ESG regulations in Europe map a clear path for the US

Financial advisers wondering where U.S. regulators might be headed with all their ESG-related rule discussions over the past couple of months should glance across the pond as a guide and look at what their European counterparts have just begun to encounter.

Over the last several months, European regulators have put into place rules aimed at boosting the transparency and accountability of investments that claim environmental, social and governance goals or characteristics.

As part of meeting its climate change commitments by 2030, the European Union is creating taxonomy rules to create a common language in this sector known for its alphabet soup of terms.

The EU taxonomy will include definitions of which economic activities can be considered environmentally sustainable so that investors, policymakers and others can evaluate and compare how “green” companies really are. The taxonomy will establish clear criteria for activities to define what it means to make a substantial contribution and what it means to do no significant harm.

Separately, in March, the first phase of the European Union’s Sustainable Finance Disclosure Regulation took effect.

Aimed at giving responsible investors clarity and guidance on a product’s green credentials, level 1 SFDR requires asset managers to publish in the fund prospectus and on their websites into which categories their products fit: funds with sustainable goals as their objective, funds that promote E or S characteristics, or funds that are not promoted as having ESG elements.

Level 2 of the rules, set to take effect next January, will require funds show “how” investments underlying the financial products are supporting environmentally sustainable goals. Those rules are very focused on taxonomy and data.

The U.K. is putting forth similar rules of its own.

Europe has led the way in the exploding market for socially responsible investing over the past 10 years; it had $1 trillion of sustainable funds at the end of 2020, compared with $179.1 billion in the U.S., according to Morningstar Direct.

So it’s reasonable to expect U.S. regulators to consider rules that follow Europe’s, too, focusing on transparency, disclosure and use of a common language in measuring impact.

Already the Securities and Exchange Commission has made it clear that the surge in investor interest in ESG investments and the growing assets under management in this space require it to do more to ensure that investors have sufficient and accurate information to use in their investment decisions.

The SEC also said that its examinations of investment advisers, investment companies and funds have shown shortcomings in how investments that prioritize ESG factors are being built, pitched and monitored.

It would especially make sense for U.S. regulators to take steps to make their rules consistent with those of regulators overseas given the global nature of investors, fund companies and, of course, the underlying mission of supporting companies and projects that think first about their environmental, social and governance impact.