The following outlines some of the key developments in regulation affecting the world of responsible investment.
Developments in the UK
HM Treasury is currently consulting on the "Future regulatory regime for Environmental, Social, and Governance (ESG) ratings providers", the consultation closing on 30th June. Ethical Screening is preparing its response and also attended the recent roundtable discussion at the Treasury this week, being impressed by the openness of the FCA's consultative process. The aims of the regulation include transparency, conflicts of interest and systems of control. Conflicts of interest include ratings providers also offering consultancy services to companies they are rating (not a service Ethical Screening provides). A voluntary Code of Conduct is also proposed to bridge the gap between now and the regulation being finalised. Ethical Screening supports the proposals for regulation and, as noted, will be responding to the consultation in due course.
FRC Consultation on Corporate Governance Code
On 24th May the Financial Reporting Council launched a public consultation on its proposed revision to the Corporate Governance Code. The proposed changes include:
- Setting out a revised framework of prudent and effective controls to provide a stronger basis for reporting on, and evidencing their effectiveness.
- Improving the functioning of comply-or-explain, taking account of recently published FRC research and reports.
- Making revisions to reflect the responsibilities of the board and audit committee for sustainability and ESG reporting, and associated assurance in accordance with a company's audit and assurance policy.
- Updating the Code to ensure that it aligns with changes to legal and regulatory requirements as set out in the Government's response to the White Paper, including strengthening reporting on malus and clawback arrangements.
The deadline for responses is 13th September.
ClientEarth v Shell
In an interesting case, the High Court of England and Wales has refused permission for climate law firm ClientEarth to proceed with a derivative claim against the directors of Shell, for failure to effectively address the risks of climate change. The case was ground-breaking as the first-ever climate litigation to try to use a derivative action to establish the personal liability of a company's directors for allegedly failing to address the threat of climate change.
Whilst the court ultimately rejected the case, it accepted that ClientEarth had established a prima facie case that "Shell faces material and foreseeable risks as a result of climate change which have or could have a material effect on it". This finding will not be lost on others seeking to bring similar claims.
Developments in Europe
European Commission - Regulations for ESG Providers
The European Union has proposed new regulations for firms selling environmental, social and governance (ESG) ratings that could "force some to restructure their businesses in a major shake-up of the industry". Key elements include that providers must stop providing consulting services to investors, the sale of credit ratings and the development of benchmarks among other things, to avoid potential conflicts of interest.
Providers will need to be authorised and supervised by the European Securities and Markets Authority, and breaching the new rules could land them with a fine of up to 10% of their annual net turnover.
EU Parliament vote on European Corporate Sustainability Due Diligence Directive
On 1st June, the EU Parliament voted on the final text of the Corporate Sustainability Due Diligence Directive, ahead of the trialogue negotiations with the EU Council and the Commission starting in mid-June.
The vote backed the previously achieved compromise in the European Committee on Legal Affairs (JURI) committee, including maintaining the financial sector within the scope of the Directive, and not scrapping the so-called "Article 8a", which focuses on the role of stewardship and engagement for financial institutions in carrying out environmental and human rights due diligence.
The main change from the JURI compromise was the scrapping of article 26, meaning that company directors will not hold legal responsibility in setting up and overseeing the due diligence process of their own companies. However, their pay may still be linked to achieving climate targets set in climate transition plans, which companies with over 250 employees will be required to develop.
EU Adopts Regulation on Deforestation-Free Products
On 16th May the European Council adopted the "Regulation on the making available on the Union market as well as export from the Union of certain commodities and products associated with deforestation and degradation". The Regulation requires affected companies to prove that commodities and/or derived products sold on the EU market:
- Are deforestation-free;
- Have been produced in accordance with the laws of the country of production; and
- Are covered by a due diligence statement.
Affected companies are those that place certain relevant commodities on European markets, specifically cattle, cocoa, coffee, palm-oil, soya and wood. Once the text has entered into force, an 18-month implementation period will follow (24-months for SMEs).
ISSB Request for Information
On 4th May the ISSB launched its consultation on agenda priorities, asking the public to provide feedback on their plans for future standards development. Specifically, it is seeking feedback on four potential projects:
- Three research projects on sustainability-related risks and opportunities associated with:
- biodiversity, ecosystems and ecosystem services;
- human capital; and
- human rights; and
- One research project on integration in reporting to explore how to integrate information in financial reporting beyond the requirements related to connected information in IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures.
The deadline for response is 1st September 2023.
Concurrently, the ISSB is seeking feedback on its proposed methodology for enhancing the international applicability of SASB standards.
Canada Passes a Modern Slavery Act
On 11 May, Canada passed "An Act to enact Fighting Against Forced Labour and Child Labour in Supply Chains Act and to amend the Customs Tariff". This Canadian modern slavery act will require companies incorporated in Canada to report on the steps the company has taken during the previous financial year to prevent and reduce the risk that forced labour or child labour is used at any step of the production of goods in Canada or elsewhere by the company, or of goods imported into Canada by the company.