Uncharted waters

Water is a crucial part of Earth’s climate system and, as a result, is intrinsically linked to climate change. While water is a victim of climate change, the way we manage and use water can contribute to it. Climate change affects the availability, quality and quantity of water required to meet basic human needs and threatens our human right to access clean water and sanitation. Water-related risks are becoming more immediate and significant, potentially adversely affecting all water users across the globe¹. On the other hand, energy use and greenhouse gas emissions in water supply, treatment and desalination can be significant contributors to global warming.

Water is input to almost all production activities. While specific sectors have unique KPIs, dependency on water is universal. In this landscape, water-resilient investments will be vital, and water data will be necessary for decision-making. Water is an important area for impact investors because water delivers a positive, clear, measurable impact – the trade-off between the benefits and sustainability of water is unambiguous². Water extraction, consumption and discharge are all closely interlinked, and good practice will have a positive chain effect.

Despite its importance, water reporting lags behind carbon reporting with information deficit and disclosure insufficiency. Many companies are still new and ineffective in water management and reporting³. The proprietary ESG Book dataset shows that even the most frequently disclosed metric for water (Quantitative Water Data Disclosure) has a coverage of only 54.91% in 2020, lower than the 65.11% coverage for Scope 3 GHG emissions (Figure 1). Moreover, the carbon reporting paradigm may not apply to water reporting due to water’s multifaceted, unidirectional, and localised nature. Unlike carbon, which can transport and accumulate worldwide, water issues are confined to certain times and geographical areas.

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What’s your fund’s ESG strategy?

The U.S. Securities and Exchange Commission (SEC) has proposed changes to the ‘Investment Company Act,’ an umbrella fund labeling regulation that requires 80% of holdings to be invested in accordance with the fund’s suggested investment focus. Funds that deem themselves ‘ESG,’ ‘sustainable’ or ‘green’ would be required, under the ‘modernized’ regulation, to identify securities included in the 80% basket. The proposed rule seeks to enhance data comparability and help investors differentiate between investment strategies. Given the investment industry’s demand for quantitative data, the S.E.C. has also introduced a standardized methodology for reporting emissions metrics. The fund labeling rule will be opened for comment and subject to further amendments. If finalized, it would be enforced at the start of the upcoming fiscal year FY 2023. In its proposal, the S.E.C. notes the rapid expansion of the sustainable investment universe – a 25 times increase from $639 billion to $17.1 trillion. The regulator is presently undertaking multiple measures to protect investors from misleading or exaggerated ESG claims, including the recent climate disclosure rule. The S.E.C. is, however, facing backlash for extending its powers. Several republican treasurers are punishing big banks including Wells Fargo, JP Morgan, and Goldman Sachs for fossil fuel divestment and preventing them from obtaining government contracts. The governing landscape is undergoing a paradigm shift in the U.S. and progressive rulemaking is being blocked beyond the treasury in republican-led state legislatures.

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One Draft at a Time

In an increasingly complex reporting landscape, firms are faced with an overabundance of frameworks and standards against which they can report their sustainability credentials. As stakeholders progressively highlight the need for consistent and comparable data1, standard-setting bodies are taking note. Public consultations for the International Sustainability Standards Board (ISSB) General Sustainability and Climate exposure drafts (IFRS S1 and S2), and the European Financial Advisory Group (EFRAG) Draft European Sustainability Reporting Standards (ESRS) were both live in Q2, 2022. The introduction of two draft standards with a potentially wide reach signals a trend towards the standardization of ESG reporting across jurisdictions.

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Fifty shades of green

Europe’s landmark anti-greenwashing rulebook for the investment industry, the Sustainable Finance Disclosure Regulation (SFDR) has triggered a growing number of investment funds to self-classify as either Article 6, Article 8, or Article 9. Since its implementation in March 2021, every financial market participant operating in the EU must disclose the extent to which their entity and investment products are aligned with the SFDR sustainable investment objectives (Article 6, 8 or 9 funds).

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Sustainable Finance Regulatory Update: August 2022

Policymakers are continuing to develop a comprehensive mechanism for investigating funds that label themselves as ‘ESG.’ A new chapter also begins in the ratings industry as regulators are pushing for long anticipated oversight and accountability. The long-awaited Social Taxonomy in Europe has been put on hold as regulators question the complexity of implementation. In Germany, regulators will now require risk analysis for supply chain due diligence. The Financial Conduct Authority (FCA) in the UK are independently evaluating the quality of TCFD climate disclosures. Across the Pond, U.S. President Biden has approved a landmark bill providing funding for climate and energy innovation over the next decade. In Australia, the financial services authority has issued new guidelines to help investors assess the level of preparedness in managing climate risk. Also in Asia Pacific, Japan has unveiled the world’s first code of conduct for ESG data providers. Turning to emerging markets, Nigeria’s securities exchange is taking stock of climate risk management by preparing disclosure guidelines. Countries around the world are building momentum around climate change policy by monitoring evolving threats in a local context. Global standards are not likely to be adopted by governments wholesale but may help shed some light on reporting best practices.

