• The cost-of-living and energy crises do not fundamentally change the science of nor the threat from climate change and nature loss, and regulators continue to work to ensure firms manage and disclose environmental risk exposures appropriately.
• Firms need to change gear on transition planning, from stating ambitions and setting targets to taking action. Supervisory focus will initially be on reviewing the credibility and effectiveness of transition plans in guiding risk management and business strategy.
• Firms need to develop the details of their transition plans, including by setting sector-specific pathways, validating science-based targets and deepening the assessment of their financed emissions.
• The foundational structure of corporate sustainability reporting requirements and the schedule for future developments is largely set, but substantial areas of detail remain to be elaborated or agreed, and there is much to do to implement the requirements.
• The EU Corporate Sustainability Due Diligence Directive (CSDDD) is expected to be finalised this year and will bring to the fore explicit and binding requirements around supply chain due diligence.

With the concept of transition plans familiar to FS firms, the focus is shifting to taking action to meet the targets that have been set. Efforts are under way to improve the structure and content of transition plans, with the UK Transition Plan Taskforce (TPT), the Glasgow Financial Alliance for Net Zero (GFANZ) and the UN HLEG having published guidelines to that effect at COP27. And although disagreements around aspects of the GFANZ framework spilled into the public arena in 2022, it has continued to develop guidance, for instance with its sectoral pathways and material on how firms can engage with clients to make a more significant impact on financed emissions. Sector-specificity will also follow in the EU through European Financial Reporting Advisory Group’s (EFRAG’s) next consultation, and in the UK through a consultation expected from the TPT in the first half of 2023.

We expect rising awareness of nature and social risk factors will also drive many firms to encompass a more holistic view of sustainability in their plans, in particular, the climate-nature nexus.

Firms will find their transition plans increasingly becoming part of “business as usual” supervision, with supervisors treating plans as one tool in their kit for scrutinising sustainability strategies, risk management and governance across the industry. Supervisors’ focus will initially be on the risks posed by climate change and the coherence of transition plans for managing them. The UK Financial Services and Markets Bill legislation introduces a new regulatory principle: “the need to contribute towards achieving compliance with Section 1 of the Climate Change Act 2008 (UK net zero emissions target)”; and the EU has proposed in the updated Capital Requirements Directive a new legal requirement for banks to prepare plans to address climate risks arising over the short, medium and long term. Once these new rules are in place, supervisors will also be equipped to take action when they see shortcomings in such plans. In the UK, this trend will be further bolstered through the FCA’s anticipated increase in focus on how firms’ governance and culture support their broader purpose and sustainability goals.

As firms progress with their work, it will become increasingly clear how pledges translate into day-to-day and strategic decision-making, and the implications for product and service offerings. These knock-on impacts will in some cases draw governmental and regulatory attention (including from macroprudential authorities), for instance around the possibility of gaps in insurance coverage or changing patterns of bank lending to particular customer segments. In the UK, these considerations will be picked up in the Government’s updated Green Finance Strategy. 

Firms will increasingly be pushed to report on their transition plans. Indeed, the TPT’s proposed framework for mandatory transition plans will likely be integrated into the FCA’s rulebook for those firms that are already subject to mandatory Taskforce on Climate-related Financial Disclosures (TCFD) reporting.

Transition planning is only one of the avenues through which firms will need to engage with climate and nature, with reporting and disclosure requirements set to continue to occupy a prominent place in the broader policy landscape. The foundational structure of corporate sustainability reporting requirements and the schedule for future developments is largely set, but substantial areas of detail remain to be detailed or agreed (and there is uncertainty whether timelines can be met).

Work is continuing at the international, regional and national levels, and firms operating across borders will face the corresponding challenge of reconciling multiple frameworks. Internationally, the International Sustainability Standards Board’s (ISSB) first set of standards is due to be finalised early this year, with the issue then becoming to what extent countries align their own reporting and disclosure frameworks with it.

Some countries, including the UK, will look to consolidate reporting and disclosure within the ISSB’s framework. Others, including the EU, will look to deliver outcomes consistent with the ISSB, but with distinctive elements, as with the EU’s Corporate Sustainability Reporting Directive (CSRD). In parallel, the nature-focused work of the Taskforce on Nature-related Financial Disclosures (TNFD) will also continue at the global level, creating further questions as to how far its final format – to be delivered in September 2023 – will be aligned with the ISSB, and to what extent it will be incorporated into binding domestic rules.

The unknowns for firms include whether the planned “handoffs” of information between initiatives (e.g. as corporate disclosures feed into Article 8 disclosures under the EU Taxonomy) will work; the extent to which developments in the quality and availability of data will keep pace with disclosures; and the extent to which the potential for a proliferation of standards and requirements will be reined in. 

The investment management sector faces particular challenges around disclosures at the product level. The general principle remains that every layer of the investment chain needs to be clear about the green credential of products, and that they are labelled and marketed correctly. However, regulators in the EU and UK share concerns around the mismatch between the use of ESG-related terminology in funds’ names and their underlying objectives, strategies and asset composition.

UK rules to mitigate greenwashing by asset managers, portfolio managers and distributors will be finalised in June 2023 in the form of the Sustainable Disclosure Regime, while the European Securities and Markets Authority’s (ESMA’s) November 2022 consultation indicates a shared interest in ESG labelling issues, proposing thresholds connected to the environmental and social characteristics of underlying assets in order for funds names to reference sustainability or other ESG-related terms. Indeed, these initiatives point to the wider regulatory interest in greenwashing, with the ESAs also undertaking their own work on greenwashing in FS.

The definition and classification of sustainable activities is also an important part of policymakers’ sustainability strategy, but we expect further development of the details of the EU taxonomy to progress slowly (at best) this year. In the UK, the Green Technical Advisory Group (GTAG) will continue its work on the UK Taxonomy but the legislative underpinnings for its work will be delayed. 

In its current form, the EU’s CSDDD, expected to be finalised this year, introduces requirements for large companies operating in EU markets relating to transition plans and corporate governance, and the obligation to identify, prevent and mitigate actual or potential adverse human rights or environmental impacts in their own operations, subsidiaries or entities in their value chain. For all companies, the compliance challenge will be significant.

An important additional open question for firms is to what extent the CSDDD will include FS activity in its scope. If it defines the value chain for FS activity broadly, the resulting compliance burden and costs – over and above those faced by all companies - will be very material. Moreover, the CSDDD captures entities incorporated or located outside the EU – potentially requiring third-country firms conducting business in the EU to ensure that other group entities within the value chain of the EU entity comply with the list of international conventions set out in the Directive.