As the world continues to grapple with climate change and environmental degradation, governments and businesses across the globe are taking steps to promote sustainable practices and reduce their environmental footprint. One key area of focus for regulators and investors is Environmental, Social, and Governance (ESG) factors, which are increasingly seen as integral to long-term value creation and risk management.
In Europe, the United Kingdom, and the United States, regulators have been rolling out sustainability legislation and disclosure requirements to better measure and report on ESG-related risks and opportunities. In this article, we will take a closer look at the similarities and differences between these regions’ regulatory frameworks and explore how they are impacting the investment landscape for fund managers.
EU Taxonomy for Sustainable Activities
The European Union (EU) has been at the forefront of sustainability legislation and disclosure requirements, since the introduction of the EU Taxonomy for Sustainable Activities in 2020. This framework aims to establish a classification system for sustainable economic activities, providing a common language for investors to identify investments that can contribute to the EU’s sustainable development goals. The EU has established an EU Taxonomy, which provides a classification system for sustainable activities. This taxonomy is designed to help investors identify sustainable investments, and it serves as the basis for the EU’s sustainable finance agenda. Under this system, investments need to meet specific environmental criteria to be classified as “sustainable”.
According to Reuters, there are six environmental objectives that underpin the taxonomy:
1. Climate change mitigation
2. Climate change adaptation
3. Sustainable use and protection of water and marine resources
4. Transition to a circular economy
5. Pollution prevention and control
6. Protection and restoration of biodiversity and ecosystems
Each objective includes ‘substantial contribution’ and ‘do no significant harm’ (DNSH) criteria, which determines whether activities are eligible and taxonomy aligned.
Companies and financial institutions are required to disclose the proportion of their business activities that are aligned with the taxonomy, and this information must be reported in annual financial statements.
United Kingdom Green Taxonomy
Following the EU’s lead, the UK government has also launched its own Green Taxonomy, which aims to set standards for sustainable investments and promote transparency and disclosure around ESG factors. The UK taxonomy covers a range of activities, from renewable energy and sustainable transport to sustainable food and agriculture.
Moreover, the UK Green Taxonomy is like the EU Taxonomy in that it provides a classification system for sustainable activities. In addition, it covers the same six environmental objectives (see above). Also, similar to the EU Taxonomy, each environmental objective will be underpinned by technical screening criteria categorising how each activity can make a substantial contribution to the environmental objective. The UK’s approach is designed to align with international standards and provide a clear framework for investors.
One key difference between the UK taxonomy and the EU Taxonomy is that the UK’s framework includes a social component, which takes into account the impact of investments on society and the economy. This means that the UK’s taxonomy covers a wider range of activities than the EU’s framework and is more closely aligned with the United Nations’ Sustainable Development Goals.
ESG Disclosure Requirements in the United States
In the United States, ESG disclosure requirements are less prescriptive than those in Europe and the UK. However, the US Securities and Exchange Commission (SEC) has been taking steps to encourage greater transparency around ESG factors in corporate reporting.
In March 2021, the SEC issued a statement alerting companies to the risks of ESG-related misstatements and omissions and outlining its expectations for disclosure in this area. The SEC has also formed a new Climate and ESG Task Force, which will focus on identifying ESG-related misconduct and enforcing existing disclosure requirements.
In the United States, there is no federal legislation or taxonomy for sustainable activities. Instead, efforts are being made at the state and local level. For example, California has established its own green bond program, which provides financing for sustainable infrastructure projects. Additionally, some states have established disclosure requirements for companies that sell securities in their state. These requirements are designed to provide investors with information about the environmental and social impact of the companies they are investing in.
At billion-air, we understand the challenges faced by financial advisors. Our comprehensive Analysis Reports aim to provide them with an audit of any ESG Fund, offering them an impartial and unbiased assessment. Our reports diligently evaluate fund score against relevant benchmarks mandated by regulatory authorities across all pertinent areas. With our expertise on sustainability and the help of Clarity AI we are committed to exposing instances of greenwashing and actively promoting ESG funds that adhere to regulatory compliance standards.
Temperature Alignment:
As the world strives to limit global warming to well below 2 degrees Celsius, temperature alignment has become a critical aspect of ESG investing. Temperature Alignment provides a detailed analysis of the carbon footprint of any fund/portfolio comparing it to the benchmark allowing you to assess its alignment with the Paris Agreement goals.
CO2 Reduction:
Reducing carbon dioxide emissions is a key objective within the ESG framework. CO2 Reduction provides all investors with a prediction of approximately how many tons of CO2 emissions they will reduce based on the amount invested in the fund/portfolio.
MIFID II Regulatory Alignment:
Compliance with regulatory obligations is essential for any fund manager. MIFID II Regulatory Alignment relies on the EU Taxonomy and Sustainable Finance Disclosure Regime (SFDR) to assess if investments meet investors’ sustainability preferences. This shows the EU Taxonomy alignment, the overall SI percentage, and Do No Significant Harm percentages, and how the fund contributes to Environmental and Social objectives.
ESG Risk Report:
Environmental, social, and governance risks can significantly impact the performance and reputation of your funds. ESG Risk score measures how Environmental, Social and Governance issues affect future financial performance. Scores integrate 3 types of data: Quantitative data, Policies and Controversies. Scores consider each organisation’s relative performance on selected peer groups. Scores are aggregated at the company level following a materiality matrix that represents the likeliness of each metric having a significant financial impact on a given industry.
United Nations Sustainable Development Goals (SDGs):
United Nations Sustainability Development Goals, the SDG Impact score measures each company’s value created or destroyed through the model of the Sustainable Development Goals. The score measures the company’s impact on 52 relevant targets across 16 goals, and then it is normalised and aggregated at the fund level to assess its total contribution to the SDGs.
Impact Highlights:
Impact Highlights examines the impact footprint of the specific fund/portfolio compared to the same amount invested in the fund’s benchmark, e.g., the S&P 500 Index (SPX). The report covers areas such as, CO2 saving for Scope 1 & 2, Water usage excess, Waste generation savings as well as job creation difference.
Fund Exposures:
Fund Exposures lists the exposure that the fund has to 16 controversial Products & Activities through 15 organisations. This is presented in the form of a table that lists subjects such as gambling, animal welfare, nuclear energy, tobacco and many more and gives a score for both the organisations and the portfolio weight.
Sustainability legislation and ESG-related disclosures are becoming an increasingly important part of the investment landscape, as investors seek to align their portfolios with their values and promote long-term value creation and risk management. While there are differences in the regulatory frameworks in Europe, the UK, and the United States, the overall trend towards greater transparency and disclosure around ESG factors is clear. We believe that it is important for all financial advisors to have information about the funds they promote, therefore owning fund audits is extremely beneficial. billion-air & Clarity AI analysis utilises a range of ESG metrics and indicators to evaluate funds and portfolios based on its own methodology.
