What is driving ESG regulation?

The spotlight on environmental, social, and governance (ESG) factors has never been brighter, yet the path to fully integrating these considerations into investment strategies is fraught with challenges, highlighting not only the demand for such data but also the glaring gaps in its availability. At the heart of the issue lies different regional interpretations surrounding ESG terminology, which has left investors clamouring for reliable data on financially material ESG factors that can influence cash flows, cost of capital, repayment, and ultimately, valuation. The increasing focus on weaving financially material ESG considerations into the fabric of investment processes.

The scarcity of reported data, coupled with fragmented and ever evolving methodologies for disclosing data and metrics, exacerbates the complexity of this endeavour. This challenge is further magnified by the vast range of ESG factors and the varying degrees of their materiality across different sectors. Companies, striving to manage risk, echo this demand for clarity and uniformity in ESG data, particularly within their supply chains. Similarly, asset owners are keen to understand how their portfolios align with their ESG objectives, seeking transparency and accountability in how these goals are achieved.

In response, governments, regulators, non-regulatory working groups and standard setters are stepping forward to bridge the gap, crafting policy, frameworks and regulations designed to ensure that investors gain access to the company and portfolio data they require. This evolving regulatory landscape signifies a pivotal shift towards more informed and sustainable investment practices, promising to reshape how investors navigate the complexities of ESG integration.

This article aims to unpack the alphabet soup of financial ESG regulation, with a focus on how key and often overlapping global rules intersect to enhance corporate accountability for sustainability disclosure, reporting and due diligence to better inform investors’ decisions.

Bridging the gap: How regulatory efforts are unifying ESG standards

The European Green Deal represents a holistic approach by the European Union (EU) to address climate change and promote sustainability while ensuring economic growth. The Deal is supported by a robust Sustainable Finance Framework including: the Corporate Sustainability Reporting Directive (CSRD) – underpinned by the European Sustainability Reporting Standards (ESRS), the Sustainable Finance Disclosure Regulation (SFDR), the Corporate Sustainability Due Diligence Directive (), and the EU Taxonomy.

These regulations, although designed to function in concert, exhibit some divergence in focus and application that have implications for companies and investors looking to navigate the evolving landscape of ESG-related reporting vital to mitigating investment risks, while capitalising on new opportunities.

• CSRD aims to expand sustainability reporting, requiring companies to disclose their impact on climate, plus policy on human rights and governance, where material. A key component of the regulation is Companies will need to provide detailed auditable reporting on Sustainability Matters considered material to that assessment.
• SFDR focuses on preventing greenwashing by mandating disclosures about how financial products consider sustainability risks and their impacts on ESG factors. It applies to financial institutions and includes both organisation-level and product-level reporting requirements.²
• CSDDD emphasises corporate responsibility in mitigating adverse environmental and human rights impacts. It mandates thorough due diligence processes across a company’s operations and value chain, setting a more explicit framework for ethical corporate conduct.³
• EU Taxonomy is a classification system that helps companies and investors identify “environmentally sustainable” economic activities to make sustainable investment decisions.⁴

ESG regulations: harmony and divergence

While these regulations share the goal of enhancing corporate accountability for their ecological and social impacts, they diverge in their applicability thresholds and specific requirements, leading to potential market confusion. However, their combined effect is to provide a more comprehensive framework for ESG reporting.

The CSRD and CSDDD overlap significantly, particularly in their emphasis on detailed planning to mitigate adverse impacts. However, the CSDDD goes further by mandating active management of these impacts and introducing stakeholder enforcement mechanisms through the courts.

Meanwhile, SFDR complements these by addressing the financial sector’s role, setting standards for how sustainability risks are integrated into investment decisions and disclosed to investors, with the aim to reduce greenwashing.

These regulations collectively bridge significant gaps in ESG-related reporting, offering clearer guidance for investors and companies. Despite some divergence in their specific mandates, together they form a coherent framework that enhances transparency, accountability, and responsible investment, guiding investors and companies towards more sustainable practices (Figure 1).

