In February 2023 the UK Financial Conduct Authority (FCA) published “Discussion Paper DP23/1: Finance for positive sustainable change: governance, incentives and competence in regulated firms.” The purpose of the DP is “to encourage an industry‑wide dialogue on firms’ sustainability‑related governance, incentives, and competencies. In a field where there are many initiatives taking place, our aim is to help narrow this field and help with highlighting good, evolving practices if finance is to deliver on its potential to drive positive sustainable change.” The focus of the DP is “regulated firms” (i.e., financial institutions of various kinds) in the UK and comments are due by May 10, 2023.

It is our view that the ideas and recommendations made in this paper have broader applicability than simply UK-based financial institutions and their regulators. Addressing climate change and integrating sustainability more generally into corporate strategy is a challenge facing companies and financial institutions all over the world. Thus, it is useful to put this DP into a broader context by acknowledging a multitude of incipient sustainability reporting standards. It is also important to acknowledge the increasingly politicized nature of sustainability, especially in the U.S. Without the appropriate governance structures and processes, incentives, and the necessary competencies from the board down to middle management, it will be impossible for any organization to deal with the complex field of sustainability reporting standards while simultaneously being caught between opposing political forces.

The popularity of ESG amongst the investor community, the saliency of climate change, and the evolution of ESG regulation have all led to a proliferation of net zero and sustainability ambitions from multinational corporations and financial institutions. And objectively the scale of change required and the opportunity that this creates is enormous.  Last year’s COP 27 Implementation Plan estimated the investment in renewable energy required for a global transformation to a low-carbon economy as USD 4–6 trillion per year from now until at least 2030.

As a result, financial institutions have increased their sustainable finance targets, reiterated their net zero goals, and started to build sector pathways for financed emissions for the period to 2030. However, this is proving an increasingly tricky road.  Geopolitical forces have created turbulence across the markets, energy security has become a dominant theme, and an increase in anti-ESG sentiment and greenwashing cases have combined to create a high stakes environment. Against this backdrop, firms are moving from an initial phase of setting targets to the harder task of implementing and disclosing performance against them.

The need for effective governance, staffing, and compliance processes to provide effective controls and robust data on performance in these circumstances is clear and is now supported by regulation. Incoming climate and sustainability disclosure requirements in the EU, the UK and the US mean that, while there is still some optionality as to their climate ambition, companies and investors will have to report their climate and sustainability performance according to a set of standards, just as they do for their financial performance. Standards do not establish ambitions and targets, such as for carbon emissions, but they do enable those interested in this information to assess the extent to which these are being met.

Already many large corporates and financial institutions must navigate several different sustainability reporting standards that apply directly to them (and they may also feel the indirect effects of disclosure obligations applicable to their investors and business partners). This year’s principal new reporting regimes are the European Sustainability Reporting Standards which will apply to companies reporting under the EU Corporate Sustainability Reporting Directive under a phased process starting from 2025 (in respect of the 2024 year), and the International Sustainability Standards Board’s standards which are expected to be applied in many other countries within a couple of years (and to be mandated, for example, under the proposed UK Sustainability Disclosure Requirements). The SEC is also expected to publish its own Climate Disclosure Rule very shortly.

While these standards all set governance expectations, the real test for boards will be in overseeing the complex and expensive preparation of disclosures that need to respond to different standards and the strategy that underpins them. Interoperability and equivalence are still a demand of preparers but are not a realistic prospect in the short term. Different disclosures will be necessary in different regions. For example, the EU requires sustainability disclosures to be determined by reference to impact materiality as well as financial materiality, while the other regimes focus on financial materiality alone. In the round, these new disclosure rules will drive a more detailed, accurate, and rigorous approach to sustainability reporting and the strategy that underlies it. For reporting organizations, it will be complex to navigate these different regulatory needs while maintaining consistent messaging on group sustainability strategy, risk management, and performance throughout.

More problematic than having to respond to different sets of reporting standards, companies and financial institutions are being subjected to conflicting forces from the left and from the right. On the left, pressures continue to mount for more ambitious targets regarding sustainability performance, particularly in relation to greenhouse gas emissions. On the right, there is a growing anti-ESG movement, especially in the U.S. led by some red states and prominent politicians. Those in this camp oppose any kind of standards for climate and sustainability disclosure more generally, are dubious about the reality and urgency of dealing with climate change. According to the Center for American Progress, 139 members of the 117^th Congress are climate deniers, 106 Representatives and 30 Senators.  They see those on the left as seeking to undermine the oil and gas energy and national energy security.

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