectation that, as this information becomes available and develops over time, the UK’s pensions and investment sectors — asset managers, asset owners and the service providers that support them — will have the data to act as effective and responsible stewards of capital.”
However, Edmans noted that this section of the report is “particularly underdeveloped”.
“It’s not enough to just state an intent. With sustainability, the devil really is in the detail,” he said.
Adaption: How schemes can tackle climate and social issues together
As the COP26 conference draws near, the summit’s theme of ‘adaptation’ has raised questions around how schemes can align their environmental and societal commitments to protect the planet’s ecology and communities.
“[The report] says that investors should ‘integrate ESG considerations into investment decision-making — when deciding where to allocate capital and which companies to invest in’. But what does it mean to integrate ESG considerations?
“Most people think it means to avoid investing in polluting companies, but this means that someone else owns them and they may not hold them to account for pollution.”
Edmans added that it is better to take a “best-in-class” approach, “where you hold the best companies in the energy sector rather than divesting all of them. The latter might do better under the taxonomy as then none of your portfolio is polluting, but then energy chief executives have no incentive to be best in class as they’ll be divested regardless, so the first approach may actually be better”.
