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The financial services sector plays a crucial role in the ESG landscape. Tracey Wright, Emma Birch, and Natalie Quinlivan from Fieldfisher’s dispute resolution practice look at the potential size and scale of fraud in the financial services sector and the triple threat of compliance issues and obligations arising from ESG.
The crucial role of financial services in the ESG landscape
In an era dominated by discussions on environmental, social, and governance (ESG) considerations, the financial services sector often finds itself in the shadows. However, this sector is far from immune to the complex web of ESG-related risks, spanning from internal organisational challenges to external obligations and individual accountability. In fact, financial institutions occupy a pivotal role in driving substantial change, transitioning economies from fossil-fuel dependency to sustainability-focused models.
One of the foremost challenges businesses in this financial services sector encounter is managing and fulfilling their internal compliance needs. This includes ensuring the transparency and accuracy of their financial reporting and disclosure requirements, which have become increasingly intertwined with ESG considerations. Businesses are now tasked with not only demonstrating compliance with their financial reporting and disclosure requirements but also ensuring the compliance of ESG investment or financial products.
Apart from internal compliance, businesses must navigate the evolving landscape of external obligations. This involves transitioning to sustainable lending policies and adhering to regulated disclosures, shedding light on the potential negative impacts of investment decisions on ESG factors.
Mitigating risk to individuals: regulatory frameworks and security systems
As financial institutions strive to meet their ESG obligations, safeguarding individual stakeholders remains paramount. This involves the adoption of a regulatory framework and robust security systems to protect not only the institution but also the clients and investors. In this context, the financial sector is taking proactive measures, including the development of new financial reporting rules and obligations on a global scale. The financial services sector is positioned as a key priority and an early adopter of such regulations.
Initiatives such as the US Securities & Exchange Commission's (SEC) proposals to expand reporting and disclosure obligations to climate issues and cybersecurity issues reflect this growing trend. Additionally, the European Union's Sustainable Finance Disclosure Regulation provides a comprehensive reporting framework applicable to all financial market participants and advisors, setting clear disclosure requirements.
Furthermore, the EU's proposal for a new Green Directive aims to regulate green claims, underscoring the global drive towards sustainable finance practices. This regulatory momentum underscores the critical role that financial institutions play in driving ESG compliance.
Collaborative initiatives: shaping a sustainable future
Collaboration among financial institutions, regulatory bodies, and global leaders is essential to expedite the transition to a sustainable future. In April 2021, the Prince of Wales initiated an alliance, joining 40 banks worldwide in the Sustainable Markets Initiative's Financial Services Taskforce (FSTF). The primary objective of this taskforce is to support the transition of the financial services industry toward a net-zero economy.
As an industry sub-group of the Sustainable Markets Initiative, the FSTF comprises members from various segments of the banking industry. This collaborative effort gave birth to the UN-convened Net-Zero Banking Alliance, where banks commit to align lending and investment strategies using existing and new technologies and policies to achieve net-zero emissions by 2030. Such collective actions also underscore the industry's commitment to sustainability.
Regulatory Guidance: FCA's role in addressing greenwashing
Pivoting back to the UK, the Financial Conduct Authority (FCA) has been at the forefront of addressing concerns related to "greenwashing" – a practice where entities exaggerate or misrepresent their ESG commitments. To counteract these concerns, the FCA has conducted consultations and issued guidance on promotional materials pertaining to ESG. These materials, though crucial, have not been subject to the same level of control as other financial disclosures.
In response, the FCA is set to release final rules under its Sustainable Disclosure Requirements (SDR) for investment products, encompassing disclosure and labelling requirements. These rules are expected to roll out gradually over 12 to 24 months after publication, beginning in Q4 2023. Furthermore, the SDR may introduce a standalone anti-greenwashing rule, applying to all FCA-regulated firms. This rule mandates that any references to the sustainability characteristics of a product or service must be consistent with the actual sustainability profile and presented in a clear, fair, and non-misleading manner. This rule will take immediate effect, further reinforcing the FCA's commitment to ESG transparency.
The financial services sector is the epicentre of the ESG revolution. Proactive engagement with regulatory initiatives and collaboration with industry peers is a move in the right direction to shaping a sustainable future. As we step into a world where ESG considerations are paramount, financial institutions must remain vigilant, adaptable, and committed to driving positive change in the financial services sector. By embracing the principles of ESG, these institutions are not only meeting regulatory demands but also pioneering a more sustainable and responsible future for global finance.
A version of this article was published via IFLR: The financial services sector needs to take bolder steps on ESG | IFLR.