The whiplash in ESG laws: keeping ahead of the rapid regulations
The rising demand for social accountability has ignited ESG investments (environmental, social, and corporate governance) in recent years. As Harvard Business Review declared: “Sustainable business went mainstream in 2021.”
Extreme weather; racial attacks; the gaping healthcare inequality– are just some public issues that are driving socially conscious investors.
Additionally, global initiatives are driving commitment to ESG investments. Some examples include the EUR100bn European Green Deal and the UN’s Sustainable Development Goals Fund, which has mobilized USD1.5bn in funding towards sustainable investments.
However, the boom in ESG labels has highlighted the need to define what classifies as sustainable practices. Recent investigations into “green-washing” practices have forced regulatory boards to rapidly intervene.
Companies who are unprepared for these quick pivots in ‘green regulations’ are struggling to keep up. Where does this put the future of ESG investments and how can investors prepare for the changes in regulation?
At KimboCare, we believe that blockchain could be a pivotal tool for boosting ESG transparency as regulations tighten. As recent trends show, companies will increasingly be required to provide detailed and accessible information on all their investments.
Blockchain is key for processing enormous amounts of data across the whole supply chain. This can break through the data siloes that often make it difficult for accurate reporting, plus provide cost-effective solutions as reporting requirements increase.
We take a deeper look at the recent challenges of ESG regulations and how they might be addressed through new technologies.
Below we discuss:
- ESG trends and ‘greenwashing’
- Recent ESG infringements and the push for regulation
- Global ESG rules and regulation
- ESG reporting requirements and blockchain technology
Record inflows for ESG investments
During the turbulent year of 2020, record inward flows started pouring into funds that supported ESG issues. This trend has since continued and 2022 is predicted to achieve similar results amid ongoing social issues.
Reuters reported that almost $650 billion flowed into ESG-focused funds by November 2021, representing some 10% of worldwide fund assets. This is a big leap from the $285 billion ESG inflow in 2019.
Stocks from companies with high sustainability ratings also enjoyed an upward turn. In the same time frame, the MSCI World ESG Leaders' index reported a 22% growth compared to only 15% growth for the MSCI World Index.
Bloomberg estimates that ESG assets will boom above $50 trillion by 2025, a third of projected assets under management.
The bottom line is: ESG is a hot investment trend. But what are the motivations behind the sudden uptick?
ESG motivations: sustainability... or profitability?
Social reputation is a driving force behind ESG efforts, especially as consumers and investors demand more accountability from companies. But research shows that organizations that embrace ESG practices are also increasing their bottom line.
This blurs the line of what is driving the current ESG investment environment: are companies acting on their moral duties or only on their financial motives?
In a survey conducted by GlobalData in 2021, 70% of executives believed that ESG targets would positively impact the company’s bottom line. Some 80% confirmed they planned to increase ESG spending in the future.
A former Blackrock executive wrote in an essay that ESG was a “dangerous placebo that harms the public interest.” He questioned whether ESG funds really impacted issues like climate and inequality.
S&P Global agrees that as these growing funds come under greater scrutiny, a key challenge will be to “manage that growth in a way that combats rising concerns about greenwashing.”
As these funds reach trillions of dollars, regulation policies are struggling to maintain control over this growth and monitor investment practices. As regulations are starting to be implemented, it seems that the bottom line is not as green as many had expected.
Deeper scrutiny of these funds has fueled the demand that ESG funds must truly benefit the environment and define what is “green”.
The grey areas of “greenwashing”
Without adequate standards, what constitutes a green ESG stock, bond, or investment is a grey area. Some experts allege that banks, fund managers, and companies may be “greenwashing” or overstating their sustainable focus.
This suggests that companies are taking advantage of ESG investments to improve their reputation, while really focused on their revenue. One notorious example was in 2019 when McDonalds introduced paper straws that were found to be non-recyclable. Another example was Keurig in 2022, which was fined $3 million dollars after misleading claims that their coffee capsules were recyclable.
However, without a set standard of what is considered ‘green,’ it has been easier for companies to get away with these practices. But that is changing as countries start making these infringements subject to criminal liability.
The push for ESG legislation
In the US, the Securities and Exchange Commision (SEC) – Wall Street’s regulator – is pressing down on ESG funds. Similar to the EU, the SEC is considering more stringent disclosure requirements amid concerns of unfounded ESG claims in the future.
- In early 2022, the SEC issued a $1.5million fine to the investment arm of the Bank of New York Mellon Corp. The company was accused of misleading ESG claims after it was revealed that it had not undertaken any quality reviews for some funds it managed.
- The asset management arm of Deutsche Bank – the DWS Group –was investigated after allegations emerged that they had overstated the environmental credentials of some of their sustainable investments.
