Navigating regulation as an impact investor in 2024

Many impact investors are looking to put their best investment foot forward, aiming to positively impact both environmental and societal challenges while also achieving solid financial returns. Like all investors, they can’t afford – on many levels – to make a misstep when it comes to regulation. How to best navigate the litany of changes in the ESG-field right now, with the number and scope of regulations continually increasing?

Increasing regulation won’t dampen the rise of impact investing

Impact investing is an increasingly important and favored strategy for our investors. It’s clear that the current global economy, in its current form, is not sustainable, and investors are realizing the important role they can play in shifting the paradigm. And it’s not a matter of trading returns for impact: we believe there is significant investment opportunity for impact areas. Consider the opportunity of renewable energy for instance – this market is set to increase given its necessity for countries and companies to meet various international goals, such as net zero, and achieve regulatory compliance.

The parallel rise in regulation in various countries is a complex area for impact investors to navigate, but one that we’re confident won’t quash conviction. Vontobel has been in the impact investing space since 2016 and the results of a major study we conducted last year back up our belief. It showed that professional and institutional impact investors around the globe:

• Feel that the time for impact investing is now
• Look for a proven track record of impact investing
• Share a strong commitment to impact investing, even through more challenging times
• Believe active, high-conviction management is needed

The regulatory tsunami to come: Three developments to watch in 2024

While rooted in the European Union, efforts to align sustainability and financial practices through regulation extend globally. And since so many new regulations have passed in the last year, 2024 will mark a pivotal transition.

The benefits include global comparability and consistency of sustainable finance products, however, this escalating global regulatory surge has been dubbed a "regulatory tsunami” for good reason. The field is wide and increasingly complex, with individual regulations gaining speed and joining force to bring a cumulative effect that can seem challenging to navigate.

Amid these waves, here are three items on the regulatory agenda that impact investors should keep in mind in 2024:

1.    Implementation of the EU’s new reporting regime: standardized double materiality in sustainability reporting comes into force

The EU Corporate Sustainability Reporting Directive (“CSRD”) came into force in January 2023. It requires companies to report on their sustainability practices and is a key component of the EU’s new regulatory framework for sustainable finance. The clear set of standards for producing these reports are outlined by the accompanying European Sustainability Reporting Standards (“ESRS”), adopted in October 2023. These developments marked a conceptual shift to the “double materiality” perspective in corporate sustainability reporting. Under this new reporting regime, companies will report on how sustainability factors can financially impact their economic activities, in addition to clarifying the companies own impact on the environment and society. For investors looking for companies to provide solutions to environmental and/or social challenges, this is exactly the data and information needed.

Which companies will be impacted by this in 2024 and beyond? CSRD will apply to companies domiciled in the EU (subject to certain size criteria) but also to non-EU companies that have significant activities in the EU. Thus, this new corporate sustainability reporting regime will be gradually rolled out to cover around 50, 000 firms active on the European market by 2028, with the first companies already having to publish their initial reports in 2025. For investors, it’s important to note that 2024 is the first year such companies will have to implement this new reporting regime.

Time will tell how useful and comparable these disclosures will be. The companies will have to conduct the double materiality analysis themselves, which is why we hope to see reports that are aligned with stakeholders, and in particular investors’ expectations. As an active asset manager, we are already in direct contact with companies in our portfolio, explaining the type of impact indicators we are looking for and how they could help to identify the “double dividend” as we call it¹. More information about this approach can be found on page 51 of our ESG integration and stewardship report .

2.    Changing rules for the labelling of financial products

A second area for impact investors to keep sight of in 2024 is the labelling of financial products in the realm of sustainable finance. One specific development to keep tabs on is the policy statement “Sustainability Disclosure Requirements (SDR) and investment labels”, published by the UK Financial Conduct Authority in November 2023, including a category called ‘Sustainability Impact’. Another is the potential revamp of Level 1 disclosures required by the Sustainable Finance Disclosure Regulation (“SFDR”), following a consultation period by the European Commission that closed in December 2023. This consultation requested feedback on a category of financial products investing in assets “that specifically strive to offer targeted, measurable solutions to sustainability related problems that affect people and/or the planet.” On a similar note, in December 2023, ESMA published the outcome of their consultation on ESG naming rules, with the conclusion that ‘impact’-related terms should be limited to investments “made with the intention to generate positive, measurable social or environmental impact.” In other words, impact funds will be considered separately from other sustainable investments going forward.

3.    A move toward the regulation of ESG rating agencies

The EU really dominated the ESG regulatory front in 2023, including an agreement by its Council to negotiate the proposal of a mandate aimed at regulating EGS ratings. ESG ratings are relied upon by investors seeking to form opinions of the sustainability profile of companies and financial instruments – therefore regulation for rating consistency within the EU represents a great step forward.

This development is expected to deliver enhanced ESG rating reliability and comparability – by ensuring transparency, integrity, and preventing conflicts of interest. ESG rating providers located within the EU will need ESMA authorization, adhering to transparency requirements and specific conflict of interest measures. The scope of ESG ratings explicitly includes environmental, social, human rights, and governance factors, aligning with CSRD.

Also ESG rating providers located outside the EU will be required to apply for equivalence, endorsement, or recognition of their own regulatory regime with that of the Council.

We welcome this development, as conversations with our clients and peers reveal that confusion around ESG ratings continues to exist despite the topic being increasingly in the spotlight. One example is the common mis-association of a good ESG rating with good sustainability practices – however such an assumption is not possible when there is no current standardized and transparent approach among the rating agencies.

Looking ahead

Such a common framework for ratings agencies will help level the playing field when it comes to understanding how ratings are formed and what exactly they mean. Similarly, the shift toward double materiality is one that we welcome, as it too provides a more comprehensive view for impact investors, and the stricter rules on labeling are important to ensure clarity and consistency. While increasing regulation won’t dampen the convictions that drive impact investors, it does need to be managed to ensure the continued relevance of impact investment as an ESG investing category. We’ve been employing this approach with our Impact Investing strategy for years now, and we strive to stay at the forefront of all regulatory developments but also new client needs, combining both factors to offer attractive products that are compliant.  In addition, we have positioned the listed impact strategy investment approach in 2016, and started our bond strategy focusing on environmental and social projects +2 years ago, both with a strong emphasis on transparency and clear messaging. In 2020, Vontobel also joined the Global Impact Investing Network (GIIN), which we recognize as the leading network in this area, helping to shape the field and also ensuring we are aligned with global standards.

1. https://am.vontobel.com/insights/reap-what-you-sow-how-to-harvest-your-double-dividend and https://am.vontobel.com/insights/gaining-traction-impact-report-2023

Important Information: Environmental, social and governance (“ESG”) investing and criteria employed may be subjective in nature. The considerations assessed as part of ESG processes may vary across types of investments and issuers and not every factor may be identified or considered for all investments. Information used to evaluate ESG components may vary across providers and issuers as ESG is not a uniformly defined characteristic. ESG investing may forego market opportunities available to strategies which do not utilize such criteria. There is no guarantee the criteria and techniques employed will be successful.

Any forward-looking statements regarding future events or the financial performance of countries, markets and/or investments are based on a variety of estimates and assumptions. There can be no assurance that the assumptions made in connection with such projections will prove accurate, and actual results may differ materially. The inclusion of forecasts should not be regarded as an indication that Vontobel considers the projections to be a reliable prediction of future events and should not be relied upon as such.

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