From niche to necessity: the development of ESG in the UK

Sustainability issues and related legislation, for example, environmental, energy, human rights and consumer regulations are long standing, but the development of a focus on ESG (and indeed the coining of the phrase/acronym itself) is more recent. Over the past decade, ESG has evolved from being a financial sector niche to a mainstream imperative, driven by regulatory changes, investor demands and societal expectations. All boards will have ESG as a key issue on their radar. 

Sustainable finance and ESG disclosures

ESG, as a collective set of considerations, arguably developed in the finance sector, partly as a function of sophisticated risk management, and an evolution of ethical, responsible and impact investing approaches. In 2004, the UN Global Compact published Who Cares Wins, which discussed the concept of ‘environmental, social and governance’ factors to describe these non-financial issues. The UN Global Compact launched the Principles for Responsible Investment in 2006, creating a framework for investors to incorporate ESG into their investment processes. 

Investors began to call for ESG-related information to compare sustainability claims and make informed decisions on sustainable investments. A number of voluntary ESG reporting frameworks emerged, including the recommendations from the Taskforce on Climate-Related Financial Disclosures (TCFD) published in June 2017, the Global Reporting Initiative (GRI) standards and the Sustainability Accounting Standards Board (SASB) standards.  

Mandatory reporting standards

The TCFD recommendations emerged as one of the leading frameworks for reporting on climate change and have heavily influenced the UK reporting framework. Voluntary reporting has evolved to become mandatory for large parts of the economy. TCFD-aligned disclosures were introduced (via the Listing Rules) on a ‘comply or explain’ basis for UK listed companies for financial years from 1 January 2021. The UK government subsequently introduced the requirement for in-scope larger companies (both traded and private) to make certain mandatory disclosures based on the TCFD framework for financial years from 6 April 2022.

Greenwashing

The increasing focus on demonstrating sustainability credentials has led to concerns about greenwashing and, more recently, greenhushing. The government and the Financial Conduct Authority (FCA) have taken robust steps to address greenwashing. The Competition and Markets Authority has been empowered to impose fines of up to 10% of global turnover on companies making misleading environmental claims and the Advertising Standards Authority has been actively cracking down on misleading green claims.

Beyond finance

The breadth of the subject matter implied by ESG is now so vast that it is not practical to note all the UK legislation connected with the topic. However, some examples that give a sense of the breadth of the legal landscape include:

• The Modern Slavery Act 2015, requiring companies to report on the steps taken to ensure that modern slavery is not taking place (although the UK regime has recently been noted as potentially now falling behind other countries);
• The Gender Pay Gap Regulations requiring employers with more than 250 employees to publish information on their gender pay gaps each year; and
• The Energy Act 2023, which stands as the most comprehensive piece of energy legislation in the UK’s history.

The COVID-19 pandemic saw a heightened focus on the ‘S’ in ESG. One area in which this is apparent is that of worker protection. The next few years will see substantial changes in this area. These changes will be implemented through the recently published Employment Rights Bill and the Equality (Race and Disability) Bill, which is due to be published, touted as the ‘biggest upgrade to workers’ rights in a generation’. The government has also committed to using public procurement to address employment standards, including proposals to mandate the consideration of a company’s record on worker treatment, equality policies and trade union recognition as part of the contract award process.

The EU’s influence continues

Despite Brexit, EU laws continue to significantly impact UK companies that access the EU single market, especially those mandating disclosures on sustainability risks, environmental impacts and due diligence on human rights and environmental issues. Key examples include the EU Corporate Sustainability Reporting Directive (CSRD) (which has extra-territorial reach from 2028/9) and the Corporate Sustainability Due Diligence Directive (CSDDD), which will start to apply from July 2027. Other corporates may be impacted as customers or suppliers of affected businesses. 

The evolving landscape

The first two IFRS Sustainability Disclosure Standards published by the International Sustainability Standards Board (ISSB) in June 2023 marked a significant step towards the development of a global baseline for reporting standards on sustainability and climate change. The UK government intends to make an endorsement decision on the first two ISSB Standards by Q1 2025. An affirmative decision will lead to the creation of UK Sustainability Reporting Standards (UK SRSs) and we can expect further consultation from both the FCA and the government on introducing UK SRSs into the UK sustainability reporting framework. 

On the horizon we can also expect:

• Enhanced disclosure of transition plans (building on the work of the Transition Plan Taskforce);
• The introduction of a UK green taxonomy, expected to take a similar approach to the EU taxonomy; and
• Disclosures in line with the Taskforce on Nature-related Financial Disclosures (TNFD) recommendations becoming mandatory. 

What is clear is that the development of ESG legislation will not stand still. The recently announced plans from the President of the European Commission to potentially merge the CSRD, the EU Taxonomy Regulation, and the CSDDD, shows a significant attempt from the Commission to harmonise these regulations, whilst fostering an efficient and competitive business environment. UK businesses will need to stay alert to further changes ahead.