- S&P Dow Jones Indices stoked this discussion when it removed the electric-vehicle maker Tesla from its ESG Index. Some areas of concern were the company’s emissions strategy and working conditions.
In addition to requiring companies to declare their ESG selection criteria and strategies, SEC Chair Gary Gensler is proposing ESG-focused metrics. This would require in-depth reporting on set metrics, such as greenhouse gas emissions or progress towards other ESG goals.
While there are several types of standards and tools for companies to disclose practices and assess ESG performance, Fortune reported that creating core metrics will be key to enhancing transparency.
Other companies are already taking their ESG reputation seriously, including decisions related to human resources. For example, HSBC suspended a senior executive after he publicly stated that the risks of climate were exaggerated, and investors need not worry about them.
ESG disclosure regulations kick in
In response to ESG infringements, various standards and regulations are rapidly developing.
To date, the world’s most stringent ESG rules came into force in March 2022 under the EU’s Sustainable Finance Disclosure Regulation (SFDR). Bloomberg reported that these are “the world’s most ambitious set of rules yet intended to fight greenwashing and promises to dramatically alter the way the investment management industry operates.” The European Commission is now considering a stricter statutory instrument called the Delegated Act.
Under the SFDR, companies must disclose in-depth firm-level and product-level sustainability information. The goal is to enable investors and consumers alike to compare companies’ sustainability profiles.
Global ESG rules and regulations
In addition to the US and EU-centric ESG regulations, there have been efforts to extend these laws to the global scene.
For example, the WHO created a set of standard metrics to improve consistency in reporting and create transparency by measuring sustainable value.
The foundation for International Financial Reporting Standards (IFRS) also announced a prototype for disclosure requirements in 2021. In addition, a sustainability board (ISSB) was set up to embark on the mission of creating a global baseline of sustainability standards.
The IFRS says the project was born out of a significant demand for high-quality information. While the current guidance and frameworks have sparked action, the fragmentation is still costly and complex for investors, companies, and regulators.
Technology is key for ESG reporting regulations
The outcome of ESG regulation is that investors will be required to consistently present detailed and complicated data. Besides the time constraints of such an endeavor, much of this information is currently inaccessible or isolated between various third parties. This makes it difficult to get accurate metrics across the supply chain and creates data siloes.
Blockchain addresses many of the challenges related to data and metrics, which are key for transparency. Blockchain can boost transparency and accountability through several applications, such as peer-to-peer reviews, automated data collection, and aggregated data centers. As a distributed ledger, it remains relatively secure from outside tampering, while being able to cost-effectively process large amounts of data in real-time.
As a result, both the OECD Global Blockchain Policy Forum and the UN’s Climate Chain Coalition are advancing blockchain digital solutions in the ESG sector. KimboCare is another player utilizing blockchain technology to meet investors’ needs for transparency, enhanced reporting, and better measurement of metrics.
KimboCare was the 2021 winner of the Herbert and Audrey Rosenfield Foundation Prize For Social Impact Innovation. Their platform offers an end-to-end digital solution for ESG investments into healthcare. Currently, they are running pilot programs in Kenya, Cameroon and Côte d’Ivoire, with plans to expand to many more countries soon.
Through its platform, ESG investors can boost transparency by monitoring and tracking exactly how their purchased health credits, prepaid medical services, are spent to drive access to quality care at the community level:
- End-to-end digital tools give full control over funding, with the ability to track processes and measure goals in real-time.
- Blockchain-enabled health credits restrict where funds can be used.
- Intelligent fraud monitoring mechanisms prevent unauthorized access to campaigns to ensure transparency.
- Advanced encryption protects payment and medical data (PCI and HIPAA compliant).
- Sponsoring companies can monitor key performance metrics and insights on a centralized data dashboard.
- Easy access to reports for communicating ESG efforts to both internal and external stakeholders.
The future of ESG investments in a regulated environment
One trend is clear: The ‘future’ of ESG regulation is already here. ESG legislation will quickly become more stringent and companies need to act now to stay ahead. Funds without the ability to adapt in time, such as Exchange-Traded Funds (ETFs), will struggle to keep up with these ‘green regulations’.
The efforts to adapt to these quick legislation changes could cost companies millions in infringements if they are unable to act timely. However, as we know that ESG reputation is related to revenue, even a small slip-up can significantly cost investors.
This will increasingly put demand on technology to meet the ESG reporting and transparency requirements. At KimboCare, we are excited to see what new ESG innovations these demands will create and it may start with the addition of an H to ESG to reinforce Health as a key pillar of thriving societies. While ESG investing provides a framework model, healthcare must become an essential part of ESG efforts in the future. Additionally, a study from 2021 found that health-focused businesses have annually outperformed the market by 2% over a 10-year period. Investing more in healthcare impact is at the core of our blockchain platform. We continue to work towards this goal because we believe that universal healthcare should be a right for everyone.