Figure 1: Interconnectivity of EU Green Deal regulations

^{Source: Janus Henderson Investors, used for illustrative purposes only.}

In a significant move aimed at enhancing transparency around the environmental impact of companies, the US Securities and Exchange Commission (SEC) adopted new rules on 6 March 2024, mandating climate-related disclosures in public companies’ annual reports and registration statements. This initiative, however, has not been without controversy, facing numerous legal challenges that have led to a temporary stay on its implementation. Despite these hurdles, the move underscores a global shift towards greater corporate accountability in environmental sustainability, aligning with similar initiatives in California and the EU’s CSRD.

The SEC rule aims to provide investors with detailed information on how climate-related risks and sustainability factors affect public companies. Key disclosure requirements include material climate-related risks, strategies, targets, governance, and the financial impacts of severe weather events and natural conditions. For larger firms, (indirect) greenhouse gas (GHG) emissions disclosures are mandated, subject to third-party validation. These requirements, scaled back from the original proposal, are based on the Task Force on Climate-related Financial Disclosures (TCFD) and the global GHG Protocol, yet the SEC created its own standards rather than adopting an existing framework outright.

Climate disclosure: California turns up the heat

In 2023, California passed Senate Bills 253 and 261, which were recently combined to form the Senate Bill 219, Greenhouse Gases: Climate Corporate Accountability: Climate-Related Financial Risk (SB-219) alongside the Assembly Bill 1305, introducing its own climate disclosure mandates. While there is overlap with the SEC rule in areas such as GHG emissions reporting including Scope 1 and 2 emissions (beginning in 2026), the California laws uniquely require disclosure regardless of financial materiality and also include (beginning in 2027).⁵

The state laws and the SEC rule diverge significantly in their approach to materiality and the breadth of required disclosures, with California’s legislation taking a more expansive stance on what . California’s climate disclosure rules apply to public and private businesses operating in the state with more than US$1 billion in revenue.

Materiality matters

The CSRD represents the EU’s ambitious effort to integrate sustainability reporting within the corporate disclosure regime. It introduces the concept of ‘double materiality’.

This approach is broader than the SEC’s focus on materiality from an investor’s perspective (’financial materiality’), and other regulators globally, requiring companies in scope of CSRD to disclose a wider range of information.

The CSRD also mandates reporting on sustainability impacts, risks, and opportunities across a company’s value chain, covering a broader array of sustainability topics beyond climate, such as water use, biodiversity, and circular economy practices.

Cross-border complexities

Companies operating across jurisdictions face the challenge of navigating these varied and sometimes conflicting disclosure requirements.

The SEC’s focus on materiality from an investor’s perspective, California’s more expansive disclosure mandates, and the EU’s comprehensive approach under the CSRD illustrate the complexities of the current regulatory landscape.

Whilst regulators are considering some adjustments to reduce complexity and facilitate a partial interoperability, such as the integration of the International Sustainability Standards Board (ISSB) frameworks by various jurisdictions, organisations must develop cross-regulatory reporting strategies that address these regional differences.

Clarity, consistency, and comparability

The evolution of ESG disclosure regulations reflects a growing recognition of the critical importance of environmental sustainability in corporate governance. As companies grapple with these new requirements, the need for clarity, consistency, and comparability in disclosures becomes increasingly apparent.

The SEC’s initiative, despite its current legal uncertainties, along with California’s laws and the EU’s CSRD, signal a significant shift towards a more sustainable and transparent corporate world.

The path forward requires careful navigation of an increasingly diverse and evolving regulatory landscape. Further, the reporting landscape is likely to become increasingly complex, given that numerous jurisdictions, including Australia, Hong Kong, Singapore and the UK, are planning to integrate the climate-related disclosure framework developed by the ISSB – International Financial Reporting Standards (IFRS) S1⁶ and IFRS S2⁷ – into their corporate reporting regimes.