Sustainability Regulation and Financial Markets

Anjeza Kadilli Professor of Finance, Co-director CAS Sustainable Finance, HEG-Genève

The Regulatory Landscape around the World

Sustainability regulation is gaining momentum, particularly in the European Union (EU). The various regulations have become mandatory for a growing number of companies operating in the EU, including SMEs. These disclosures concern the monitoring of the supply of sustainable investment opportunities and the disclosure of information relating to the environmental and social impact of companies' activities. The Sustainable Finance Disclosure Regulation (SFDR, Eurosif, 2021) is a European regulation – effective from 2021 – on the publication of sustainability information in the financial services sector for investment purposes. The EU Taxonomy (European Commission, 2020), effective from 2022, establishes a classification system for environmentally sustainable business activities. The EU Corporate Social Responsibility Directive (CSRD, European Commission, 2022), which came into force in 2023, regulates the social and environmental information that companies must communicate.

In the US, there is no SFDR equivalent in terms of sustainable investment guidelines. However, large financial institutions with more than USD 100 billion in assets must comply with the Principles for Climate-Related Financial Risk Management (Federal Reserve, 2022) and disclose information on their climate-related risks. In the UK, the Stewardship Code (UKSC, UK Financial Reporting Council, 2020) outlines best investment practices for asset owners and managers. The 2006 Companies Act requires large and medium-sized companies to disclose ESG-related information such as the company's environmental impact, social issues and policies.

In Switzerland, members of the Swiss Bankers Association have integrated mandatory self-regulation on client ESG preferences into investment advice and portfolio management from 2023 (SBA, 2022). Similarly, the Swiss Asset Management Association has imposed mandatory self-regulation on its members at institutional and product level from 2023 (AMAS, 2022). Furthermore, following the guidelines of the Task Force on Climate-Related Financial Disclosures (TCFD, 2022), the Swiss authorities require medium and large Swiss companies to report on the ESG risks of their business activities from 2024 (Federal Council, 2022).

Many emerging economies in different regions have introduced mandatory sustainability regulations. Some of these regulations date back to the 2000s (e.g. Argentina, China, Malaysia) and the 2010s (e.g. Chile, Hungary, India, Indonesia, South Africa). Most of these regulations are issued by governmental institutions and require disclosure of information related to ESG issues.

Impact on financial and non-financial outcomes

There is growing evidence that sustainability regulation has a significant impact on a range of financial and non-financial outcomes. Some important facts are the impact on risk-adjusted returns, cost of capital, liquidity and investment. Companies that comply with sustainability regulations are found to have better risk-adjusted returns, as they should be better protected against short- and long-term risks. This also implies that these companies can grow and have access to lower financing costs. Their shares are more easily traded. They are also shifting their investment projects towards more innovative ones to meet regulatory requirements, such as reducing their carbon footprint.

Carbon emissions are significantly reduced by companies required to comply with sustainability regulation, with many acting on the announcement of disclosure. Carbon emissions are also being reduced by companies that anticipate that regulatory requirements may be extended to them. Understanding, implementing and taking concrete action to comply with sustainability regulation requires new skills and creates new jobs. Sustainability regulation has also accelerated the restructuring of supply chains as companies seek responsible partnerships.

Future developments

The ongoing development and implementation of sustainability regulation is likely to take place over a long period of time. In Switzerland, the potential impact of the mandatory self-regulation of financial institutions by the Swiss Bankers Association (SBA, 2022) and the Asset Management Association Switzerland (AMAS, 2022), as well as the nationwide regulation for Swiss companies with more than 250 employees based on the TCFD, has yet to unfold. The interconnectedness of the financial sector gives mandatory European regulation a global dimension, the full impact of which needs to be assessed. To attract more investment in sustainable projects, emerging markets need better sustainability frameworks, of which regulation is a key component.

To be more effective, sustainability disclosures need to be comprehensive and actionable. In addition, regulators should seek international agreements that set long-term standards to create more resilient supply chains and financial markets.

Biography

Anjeza Kadilli is Professor of Finance and Co-director of the Certificate of Advanced Studies in Sustainable Finance at Haute Ecole de Gestion in Geneva. Her research focuses on international and sustainable finance, macroeconomics and quantitative methods. She has several years of experience as a Senior Economist at Pictet Asset Management in Geneva and Zurich. Anjeza holds a PhD in Econometrics with applications in finance from the University of Geneva. Her research aims to bridge the gap between academic research and practical applications.

References

• Asset Management Association Switzerland. Self-regulation on Transparency and Disclosure for Sustainability-related Collective Assets, 2022.
• European Commission. Taxonomy, 2020.
• European Commission. Corporate Sustainability Reporting Directive (CSRD), 2022.
• Eurosif. Sustainable Finance Disclosure Regulation (SFDR), 2021.
• Federal Council. Ordinance on Mandatory Climate Disclosure for Large Companies, 2022.
• Federal Reserve. Principles for Climate-related Financial Risk Management, 2022.
• Swiss Bankers Association. Guidelines for the Financial Service Providers on the Integration of ESG-preferences and ESG-risks into Investment Advice and Portfolio Management, 2022.
• Task Force on Climate-related Financial Disclosures (TCFD), Report, 2022.
• UK Financial Reporting Council. UK Stewardship Code, 2020.