Can financial regulators save the planet?
As the SEC faces accusations it is becoming a ‘climate regulator’, questions are being asked as to whether financial watchdogs can do both jobs.
Many governments recognise the critical role both asset managers and owners play in aiding the transition to a net-zero society. And, as a result, financial regulators have been given greater authority to oversee markets’ progress in reducing emissions.
In the US, this has recently led to claims by the State Financial Officers Foundation – an anti-ESG lobby group – that new rules proposed by the Securities and Exchange Commission (SEC) would make it a climate regulator and “foist new ‘green’ policies on America’s issuers”.
As such, there has been some discussion over the role regulators should play in the transition and whether they have the appropriate tools for such an important role.
Not all stakeholders have been as negative on the shift towards greater oversight of companies’ climate-related disclosures.
The US Investment Consultants Sustainability Working Group welcomed the SEC’s proposed rules, which require public companies to file climate-related financial information alongside other financial disclosures. However, it called on the regulator to go further and request that private market companies are also required to make the same disclosures.
“As private market investments grow as a share of institutional investor’s asset allocations, the need for comparable, reliable, decision-useful information on climate-related issues for private markets companies becomes more critical for investors,” it noted in June.
Elsewhere, there have been similar moves to enhance the role of financial regulators in transitioning to a low-carbon economy.
Ottilia Csoti, associate at law firm Fladgate LLP, says UK financial services regulators are mandated to assist with and promote a market-led transition to a more sustainable, low-carbon economy. These authorities have “disclosure-based” tools that require sustainability disclosures to help allow investors factor in climate change concerns in their financial decisions.
She explains: “The tools regulators are equipped with are designed to improve the transparency, consistency and accuracy of the information available to the market to assist others in making the choices required for a ‘market-led’ transition away from a carbon-intensive economy.”
However, though regulators have the power to introduce mandatory rules – with the threat of fines and bans for non-compliance – there are concerns that there are limits to how much change regulators can influence. In the end, change has to come from investors themselves, says Csoti.
“Regulators are equipped to encourage the flow of funds but cannot divert these directly to more sustainable ends,” she adds.
And while certain companies are required to report on their energy consumption, emissions and energy efficiency in the UK, these are often based on independent standards, says Csoti.
She adds: “These requirements too are a form of disclosure-based regulation. The regulators have the ability to require entities to publish the information, but it is largely up to the shareholders and the market to decide what to do with it.”
The data challenge
Taking on additional climate duties means financial regulators will require more data from the companies they oversee.
And here, they may need to address data gaps, information asymmetries and inherent data biases, says Marion Leslie, head of financial information and executive board lead for sustainability at market infrastructure specialist SIX Group.
“Financial institutions are focusing on meeting the goals and expectations of the next generation of investors, which are mandating for more transparency, authenticity and integrity in relation to their daily and financial decision-making processes,” says Leslie, who highlights that ‘clarity, consistency and comparability of extra-financial information form part of the European Securities and Markets Authority’s 2022-24 “sustainable finance roadmap” published earlier this year.
“These developments, in turn, place more pressure on the processes and due diligence linked to sourcing, management and aggregation of ESG data across the investment value chain,” she adds.