While Environmental, Social, and Governance factors, more commonly known in their abbreviated form as ESG, may not be a completely new topic of discussion or treatise, they have recently gained increased and conspicuous attention from policymakers particularly in the European Union (EU) and the US.
That the policymakers are not beating around the bush is evident from various ongoing governmental activities that target morphing ESG from an apparent buzzword to an integral component of mandatory company disclosures.
In the US, for example, on May 20, 2021, President Joe Biden issued an executive order on climate-related financial risk to help 'tackle the climate emergency', which is a major shift in priority from the Trump administration. The US Securities and Exchange Commission (SEC) is also actively looking into ways to mandate ESG disclosures for security issuers by making new rules.
While ESG related activities by the US government are still in an early stage, the EU has already made some good strides. For example, the EU has recently adopted a new regulation called Sustainable Finance Disclosure Regulation (SFDR) which has started phasing in from March 10, 2021.
Moreover, the Sustainable Finance Disclosure Regulation (SFDR) has imposed extensive ESG disclosure requirements on in-scope financial market participants such as asset managers who offer portfolio management services to pension funds, insurance-based investors, etc. in the EU. The overarching objective of the SFDR is to ensure that the financial market participants can sustainably finance growth while preventing 'greenwashing' which involves firms making dubious environmental claims to appear more environmentally friendly.
It is not very difficult to identify the rationales that drove the recent moves by the policymakers in Europe and the US. Firstly, climate change has become a topic of growing importance in the discussion amongst policymakers.
Secondly, investors are increasingly interested in the non-financial aspects of companies, such as the diversity of the workforce, labour conditions at the supply source, the governance structure of the company (i.e, board composition), the number of jobs created, etc. For example, the CEO of BlackRock, the world's largest asset management company, recently issued a letter to its investee companies and boards emphasising the importance of incorporating sustainability information into its investment strategies.
While social responsibility is certainly a motivation for investors to hone in on ESG disclosures, many investors also use sustainability information to red flag potential investment opportunities. Therefore, there is a business case for ESG disclosures from a financial perspective.
Several standard-setters have already developed standards and reporting frameworks for ESG disclosures, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). In response to increased demand from investors, these standard-setters are now coordinating with one another to harmonise their standards so that the ESG disclosures made using different standards become comparable.
All these activities herald a change in the policies of foreign jurisdictions which may require ESG disclosures to be an integral part of financial reporting within a few years in advanced economies. Now the question is, what level of exposure does Bangladesh have to such a change in company disclosure rules?
Bangladesh can be affected by the new ESG disclosure mandates in various ways. Firstly, the Bangladesh Securities and Exchange Commission (BSEC) is an 'ordinary' member of the International Organisation of Securities Commissions (Iosco) and therefore, is a signatory to the Iosco Multilateral Memorandum of Understanding (MMoU).
The MMoU sets an international benchmark for cross-border cooperation and information sharing. As a result, the BSEC is expected to collect and share company information on the misrepresentation of material information if such requests are made by another ordinary member of the Iosco.
The possibility of receiving such requests in future involving ESG matters does not appear to be a long shot given that the Iosco has expressed its intent to consider the potential endorsement of sustainability standards to be created by the International Financial Reporting Standards (IFRS) Foundation.
Secondly, if the EU and the US companies become subject to mandatory ESG disclosure requirements, there is a reasonable chance that they may pass on the burden of satisfying some of those requirements to their suppliers located in Bangladesh in a bid to fulfil their obligations.
Failure to satisfy those requirements by Bangladeshi suppliers may lead to lost business opportunities as the foreign buyers would look for alternative suppliers who can help them issue sufficiently transparent ESG disclosures to receive favourable assurances.
Some of the factors that foreign buyers may become particularly concerned with include workers' safety and hygiene, the environmental impact of suppliers' business operations, pay equality, etc.
From Bangladesh's point of view, the good thing is discussions on mandating ESG disclosures and assurance in the international arena are still at an early stage, and therefore, Bangladesh should have ample time to catch up with the momentum if it starts acting now.
Considering the potential impacts that mandatory ESG disclosures in the EU and the US may have on Bangladesh, it is in Bangladesh's best interest to keep a sharp eye on developments related to ESG disclosures in other jurisdictions, particularly in the EU and the US.
A prescient capital market authority should also keep tabs on the Iosco's activities with respect to ESG, and disseminate pertinent information in a timely manner to market participants including issuers of securities, investors, as well as auditors. As far as a concerted effort is concerned, the Government of Bangladesh may find a useful partner in the Institute of Chartered Accountants of Bangladesh (ICAB).
If Bangladesh forgoes the opportunity now to stay on top of ESG related developments in the EU and the US and fails to take necessary actions at home early enough, it may get caught off guard when it is suddenly faced with the necessity to up its ESG game to remain competitive in the international market.
That, for one thing, will impede any future effort to lure sophisticated foreign investors into the domestic capital market. The export industry, as discussed above, may also have to bear the brunt, which does not forebode well for the overall economy.
Dr Tasneem Raihan is a Financial Economist. The views expressed here are those of the author.