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The current volume of ESG disclosure has not provided information that is really useful to investors, a white paper from ratings giant Morningstar has concluded.

In the paper, entitled ‘The Evolving Approaches to Regulating ESG Investing’, Morningstar suggests that “while new disclosures are critical, the current volume of disclosure has not led to useful information for investors”.

The report adds that it is essential standardised disclosures, common terminology and clear language are used to inform investors and counteract ‘greenwashing’.

One significant global division is that European regulators generally require a ‘reasons why not’ approach to disclosure and ESG, while the US approach asks for ‘reasons why’.

Flows grow

The paper does acknowledge that sustainability has become a key driver of fund flows in Europe and the U.S. over the past few years.

These flows have contributed to assets under management in ESG-oriented funds growing 40% to €684bn (£429bn) over the four years to the end of 2018. In the U.S., such funds have more than doubled from approximately $40bn (£31.5bn) in 2013 to almost $90bn (£71bn) in 2018.

The paper says that as nascent sustainable financial products rapidly grow up, regulators have been examining a spectrum of policy interventions. The aim is to facilitate sustainable investing without stifling private-sector innovation or eroding investor protections, with retirement provision a key sector.

Morningstar says that the main policies regulators have been exploring include:

  • if and how to incorporate sustainability factors into the investment management and the investment advice processes
  • disclosures, both by issuing companies and managed investment products;
  • governance and stewardship of investments
  • the definition of what should qualify as a sustainable investment, with a new common language and taxonomy of sustainable investment types

It also notes that a great deal of work has been been done to create voluntary standards with a great deal of work already done by the private sector so regulators should avoid ‘reinventing the wheel’.

The report also notes the different progress being made across the globe.

ESG – a partisan issue for the US

The report warns that in the US, ESG regulations may be caught up in the partisan divide over climate change and regulations more generally.

It says: “Unlike in Europe, U.S. policy on ESG has become part of the partisan divide among policymakers, as the Department of Labor under President Donald Trump has tried to weaken Obama-era guidance that aimed to make it easier for retirement plans to offer sustainable investments as options.

“Consequently, there has been much less policy activity, though the DoL promulgated guidance in 2015 designed to guide retirement plans that wish to consider ESG factors as part of their investment-selection process. More-recent guidance from 2018 was less positive about using ESG factors under current law, but some members of Congress have floated bills to make it easier for plan sponsors to include sustainable investments.”

China wants mandatory disclosure by 2020

China and Hong Kong are making progress on significant initiatives though across Asia progress is more disparate.

“Developments in Asia are more disparate, though policymakers in many countries are evaluating what steps they need to take. The Chinese mainland is working toward mandatory disclosure of environmental information by 2020. The Hong Kong Securities and Future Commission set out its Strategic Framework for Green Finance11 in 2018 in which its top priority is to enhance listed companies’ reporting of environmental information. The SFC has also been evaluating policymaking in the asset-management arena and, in April, issued a circular specifying detailed reporting requirements. From the end of this year, it will maintain a public list of regulated funds that meet its ESG criteria,” it says.

EU – risk of relegating social and governance standards

Morningstar has some concerns that the EU focus on the environmental component could take the focus off the other two aspects of ESG i.e. social and governance criteria and this could lead inconsistencies.

“The EU sustainable finance package included proposals for a taxonomy that will identify which activities are sustainable. In the near term, the work will focus exclusively on environmental activities. While this may be pragmatic, it runs the risk of relegating the relative importance of social and governance issues, leaving scope for inconsistent interpretations in these areas for years to come,” it says.

Indeed, the report makes a number of recommendations to achieve a consistent, effective regulatory approach.

  • Utilise the head start and experience of nonregulatory expert groups and avoid reinventing wheels or, worse, setting divergent standards
  • Collaborate to avoid non-cohesive requirements across sectors or markets that will result in higher costs for investors
  • Develop extensible regulatory frameworks, rather than highly prescriptive rules, to avoid stifling innovation, and enable timely updating as results are evaluated
  • Avoid requirements to disclose the extent to which sustainability risks are expected to affect returns (as the EU plans), as these are likely to confuse rather than enlighten investors

It adds: “Asset management is an increasingly global activity. If investable products are to be offered to investors, wherever they reside, as efficiently as possible, then more-consistent rulebooks for product manufacturers and distributors create lower costs and more comparable and understandable choices for investors.”

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