Securities Regulation Daily Wrap Up, CORPORATE FINANCE—IOSCO seeks feedback on proposals to help emerging market regulators with sustainable finance, (Feb 6, 2019)
Recommendations could help facilitate the development of sustainable products and instruments such as green bonds, social impact bonds, and ESG funds in emerging capital markets.
The Growth and Emerging Markets Committee of the International Organization of Securities Commissions (IOSCO) has requested public comment on a set of 11 recommendations aimed at helping emerging markets regulators deal with sustainable finance. IOSCO has proposed, among other things, requirements for the disclosure of material environmental, social, and governance (ESG) specific risks that are intended to enhance transparency.
In the consultation paper, IOSCO examines the trends and challenges that influence the development of sustainable finance in emerging capital markets. The paper also includes an overview of the initiatives that regulators, stock exchanges, policy makers, and others key stakeholders in emerging markets have undertaken in recent years.
IOSCO outlines some prerequisites needed for the creation of an ecosystem that facilitates sustainable finance, such as an appropriate regulatory framework and fit-for-purpose market infrastructure, and reporting and disclosure requirements. Other prerequisites identified in the report include governance and investor protection guidelines, and mechanisms to address needs and requirements of institutional investors.
Increased focus on ESG. The proposals come from IOSCO’s understanding that in the past few years market participants, regulators, and policy makers have increasingly focused their attention on issues concerning sustainable finance. Moreover, investors and asset managers are seeking to better understand sustainability-related issues to ensure that capital is allocated according to investors’ preferences.
The Growth and Emerging Markets Committee conducted a survey and engaged in discussions with stakeholders and found that several securities regulators in emerging markets have already taken steps to adopt regulatory frameworks for sustainable finance. However, the committee felt that more work was needed, and that it could help facilitate the development of sustainable finance, including sustainable products and instruments such as green bonds, social impact bonds, and ESG funds in emerging capital markets.
The first recommendation is to integrate ESG-specific issues into overall risk appetite and governance of regulated entities. IOSCO believes this will enable ESG-specific issues to receive attention of the board, and will promote the development of sustainable investments and contribute to a more sustainable economy.
IOSCO noted that due to short-term market pressures, issuers and other regulated entities often focus on short-term financial performance and pay less attention to the opportunities and risks generated from ESG-specific issues. ESG considerations are almost by definition longer term in nature, according to IOSCO, and, therefore, align well with the focus on long-termism. IOSCO cited recent studies showing that incorporating ESG factors into the business is becoming integral to a company’s long-term viability, and that institutional investors and companies have started to use materiality assessments to define those ESG issues that matter most to their businesses.
Disclosure and data quality. IOSCO’s second and third recommendations deal with ESG-specific disclosures and data quality for issuers and collective investment schemes (CIS). IOSCO recommends that regulators require disclosure with regard to material ESG-specific risks and opportunities in relation to governance, strategy, and risk management of an issuer or CIS. It also recommends that when regulators determine that additional ESG-specific reporting is needed, regulators should aim to ensure adequate data quality for ESG reporting, including, among others, through updating listing rules, the use of external reviews, and through the operation of other information service providers such as credit rating agencies.
In its survey, the committee found that the lack of accepted standards is one of the main impediments for the development of sustainable capital markets, so there is a need for sustainability frameworks and consistent taxonomies to be implemented with a focus on quality of disclosures. IOSCO’s recommendations intend to assist in enhancing transparency of ESG-specific risks by establishing disclosure requirements for ESG-specific issues and taking actions to ensure adequate data quality for ESG-specific reporting.
Sustainable instruments. IOSCO next offered six recommendations that address sustainable instruments, which may include green, social, and sustainable bonds; green asset backed securities; as well as green exchange-traded funds and ESG funds. The recommendations aim to promote integrity in the development of the sustainable instruments market. IOSCO believes that increasing trust in sustainable instruments will channel more investments into sustainable instruments and contribute to the development of sustainable capital markets in many emerging markets.
The instruments-related recommendations include that sustainable instruments should be clearly defined and should refer to the categories of eligible projects and assets for which the funds raised through their issuance can be used. IOSCO also recommends that funds raised through sustainable instruments should be used for projects and activities falling within the categories of environmental, social, or governance.
The four other proposals related to sustainable instruments are: (1) regulators should establish requirements for the offerings of sustainable instruments including the use and management of the funds raised through the issuance of such instruments, and the processes used by issuers for project evaluation and selection; (2) regulators should establish ongoing disclosure requirements regarding the use of the funds raised through the issuance of sustainable instruments including the extent of unused funds, if any; (3) regulation should provide for measures to prevent, detect and sanction the misuse of the funds raised through the issuance of sustainable instruments; and (4) issuers should consider the use of external reviews to ensure consistency with the definition of the sustainable instruments.
Institutional investors. IOSCO proposes that, consistent with their fiduciary duties, institutional investors should incorporate ESG-specific issues into their investment analysis, strategies, and overall governance and take into account material ESG disclosures of the entities in which they invest. Most institutional investors that are committed to incorporating ESG-specific issues into their investment analysis and strategies are from developed markets, according to IOSCO, and there is no specific framework to encourage institutional investors in emerging markets to incorporate ESG-specific issues into their analysis. IOSCO’s proposal would help the development of sustainable investments once institutional investors begin to incorporate ESG-specific issues into their analysis, strategies, and overall governance.
The final recommendation in the consultation paper is that regulators should analyze the gaps in capacity and expertise with regard to ESG-related issues, and consider targeted capacity building to address the gaps. IOSCO feels that regulators also should have appropriate monitoring mechanisms in place to encourage application of these recommendations.
IOSCO said that it will develop a final report with respect to its recommendations after considering all comments that it receives.
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