ESG Regulatory Maze Requires a Tactical Approach
Shifting policies and priorities are reshaping the global investment ecosystem and adding complexity to fundraising across jurisdictions, says Ruth Knox, Partner at Paul Hastings.
As ESG regulations continue to tighten across the UK and EU in response to the ‘Trump Bump’, both asset managers and owners are facing an unprecedented compliance landscape. From initial noises signalling a crackdown on greenwashing under the Sustainable Finance Disclosure Regulation (SDFR) to expanded (and then, reduced) sustainability reporting requirements, firms are facing more pressure than ever to maintain higher transparency standards (and to keep track of the backtracking on regulatory proposals) whereas, in the US, ESG has almost disappeared from the agenda.
At the same time, shifting climate policies, government-led sustainability initiatives and political motives are reshaping the global investment ecosystem and adding a layer of complexity to fundraising across jurisdictions.
The regulatory roadmap for ESG has shifted once again, and asset owners need to be up to speed with how the changing policies, including in the UK and Europe, will aid – or challenge, their ability to spot genuinely sustainable investments that align with their own compliance and sustainability objectives.
Understanding these regulatory shifts will be critical for mitigating risks, seizing opportunities and ensuring alignment between investor expectations and broader ESG goals.
Greater clarity, or adding complexity?
While the overarching aims of regulatory shifts are to provide greater transparency and standardisation in ESG reporting, the reality is that new frameworks, delayed implementation, and inconsistencies between jurisdictions are adding smoke to the fog.
The proposed review of the EU SDFR for example, is set to introduce a new labelling regime – yet, the forthcoming framework does not match clearly to existing designations, which will no doubt leave asset managers and owners uncertain about how existing funds and future investment strategies will fit into the new classification system.
In the UK, delays in implementing the Sustainability Disclosure Requirements (SDR) have had a different effect – so instead of adding complexity to the market, they are more responsible for slowing market movements. Further questions have also been raised as to when the regime will apply to certain market participants, particularly non-UK sponsors registering funds for UK investors, adding to the uncertainty.
That said, the regulatory delays to both SFDR reform and SDR have also resulted in certain sponsors seeing first-mover opportunities to lean into the proposed changes, either by designating at the top of the existing hierarchy, or by launching new funds which have adopted new labels voluntarily.
Fundraising across the Atlantic remains a challenge
One of the primary challenges facing asset managers lies in managing fundraising across jurisdictions with diverging ESG approaches. We are currently seeing a fragmented regulatory environment in the US, where pro- and anti- ESG reforms may vary from state to state, and potentially further complications from federal-level restrictions.
Meanwhile, the regulatory focus in Europe remains firmly on enhancing sustainability disclosure and compliance and strengthening its utility. ‘Blue state’ investor expectations and legal obligations across the pond are reflecting EU and UK iterations from early years of the ESG megatrend; ‘red state’ equivalent provisions are honing in on the connection to value creation and financial return.
There is also a lack of universally clear definitions surrounding sustainability risks, impacts and materiality. Without a standardised framework, investment teams will struggle to determine what constitutes material ESG factors, how they can be assessed consistently, and how to ensure compliance without over or under-disclosing relevant information. There almost seems to be an absence of will to trust the market to determine the winner on ESG risk and opportunity-related judgement calls.
Further to this, concerns over potential antitrust actions linked to pro-ESG engagement have further complicated decision-making, and chilled investor initiatives seeking to standardise solutions.
With some regulators questioning whether collective climate commitment or industry-wide ESG initiatives could breach competition laws, asset managers will need to find ways to balance sustainability ambitions with legal considerations and responsibilities. It will become critical to carve out unique paths for the organisations we represent.
Government priorities shift
Ongoing global political tensions have also caused a shift in government attitudes towards ESG. The UK for example, is now turning its focus towards defence spending, which is set to increase to 2.5% of GDP from April 2027.
As the UK government also grapples with strengthening the economy, and the implementation of Brexit continues to rumble in the background, green investment is naturally becoming deprioritised. The very concept of a net zero trajectory is being challenged. Recent government investment in aviation, housing and transport further support the position that the net zero agenda is no longer in focus in its usual conception.
While the Financial Conduct Authority (FCA) has (expressly) prioritised anti-greenwashing supervision, it is challenging to see how this can become a true focus when resources will need to be deployed to support the initiatives described. The UK has indicated its plans to adopt the International Sustainability Standards Board (ISSB) framework, but it is difficult to see how this could happen in the next couple of years, with the net zero agenda (and associated infrastructure) facing new and different challenges day by day.
Green investment trends remain centred on the energy transition and natural capital, with decarbonisation, transition infrastructure and nature-based sustainability strategies continuing to benefit from targeted capital flows.
Investments in carbon funds, which provide offsets to support decarbonisation goals, have played a key role in corporate ESG commitments. While these trends are set to persist, the pace of growth is expected to be moderate over the next five years due to the influence of changing regulatory frameworks and shifting government priorities.
How can asset owners be prepared?
Both asset managers and owners must take a tactical approach to navigating the ESG landscape in 2025. Engaging strong external ESG counsel with a multidisciplinary and multi-jurisdictional legal perspective will be crucial to ensure compliance amid evolving disclosure requirements, litigation and enforcement risks.
Additionally, staying attuned to investment returns across different asset classes will help asset owners consider the initial rate of return across different sustainable investments. If ESG really does lead to higher or lower returns, the truth will be in the numbers.
Asset managers courting capital from investors across the spectrum should also resist any inclination to move away from broader, diversified strategies, even when faced with fresh limited partner preferences that lean toward purist ESG approaches, e.g. those mandating fund-wide science-based targets.
Balancing sustainability commitments with macroeconomic realities through a diverse portfolio will be key to long-term resilience, enabling asset owners to remain agile and well-positioned in an increasingly complex regulatory and investment environment.
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