It’s a safe bet that environmental, social, and governance (ESG) will continue to be one of the hottest topics during the next year. However, what is characterized as ESG should continue to evolve. Somewhat vague notions of what falls under an ESG framework should gradually be replaced by rules and regulations that have recently been enacted or are currently being considered by Brazilian authorities and authorities outside of Brazil.
The definition, relevancy, and positive impacts have been the takeaway for most of the materials published on ESG. Most of such materials focus on “Environmental” matters, such as climate change and environmental sustainability. “Social” and “Governance” are more or less related topics developed by governmental entities and regulators outside of Brazil. Nevertheless, both “S” and “G” have increasingly become the focus of regulators, particularly considering the “Diversity, Equity & Inclusion” or “DEI” framework.
In order to better analyze general expectations for the next year, it is important to develop an understanding of some of the most relevant regulatory matters that have been recently discussed by regulators with respect to ESG:
United States of America: Several rules and potential regulations have recently been in the spotlight in the U.S. U.S. regulations tend to have an impact on the international capital markets given the U.S. markets’ importance.
The United States Securities and Exchange Commission (SEC) proposed rules regarding new climate-related disclosure requirements. These potential rules would require public companies to provide investors with extensive, consistent, and comparable climate-related information in their Securities Exchange Act of 1934 and Securities Act of 1933 filings. According to SEC, these amendments would enhance disclosure by:
- Requiring additional specific disclosure requirements regarding ESG strategies in fund prospectuses, annual reports, and adviser brochures;
- Implementing a layered, tabular disclosure approach for ESG funds to allow investors to compare ESG funds at a glance; and
- Requiring certain environmentally focused funds to disclose the greenhouse gas (GHG) emissions associated with their portfolio investments.
Additional details regarding this proposal are provided here.
While the SEC proposal might be seen as a significant development focused on “Environmental” and “Governance” topics, the “Social” side has also been targeted by the Nasdaq Stock Market (Nasdaq). In May 2019, Nasdaq launched the global environmental, social, and governance (ESG) reporting guide for public and private companies. Also, in 2021 the SEC approved the Nasdaq’s Board Diversity Rule that requires companies listed on their U.S. exchange to:
- Publicly disclose board-level diversity statistics using a standardized template; and
- Have or explain why they do not have at least two diverse directors, considering the definition provided in the abovementioned rule.
In addition, the SEC launched in 2021 an ESG-focused task force (the Climate and ESG Task Force). These regulatory initiatives will demand increasing levels of action on the part of companies regarding the implementation of effective governance, social and environmental practices.
Europe: Beginning in 2017, the European Union (EU) implemented a number of measures addressing sustainability reporting standards. Directive 2014/95/EU, known as the “Non-Financial Reporting Directive” (NFRD), was published and provided rules on the disclosure of non-financial and diversity information for large public companies having more than 500 employees.
However, a broader rule replacing the NFRD should come into force by January 2024. The “Corporate Sustainability Reporting Directive“ (CSRD) provides additional reporting requirements for all large companies located in the European Union and companies listed on the EU-regulated markets, including EU subsidiaries of non-EU parent companies. Among other changes, the CSRD includes additional requirements concerning “sustainability” matters. New rules regarding disclosure requirements, auditing and management reports will request information and metrics on topics such as human rights, diversity, and anti-corruption matters.
Brazil: The Brazilian government has become increasingly focused on “Environmental” and “Social” matters. On May 19, 2022, the Brazilian Federal Government published Decree No. 11,075/2022, which:
- Creates the National System for the Reduction of Greenhouse Gas Emissions (SINARE) and sets guidelines for sectoral emission reduction plans;
- Establishes the procedure for the preparation of Sectorial Plans for Mitigation of Climate Change; and
- Establishes the framework for the carbon credit market in Brazil.
The Brazilian Securities Commission (CVM) published Resolution No. 59, amended by Resolution No. 168, which will come into force in January 2023. This new resolution provides a new framework for disclosure to be included in the Formulário de Referência , the disclosure document filed by Brazilian publicly-held companies with the CVM. Among other changes, the CVM will require detailed information on ESG, including disclosure concerning ESG key performance indexes, compliance with international ESG standards, information regarding greenhouse gas emissions, and social and diversity information regarding a registrant’s employees and management. Regarding governance, the new resolution will request the disclosure of information regarding board members and their potential roles and duties in ESG roles matters.
The Brazilian Stock Exchange (B3) also provided new materials and guides on ESG topics. Recently, a third edition of the “Companies Sustainability and ESG Management” guide was published by the B3, in addition to a myriad of related products, services, and materials available on the B3’s website.
Over the last few years, governmental regulators, self-regulatory organizations and industry groups have been developing legal and regulatory frameworks to address ESG. There are several factors contributing to the increasing importance of ESG to regulators and businesses. As such, more than a trend, ESG matters should be seen essential for any company. Compliance and financial regulation gained a significant amount of focus following the financial crisis of 2008. That focus has remained long after the financial crisis and continues to be an essential element of doing business. The same could apply to ESG: new rules are being discussed and approved at various levels, including local, state, country and global levels. ESG is increasingly becoming critical to a company’s ability to conduct business. We expect increasingly more sophisticated standards and disclosure requirements with respect to corporate governance and sustainability. Particular importance to “social” matters should be addressed in new regulatory frameworks for ESG, following market trends and social expectations.
In the next article in our series, we will address ESG and business integrity - the importance of communicating practices correctly (greenwashing, pink washing, social washing, and rainbow washing).
Authored by Isabel Costa Carvalho, David Tyler, Ana Laura Pongeluppi, Cintia Rosa, Mariana Matos and Lizandra Baptista.
