Last week, we did a whistle-stop tour of 2021: a year in which sustainable finance began to show characteristics of maturity. Picking up where we left off, two questions hang over 2022. What are the drivers of a mature market? More importantly, what are the consequences?
Regulation: A precedent for the unprecedented
Get ready to strain the alphabet soup.
ESG has, fairly, been awarded the epithet ‘Wild West’ thanks to an absence of coherent regulation and standardisation. That’s about to change. In 2022, corporate disclosure requirements will ramp up on both sides of the pond.
In the UK, large companies and financial institutions will have to disclose climate-related financial information from April: the first step towards mandatory national Task Force on Climate-Related Financial Disclosures (TCFD) reporting.
The EU is publishing the Corporate Sustainability Reporting Directive (CSRD), which replaces the Non-Financial Reporting Directive (NFRD) in both name and essence. Policymakers are moving away from the idea that sustainability information is ‘non-financial’, with strict format and auditing reporting standards for 50,000 public and private companies.
US companies, too, are bracing for regulation. Following a preview in June 2021, the SEC is expected to mandate corporate disclosures on social and environmental issues, with a particular focus on emissions.
All three have stated their aim is to improve consistency and comparability for investors.
There to help is the recently unveiled International Sustainability Standards Board (ISSB), whose goal is to ensure universal sustainability reporting is as rigorous as financial reporting. The closest thing to a global standard yet, the ISSB will develop disclosure standards for parent company the International Financial Reporting Standards (IFRS), which already governs financial reporting in 166 countries.
The International Organization of Securities Commissions (IOSCO) has indicated rules for third-party ratings providers are up next.
So: Contradictions are out; coordination is in. Good news, right?
Data: From the mainstream back to the margins
On the one hand, sure. Uniform, accessible disclosures benefit both shareholders and stakeholders. We might actually bridge the gap between margins and mainstream, nice-to-have and must-have, idealism and implementation. A precedented year may be upon us in the not-too-distant future; the new normal may soon be, simply, normal.
On the other hand, if everyone’s a green investor, no one’s a green investor.
2021 wasn’t kind to asset management. The FT’s year in review paints a stark picture for the industry: margins are plummeting (5% p.a. since 2015); consolidation is soaring (100+ deals in 2020 + 2021); and mutual funds are dying ($44B in flows vs. ETFs’ $850B). Those trends will escalate on the back of central bank tapering, rising costs and fee pressures, and the proliferation of low-cost trading and direct investing, respectively. Then there’s the prospect of choppy markets.
To date, ESG has proved something of a buffer, since it bolsters performance (information asymmetry yields alpha) and brand (Doing the Right Thing is a differentiator at a corporate and product level).
But as the adoption curve begins to trend downwards, so does any first-mover advantage.
Maintaining an edge will require a pivot to alternative-alternative data. Fortunately, companies leave a trail of information about their social and environmental impact that doesn’t make it into reports. Even better, advances in technology make it possible to aggregate and parse the breadcrumbs.
As ever, the information omitted from corporate reports is just as valuable as the information included—if not more so. As regulation drives traditional ESG data into the second bucket, it’s simply time for investors to find new sources.
And they must. In the current market, innovation and differentiation are not just urgent, but existential.