Sustainable Business and Finance: Evolving standards and investor expectations

Paul Gregory.

Just as markets and investor and consumer expectations evolve, so do laws, regulations and standards. This is especially true right now, when financial providers are required or can choose, in an increasing variety of ways, to describe their approach to social and environmental issues — notably target="_blank">climate change.

The key challenge for providers, regulators, investors and consumers is for the information provided — through formal and informal channels — to be articulate and well-substantiated. When this happens, it helps investors and consumers to make good decisions; it helps regulators to understand if there are misleading gaps between what is claimed and what is delivered; and it helps boards and senior leadership of providers to have specific clarity about what outcomes and performance they are accountable for.

Three examples of this in New Zealand are climate-related disclosures, fair dealing as it applies to products claiming ethical, sustainable or similar benefits (commonly referred to as “greenwashing”), and the regulatory settings for green bonds.

Climate-related disclosures

CRD is an evolving reporting framework meeting international and local demands for visibility of and accountability for the risks and impacts of climate change on certain businesses (mostly, listed issuers, managed funds and insurers). This includes accounting for their impact on climate change by disclosing their greenhouse gas emissions.

From April 2024, this lands for consumers, investors and regulators through publicly available climate statements. The statements are intended to help investors and other users to understand the current state and potential future implications of a business’ climate risk and compare the risks — and any plans to address those risks — across similar businesses.

For reporting entities, the CRD regime has two key planks: the collection of information to enable robust assessment of what the climate risks and opportunities are for your business; and, from there, analysis of the impacts of those risks and opportunities — including scenario analysis — for how you operate.

As the regulator who supervises and enforces the CRD regime, we should be clear that once disclosed, what reporting entities do with their work is up to them. We are not enforcing against entities who do not act in response to what is shown in their climate-related statements (provided it is not misleading or there isn’t some other dimension of misconduct). Where a firm provides a transition plan to mitigate material risks disclosed in their climate statements, those plans should be supported by the evidence they are being delivered — in order not to be misleading.

But if disclosure is the end of the process for a reporting entity, that’s a board and senior management risk appetite decision to do nothing with the knowledge you have fixed yourself with. Ultimately, it is also another way to deliver on the long-game policy intent of climate disclosures, which is that they influence capital allocation for institutional and retail investors. And of course, capital allocation is, to a varying extent across the different types of reporting entities, and over time, a zero-sum game. What you do or don’t do with it is important, but only part of the point. What really matters is how investors — big and small — choose to react to whether or not you are doing anything — and what that is — about what your disclosure reveals. We’re seeing increasing media scrutiny of voluntary reporting by NZX 50 companies in the lead-up to new CRD statements.

Meanwhile, we are delivering on what we said from the outset of the CRD regime, that our initial approach would be supportive and constructive. Practically, that has meant extensive industry engagement to listen to the market, including guidance, presentations, talking with industry bodies and participating in webinars.

With months to go until April 2024, there is mixed progress among the reporting population. While we acknowledge and are aware of the challenges (which our published monitoring approach reflects), reasonable efforts do need to be made.

Fair dealing and greenwashing

Fair dealing will apply to the climate-related disclosures regime, but also applies more broadly to products claiming responsible, ethical or similar benefits. We trust it’s well-understood the Financial Markets Authority’s position on “greenwashing” in New Zealand is not deciding what is an ethical investment approach or portfolio. Rather, it is to say that if a provider uses “responsible” or “ESG”-type terms, they must be properly explained and substantiated.

This work is now supervisory business as usual.

In the course of this work, we hear the greenwashing accusation bandied about but, having looked into a number of these, it typically turns out the complainant is not differentiating what is misleading with regulatory significance from an investment they simply don’t like.

In any event, and as with all our regulatory work, the absence of enforcement action to date doesn’t mean any regulatory activity. Fair dealing enforcement action is just part of our work.

Day-to-day, we gather and assess information, which typically involves looking at underlying investment holdings to see if they appear to comply with reported exclusion policies and are consistent with broader ethical, environmental or other commitments implied — or stated — by fund labelling, disclosure, marketing and other narratives.

To date, this work has resulted in a number of changes to disclosures for new and existing products and is ongoing.

Our concern is to prevent the quite personal harm arising from an investor discovering they have been investing contrary to their values — perhaps for decades.

It is not in any investor’s interests to find they have under-performed their moral index because they have been misled about what they were investing in (and ultimately profiting from). Ethical investors do not want to feel responsible for harming other people, animals or the environment when they have reason to believe otherwise.

Regulation and bond offers

Facilitating fair, efficient and transparent markets also means we are open to making regulatory settings more efficient, which contributes to good market and consumer outcomes. Following interest from industry, we are considering whether we could make the settings for issuing green bonds more efficient to encourage issuance from a wider variety of firms. This will likely come in the form of a consultation.

The opportunity is obvious, particularly with the New Zealand bond market being substantially retail in nature. There are potential link-ups with the CRD regime, where issuing or investing in green bonds or sustainability-linked bonds might contribute to a CRD reporting entity’s plan for responding to its climate risk.

But with the potential additional complexity involved with certain kinds of green or sustainable bond offers, we also need to be sure retail investors have enough information to understand the financial and “green” features, and any risks involved, in such offers. How that is achieved is an important part of what we plan to test and form a view on, as part of the consultation.

Overall, we’re conscious this area is becoming increasingly complex. A single listed issuer or fund manager could have an ethical strategy, CRD reporting requirements, issue or invest in green bonds, be a signatory to domestic and international standards (like the Stewardship Code and Responsible Investment Association of Australasia accreditation) and have net zero-type commitments. Just practically, that is a lot to meld into a cogent story, let alone to manage as a reputational and regulatory risk. Nevertheless, we believe the New Zealand firms we regulate have the capacity and skill to manage the risks and seize the opportunities which lie ahead, to support consumer and investor trust and confidence in the integrity and leadership of our capital markets.

Paul Gregory is executive director of response and enforcement at the Financial Markets Authority.