The European Social Taxonomy postponed indefinitely 
According to sources, the EU Social Taxonomy has been postponed indefinitely due to difficulties in arriving to a common conceptual framework that would work at both the EU and global level. The EU’s Platform on Sustainable Finance published a set of proposals for the social taxonomy in February 2022, after a four-month delay from the original schedule. The list includes guidelines on pay, gender equality and sustainable supply chain practices. The recommendations did little to accelerate the process, leading up to a political stalemate. The implications for firms and investors who were looking to work with a well-defined set of ‘Social’ criteria could be significant. Read more. 

Germany’s Economic Affairs Department provides guidance to support compliance with a due diligence law 
BAFA (Bundesamt für Wirtschaft und Ausfuhrkontrolle) has issued guidance for companies required to conduct risk analysis under the German Supply Chain Due Diligence Act (SCDDA). The law requires companies to assess environment and human rights characteristics across the supply chain on an annual basis. Companies may also produce ad hoc risk reports in circumstances where there are substantiated findings or operational changes. The purpose of risk management is to help companies implement ‘appropriate’ measures to rectify negative outcomes and business impact. Read more.

United Kingdom 
UK’s FCA and FRC review the quality of premium listed companies’ climate disclosures 
The Financial Conduct Authority (FCA) and Financial Review Council (FRC) have independently conducted high-level analyses of TCFD aligned disclosures from premium listed companies. The reports acknowledge an uptick in climate disclosures from 2020, following the implementation of ‘comply or explain’ listing requirements since January 1, 2021. Report findings show steadily improving quality of disclosures with 90% reliability rate for governance-related metrics. However, a review of quantitative data such as scenario analysis shows that companies are having issues with TCFD recommended materiality assessment. For future disclosures, FCA and FRC recommend furnishing granular data such as climate change data across the supply chain and on a sectoral level in accordance with TCFD’s four themes. Read more. 

Biden signs landmark US climate and energy investment bill, aiming to cut GHGs 
US President Joe Biden signed the Inflation Reduction Act on Aug. 16, providing for $370 billion in energy security and climate change spending over the next ten years. The legislation has the intention of spurring innovation in clean energy and transportation manufacturing and driving down greenhouse gas emissions. Read more.

Asia pacific 
Australia’s Financial Services Council issues climate disclosure standards for asset owners 
Australia’s financial services authority has issued new guidelines establishing ‘common baseline expectations’ for the disclosure of climate-friendly investment by investment managers. The voluntary guidelines support the management of climate risk and illuminate the investment management industry’s path to achieving net-zero commitments. Read more.  

Japan compiles code of conduct for ESG data providers 
Japan’s Financial Services Authority has become the first national regulator to prepare a code of conduct for ESG data providers. A voluntary set of guidelines provides the framework for building technical skills and competencies across the industry. The draft code is also a direct response to a report questioning the legitimacy of ESG ratings and other data published by the International Organization of Securities Commissions (IOSCO) in 2021. The code of conduct contains 6 pillars to improve the quality and transparency of data. It encourages all organizations providing ESG data in Japan to signal the robustness of evaluation and proprietary data. Read more.

Africa and middle east  
Nigeria’s stock market regulator to issue new climate disclosure guidelines 
Nigeria’s top stock exchanges will release the first set of climate disclosure guidelines to complement existing sustainability disclosure guidelines. The forthcoming guidelines will borrow from TCFD and contain best reporting practices in compliance with global standards such as GRI. A voluntary regulation will help key actors across the investment chain navigate the ESG landscape, however, the regulator is hoping the government will set mandatory ESG and climate reporting requirements. This will help create ‘deliberate partnerships’ between public and private stakeholders in Nigeria. Read more. 

Other News & Resources 

  • Call for feedback on Minimum Social Safeguards criteria: Open until 6 September 2022. The Platform on Sustainable Finance seeks public feedback on its draft report on minimum safeguards. The minimum safeguards set out in Article 18 of the Taxonomy Regulation require that companies implement procedures to comply with OECD Guidelines for multinational enterprises and the UN guiding principles on business and human rights. The report on minimum safeguards aims to provide advice on how compliance with minimum safeguards could be assessed. The Platform’s advice will feed into Commission work on the usability of the EU taxonomy. Read more. 
  • Eurosif Survey on Climate Data & Indicators: With its survey Eurosif wants to better understand which climate-related information are truly decision-useful for investors. The survey will be open until 7 October 2022. Read more.