As the world moves towards a more sustainable future, the financial sector is at the forefront of change. With an increased emphasis on the importance of nature and the fight against climate change, 2023 will be a critical year for financial institutions. The launch of the Taskforce on Nature-related Financial Disclosures (TNFD) will require these institutions to disclose their impact on the environment, while new regulations for ESG ratings providers and the adoption of a Green Taxonomy will drive a more responsible approach to investments.
Climate and nature – one agenda
Whilst the shared global imperative is to reach net zero carbon emissions by 2050, with many companies focusing on reducing emissions across Scopes 1, 2 and 3, the importance of biodiversity loss and the lack of similar focus on this agenda has come into stark focus in the last 18 months. By not considering the importance of nature in helping mitigate and adapt to climate change we have an incomplete approach.
At COP27 this year that was very much the message on Biodiversity Day.
There is likely to be more emphasis on financial institutions in 2023 to reflect the value of nature within their targets and commitments. This will only pick up more momentum by the introduction of the Taskforce on Nature-related Financial Disclosures (TNFD) which follows similar recommendations to the Taskforce on Climate-related Financial Disclosures (TCFD).
Various consultations have been taking place throughout 2022 and will continue into 2023 with the aim to formally launch the framework in September 2023. The initial thoughts are that financial institutions will be the first who will need to disclose.
We expect the trajectory of the TNFD to move at a far greater pace and companies would do well to prepare and consider their impact on nature alongside climate in readiness for reporting and disclosure.
TCFD – what's new?
Whilst the TCFD has been in place for almost a decade, it has only really started to get traction in the last couple of years since it was mandated.
In April 2022 it was announced a further 1,300 financial institutions and listed companies are now required to disclose as well as private companies with over 500 employees and £500 million in turnover. Making the UK the first G20 country to mandate TCFD with the EU set to follow suit.
The FCA is also working closely with the UK Government’s Transition Plan Taskforce and other key stakeholders to develop a ‘gold standard’ transition planning and disclosure framework to integrate and build on TCFD.
Meeting customer needs - sustainable investing
It is likely that we will continue to see a surge in ESG and sustainability-linked investing throughout 2023 with many financial institutions looking to prioritise and create more opportunities for investors.
However, it was reported last year that most investors currently do not feel that their portfolios are meeting their needs or at the level they would expect. So whilst the appetite is there the sustainable fund market could reduce in terms what qualifies as a true ESG and sustainability-linked investment and therefore financial institutions will need to be cautious how they label "green products" for fear of reputational and financial damage linked to greenwashing.
In August, the EU implemented new rules to help clarify what can be considered an ESG and sustainability-linked investment and the UK are looking into a similar framework with a revised Green Finance Strategy expected in early 2023. In the US, the SEC are also likely to announce their framework towards the end of the year. This means throughout 2023 there could possibly be a huge downgrade in products currently considered "green".
ESG ratings…finally time for a change?
ESG ratings are used globally to measure the sustainability performance of companies and help to inform investment decision making by pension fund providers, asset managers and insurers to name a few. Currently there are estimated to be around 150 ESG rating providers worldwide from the well-known such as S&P Global, Moody's, MSCI and the FTSE4Good to more niche smaller rating providers.
For some time ESG ratings have come under scrutiny for the lack of standardisation and therefore no universal benchmark in which a company is rated. The market has listened and in 2023 the FCA and HM Treasury are working on a code of conduct and new regulation respectively which will require a consistent approach to transparency, good governance, management of conflicts of interest and robust systems and controls for ESG ratings providers.
It will also be interesting to see what role ESG ratings providers play over the long term as more regulation and mandatory disclosures comes into effect over the next couple of years.
SMEs call for help
UK SMEs represent 52% of UK turnover, and 60% of UK employment. SME's globally represent 90% of businesses. They are therefore responsible for considerable emissions worldwide, yet are particularly challenged by effecting and understanding low carbon transition and the role they play.
Without SMEs committing to reducing their emissions a net zero future is very unlikely and it is incumbent on larger organisations especially those that support SME's such as asset managers and banks to support in transition. Companies that work with a large number of SME's are urged to lead by example and help others to understand what they need to do.
Due to the level of influence that financial institutions could have and the increasing regulation they are subject to, they are more equipped than others to rise to the challenge and need to do so expect to see what they will be doing to support SMEs in 2023.
What else should financial institutions be looking out for in 2023
- The UK is planning to adopt a Green Taxonomy, which is expected to incorporate principles similar to the EU Taxonomy. It is anticipated that this will take effect in 2023.
- The European Commission published its long-awaited proposal for a directive on Corporate Sustainability Due Diligence (CSDD) with the general aim of motivating companies to inspect their supply chains for human rights and environmental breaches. Whilst it isn't likely to come into effect until 2024, companies will be gearing up throughout 2023 to meet the requirements which will be dependent on size and turnover of EU and non EU companies.
- The delayed second phase of the EU Sustainable Finance Disclosure Regulation (SFDR) is likely to come into effect early in 2023. The SFDR obliges investors and asset managers to disclose how they integrate ESG factors into their risk processes and each phase will include new areas of focus.
- The Science Based Targets initiative (SBTi) is set to launch the first Net- Zero for Financial Institutions framework in 2023 specially to support the sector.
- There are also a number of other reporting requirements coming down the track throughout 2023, these include the International Sustainability Standards Board (ISSB) and European Financial Reporting Advisory Group (EFRAG) which are looking to consolidate other reporting requirements and disclosure frameworks.
- There is likely to be continued pressure on how financial institutions are aligning their supply chains to their own values and more emphasis on double materiality (measuring the impact).