Written by Alexandra Mihailescu Cichon, Chief Commercial Officer, RepRisk
The push for transparency and accountability in the financial services industry is gaining momentum. Both the United Kingdom and European Union are taking significant strides in implementing standardized and robust ESG regulations.
In the UK, the recent introduction of the Financial Conduct Authority’s Sustainability Disclosure Requirements (SDR), signals a clear recognition of the need to equip investors and asset managers with the tools to make informed decisions.
The SDR promises to bring greater transparency to the market and is essential for building trust and creating long-term progress. Governments and regulatory bodies are smart to bring in stricter rules that help address risks such as greenwashing. Data has shown that greenwashing accelerated from 2022 to 2023. For the banking and financial services sector specifically, in October 2023 there was a 70% increase in the number of climate-related greenwashing incidents over the previous twelve months. This alarming trend shows that access to reliable, transparent data is vital for investors.
Data has a critical role to play here – it always has, before and after the regulations. Before, data helped investors to cut through the noise by giving them access to reliable insights to make informed decisions based on a company’s ESG performance. After the regulations are in place, outside-in data still has an important role to play to capture things that may not be revealed in disclosures.
Beyond tick-box reporting to standardized regulations
ESG regulations provide asset managers and investors with a framework from which they can develop a firm understanding of complex issues. These rules are designed to encourage organizations to approach sustainability disclosures with more rigour. The SDR’s investment labels that came into force on 31 July, for example, will significantly impact how the language around sustainability is used in the industry, and promote uniformity, reducing the potential for inaccuracy and business risks. With company disclosures too often proving unreliable and inconsistent, regulations such as the SDR provide clarity and establish consistent expectations for companies’ ESG reporting. This clarity and consistency is essential for enabling investors to make informed decisions aligned with their sustainability goals.
Compliance with these regulations will be crucial, and both asset managers and investors need to be aware of this wider shift towards standardization.
The UK is not alone in this increasing trend towards regulation. The EU’s Sustainable Finance Disclosure Regulation (SFDR) has similar objectives with emphasis on its Principal Adverse Impact (PAI) indicators. These metrics are similarly designed to show participants in financial markets how certain investments pay pose sustainability risks.
Ultimately, regulations such as the SDR and SFDR encourage investors and asset managers to implement their sustainability goals more effectively. By providing a framework for disclosures underpinned by clarity and consistency, these regulations help identify early indicators of poor business conduct and accelerate the transition to an ESG-compliant economy.
The future is data-driven
While regulators are right to demand more rigorous disclosures from companies, this alone will not provide investors and asset managers with all the information they need. This is why investors are shifting away from relying on annual company disclosures, towards more reliable data-driven processes. The proactive management of sustainability risks and issues needs data that is transparent and accurate.
Crucially, data provides the “outside-in” perspective, meaning data from the likes of regulatory reports, media and NGOs, that is essential for investors and asset managers to understand greenwashing risks better and mitigate potential compliance, reputational and financial risks. This contrasts with the “inside-out” perspective provided by company disclosures which, as we have seen, all too often paint an incomplete picture of ESG risk.
The example of greenwashing shows how robust data has become indispensable for asset managers and investors. The SDR’s anti-greenwashing rule underscores this fact by mandating that any sustainability-related claims be “fair, clear, and trustworthy”. Investors should leverage data-driven insights, which have a role to play with and without regulations, to cut through the noise of greenwashing and gain a clearer understanding of the potential risks they may encounter.
Fortunately, a new wave of data solutions is emerging to meet this need. The industry’s first thematic risk scores – providing organizations of all sizes and across industries with easy access to transparent, accurate metrics – enable the targeted assessment of material ESG risk factors such as biodiversity, human rights and individual regulations. These granular and timely scores allow organizations greater insight into the level of risk they face within specific issues, which can often be varied as companies may have a high score in one area and a low score on another. Banks, investors, and businesses now have access to readily deployable risk metrics which will allow them to streamline their due diligence processes when making financial and investment decisions.
As the demand for transparency and accountability grows, investors increasingly recognize the limitations of relying solely on company disclosures. The era of superficial ESG claims is giving way to a new era of data-driven due diligence, where robust, independent data serves as the foundation for informed investment decisions.
Asset managers and investors who embrace this change, equipping themselves with the tools and knowledge to navigate this evolving landscape, will be best positioned to mitigate risk, identify opportunities, and drive meaningful progress towards a more sustainable future.
