An increasing theme among financial services firms is just how much disclosure, reporting and transparency regulation will change asset values and access to capital. While the EU is ahead right now, with a focus on climate related disclosure, the Biden administration and COP26 will provide further impetus across large parts of the globe. Issues such as green washing are now well known, and investors and consumers are looking for data to show them the truth and guide decision-making.
Climate related stress testing will certainly impact the cost of capital as central banks review the initial pilot tests and look to read across to the wider sector. The shape of bank lending portfolios is already being slowly changed by the newly recognised risks.
This much we know, but how will upcoming regulations affect this landscape? Picking the EU Sustainable Finance Disclosure Regulations that take effect in March is a good place to start. The net is cast wide with the scope including banks, insurers, asset managers and pension funds. The aim is to facilitate transparency and consumer choice. Product descriptions, for example, will have to show how environment or social outcomes are actually achieved. More detail will become the order of the day. We can also throw in the EU Taxonomy and expected revisions to the Non-Financial Reporting Directive as further drivers of detail and transparency aligned to policy objectives and climate targets within the EU’s orbit.
We can expect to see improved disclosure – initially from corporations and then by investment firms, which are reporting about their funds and holdings. Moody’s 2021 ESG Outlook publication predicts that 2021 will see an increase in momentum for companies that can better position themselves for ESG issues. Sector alignment to taxonomies is important, but also within sectors – there will be winners and losers. As the market focuses more on climate change, for example, investors, lenders and insurers will seek to minimise exposure to carbon intensive activities such as coal mining. While that is an obvious example, we will start to see less obvious examples of companies facing an increased cost of capital and divestment of their securities, particularly as transition timing expectations differ between the corporations and the investors, funders and insurers.
This may start slowly, with marginal divestments and cost increases, but the pressure is certainly building. Moody’s highlights the point that the next generation of consumers will influence corporate behaviour and will have the technology not just to better monitor, but also to rapidly share what they find across social networks. And they will be prepared to pay a little more in order to ‘do the right thing’. From a financial services point of view, the risk is that slow movers are left behind and end up holding, insuring or funding what others no longer want.
If you’d like to discuss any of the points raised in more detail, please don’t hesitate to contact me.