Earlier this year, Cathie Armour, a Commissioner of the Australian Securities and Investments Commission (ASIC), gave a speech on the rise of greenwashing and its potential threats. A copy of this speech can be found here. Armour referred to the number of different disclosure frameworks and how this multiplicity may cause a lack of clarity about the standards that apply to issuers when they assess their products. This could ultimately increase the risk that product issuers overstate their green credentials.
More recently, on 8 September 2021, the Managing Director of the Monetary Authority of Singapore, Ravi Menon, gave a speech at the Financial Times Investing for Good Asia Digital Conference on the ability of green finance to unlock a sustainable future. A copy of this speech can be found here. Menon echoed Armour’s concerns, noting that, internationally, there are more than 200 frameworks, standards and other forms of guidance on sustainability reporting and climate related disclosures. Menon emphasised, among other things, that there needs to be greater consistency to cut through this disclosure diaspora.
This article considers the current environmental, social and governance (ESG) disclosure regime in Australia for Australian financial services (AFS) licensees and cites aspects of the new European Union regulatory regime that could be useful to consider if the Australian ESG disclosure regulations were refined and updated.
ESG factors include climate change, environmental impacts and management, human rights infringements, diversity and inclusion, corruption, financial and corporate reporting and data protection practices. From an investment funds perspective, the consideration of ESG factors is most clearly present in the creation of investment objectives and in determining the investment mix that will achieve that objective. For many funds managers, ESG factors represent another qualitative element considered in making investment decisions.
ESG investing has been increasing over the past decade, but had a sharp increase most recently during COVID-19 and the rise of shareholder activism forcing fund managers to look beyond financial metrics to take into account ESG factors in their investment guidelines. Currently, 20% of all assets worldwide are held by funds that employ some form of ESG criteria.[1]
Investments funds offered under a product disclosure statement (PDS) are subject to the following ESG disclosure requirements:
Given that RG 65 was last updated in November 2011 and the change that has occurred in this area, it may be time for ASIC to revisit its guidance. As the Organisation for Economic Co-operation and Development (OECD) Report ESG Investing: Practices, Progress and Challenges notes:
“ESG investing has evolved from socially responsible investment philosophies into a distinct form of responsible investing. While earlier approaches used exclusionary screening and value judgments to shape their investment decisions, ESG investing has been spurred by shifts in demand from across the finance ecosystem, driven by both the search for better long-term financial value, and a pursuit of better alignment with values.”[2]
A copy of the OECD report is available here.
Fund managers may want to take into consideration the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) which address the disclosure of the governance practices, strategy, risk management, and metrics and targets in relation to climate related risks and opportunities. The Final Report detailing the recommendations of the TCFD can be found here.
In June 2021, CDP, the Investor Group on Climate Change and the Principles for Responsible Investment released a roadmap titled ‘Confusion to clarity: A plan for mandatory TCFD-aligned disclosure in Australia’, a copy of which can be accessed here. The plan outlined global and domestic developments in the climate disclosure space, made a case for mandatory TCFD-aligned disclosure and outlined a number of proposals for the implementation of mandatory climate risk disclosure in Australia. One such proposal was the amendment of existing ASIC regulatory guidance to ensure that listed companies, large non-listed companies and fund managers report in accordance with the TCFD recommendations.
Some fund managers may also wish (or be required) to take into account the OECD Guidelines for Multinational Enterprises, a copy of which can be found here. The Guidelines provide a series of non-binding principles and standards for responsible business conduct covering a broad range of topics including human rights, the environment and anti-bribery actions.
ASIC has raised the possibility that financial advisers may need to take into account ESG factors when providing personal financial product advice. In Regulatory Guide 175 Licensing: Financial product advisers – conduct and disclosure (RG 175), ASIC states that financial advisers must determine whether section 961B of the Corporations Act (the statutory best interests duty) requires an adviser to take into account ESG considerations when providing personal financial product advice. If an adviser determines that the best interests duty requires them to take ESG factors into account, then the adviser would have to do so when providing their personal financial product advice. Presumably, subject to the particular circumstances, an adviser could determine that section 961B of the Corporations Act will require a consideration of ESG factors for some clients, but not others.
Fund managers should also be cautious about the use of ESG-related names of managed funds and financial products if they do not have a sufficient ESG nexus. Whilst ASIC has not provided specific guidance on this particular issue in the context of ESG, the United Kingdom’s Financial Conduct Authority has expressed its concern over funds with misleading ESG-related names whilst tracking non-ESG focused indexes.[3]
The European Union (EU) recently adopted a legal framework designed to provide greater transparency through increased disclosure of sustainability risks within financial markets in a way that ensures comparability and prevents greenwashing. This legal framework, which came into effect on 10 March 2021, is the EU Sustainable Finance Disclosure Regulation (2019/2088) (SFDR). A copy of SFDR can be accessed here.
The SFDR defines sustainability risks as ESG conditions which may have actual or potential material negative impacts on investment values. No doubt much consideration went into the definition, but it is, nonetheless, very wide, and capable of varying interpretations.
The SFDR applies to financial advisors and financial market participants which include alternative investment fund managers (aka AIFMs), investment firms which provide portfolio management, management companies of undertakings for collective investment in transferable securities (aka UCITS) and manufacturers of pension products. Some of the key features of the SFDR are outlined below:
In contrast, Australia’s ESG regulatory disclosure requirements pale in comparison. However, notwithstanding the comparative paucity of regulation, many Australian fund managers and superannuation fund trustees in Australia are increasingly disclosing their ESG credentials and initiatives voluntarily.
The agreement under which a fund manager manages assets generally specifies the guidelines to be followed by the manager when managing the assets. Increasingly, these include at least some ESG considerations and not simply negative filters (such as no tobacco or coal investments). An IMA can also require the manager to obtain the client’s consent before particular transactions are completed (thus giving the client a veto right in relation to particular ESG considerations). An IMA can also require a manager to give the client additional reporting on ESG factors, including current holdings, performance against benchmarks and ESG market conditions.
The establishment of ESG focused managed investment schemes represents a way to capitalise on the growing demand for ESG investments. Some product issuers have also opted to establish a separate class and pool of assets within an existing fund aligned with ESG investment objectives, rather than establish an entire fund. The creation of different classes of units referrable to a separate pool of assets within the fund allows a fund manager to employ different strategies within the same fund, including where one of those strategies effectively has an ESG overlay.
The rise of ESG investing in Australia, the current quality of specific legislative and regulatory guidance in relation to ESG considerations for financial products and services, provide challenges and opportunities for financial service providers in Australia.
[1] KPMG, 2020, Catalyst for Change: Sustainable finance developments across Asia Pacific.
[2] Boffo, R., and R. Patalano, 2020, ESG Investing: Practices, Progress and Challenges, OECD.
[3] UK FCA, 2021, Authorised ESG & Sustainable Investment Funds: improving quality and clarity.
Finally, the Australian Government has initiated the long-waited for Tranche 2 reforms to its anti-money laundering regime with considerable fanfare.
The Federal Court last week handed down its decision in Australian Securities and Investments Commission v Firstmac Limited [2024] FCA 737. ASIC was successful in its claim that Firstmac Limited...
The Federal Court has found in favour of ASIC against digital currency payments provider BPS Financial Pty Ltd over its Qoin Wallet product. We unpack the Court’s findings and comment on the...