By: Tom Willman, Regulatory Lead, Clarity AI

In a world of uncertainty around sustainability regulations, interoperability – the capacity for regulatory systems to function harmoniously across different regions – remains a key priority for asset managers. While the benefits of interoperability are often framed in terms of cost-savings and a reduced administrative burden, its significance goes far deeper. Interoperability is essential to effectively tackle the global challenges of climate change, biodiversity loss, and human rights abuses. A fragmented regulatory landscape means resources can be diverted away from contributing to the transition, ultimately hindering progress toward sustainability goals. It also has a knock-on impact on consumer trust, further hampering progress towards sustainability objectives.

Ultimately, complete interoperability is likely to remain more of an aspiration than a tangible reality. Variations in markets, political environments, and policy priorities naturally shape the design and implementation of regulations, making some degree of divergence inevitable. While these differences pose challenges, they also reflect the varied economic and social conditions across regions, complicating the pursuit of global alignment in sustainable finance regulation. Still, this doesn’t undermine the value of striving for greater interoperability.

 The global journey toward interoperability

On a global scale, the path to interoperability is far from complete. While the EU’s position as a leader in sustainable finance regulation comes under threat from its Omnibus proposal, other markets such as Hong Kong, Japan, China, Singapore, Canada, Australia, Switzerland, and the UK are also progressing with their own sustainability frameworks, each with distinct priorities and approaches. As the market awaits the finalisation of its “Omnibus” regulation, any requirements for non-EU companies to report under the EU Corporate Sustainability Reporting Directive (CSRD) will significantly increase regulatory expectations. As of today, EU-based subsidiaries that reach the size thresholds must comply with CSRD requirements, while operations of the same group in other jurisdictions may be subject to reporting under other regulations such as the International Sustainability Standards Board (ISSB) standards.

In the U.S., the lack of a standardised ESG framework only serves to further complicate these challenges. Companies must balance their ISSB reporting obligations abroad with the risk of appearing to omit material information in SEC filings, creating uncertainty and potential compliance risks. For businesses, dealing with this fragmented regulatory landscape is a significant undertaking.

While regulatory developments in transparency and management of sustainability-related risks demonstrate progress, they also highlight the urgent need for better alignment not merely for consistency’s sake but to simplify matters for both businesses and investors.

Why should we care about fragmented regulations?

The absence of interoperability in sustainability regulations creates significant risks, not just for businesses but for society at large.

Firstly, fragmented regulations can result in the inefficient use of resources. Multinational corporations operating in regions like the EU, Asia, and North America often face conflicting compliance requirements, diverting attention and funds from where they are most needed—innovating solutions to pressing global challenges. Rather than investing in technologies to reduce climate risks or improve supply chain transparency, businesses may be bogged down by compliance exercises like changing product names or modifying descriptions to satisfy different regulatory regimes. Moreover, the need to meet multiple reporting requirements often means reallocating staff and resources from high-impact initiatives to administrative tasks, further hindering their ability to address complex climate challenges effectively.

Secondly, this fragmentation harms consumers. There remains a surprising lack of clarity over the meaning of core sustainability terms like “sustainable,” “impact,” or “material.” For consumers to make informed decisions, they need to be able to trust that these terms carry the same meaning wherever they are used. Without this trust, they are left to navigate a confusing environment, often making decisions based on misleading or incomplete information.  In the absence of even a base level of interoperability in terms of nomenclature, we risk eroding consumer confidence in sustainable finance altogether.

Advancements and hurdles in investor regulation

When it comes to investor regulations, progress on interoperability has been uneven. In some areas, significant strides have been made; in others, fragmentation persists.

Consider the Sustainable Finance Disclosure Regulation (SFDR) in the EU, for instance. While it has provided a foundation for sustainable investing, it differs significantly from the UK’s Sustainable Disclosure Requirements (SDR). While there is no direct counterpart in the US to compare to, the ESG fund categorization rules proposed by the US Securities and Exchange Commission (SEC) in 2022 were, again, different in their form. Each framework brings its own nuances, further complicating the global landscape.

Nevertheless, there are reasons to be cautiously optimistic. The FCA – in developing the UK’s SDR – seems to have learnt from some of the early challenges of the SFDR, and the anticipated SFDR 2.0 may, in turn, incorporate elements of the SDR’s refinements. Taxonomies like the EU Green Taxonomy offer a potential bridge, but their complexity and region-specific focus have faced criticism. Notably, the UK is recently consulted on the case for developing its own taxonomy, representing a critical inflection point: will it align with the EU’s approach or pave its own way? This decision will have a significant impact on interoperability, either driving greater alignment or further fragmenting the global regulatory landscape. These taxonomies show promise, but they need to evolve towards a more globally unified approach.

Sustainability reporting: The divide between two standards

Sustainability reporting encounters comparable obstacles. While the ISSB was designed to serve as a global standard to support consistent reporting across borders, its implementation may vary based on local circumstances. Moreover, the ISSB and the EU’s CSRD represent two divergent approaches to the same goal. The ISSB focuses on financial materiality, while the CSRD – in its current form – embraces double materiality, encompassing broader social and environmental impacts alongside financial risks.

Despite these differences (and some doubts on the future form of CSRD), there are glimmers of hope. Notably, within the ISSB and the European Financial Reporting Advisory Group (EFRAG), efforts are underway to address the lack of interoperability. Support from regulatory bodies to guide companies on reporting simultaneously against ISSB and CSRD standards would be a significant step forward. However, the risk of inconsistent implementation across jurisdictions remains.

Important developments on the path ahead

The road to interoperability will not be without challenges, but two key developments hold promise: further harmonization of regulations and technological advancements.

Efforts to harmonize corporate reporting or fund disclosure rules are important examples of this trend. We have also seen moves to align taxonomies across regions, such as the  International Platform on Sustainable Finance (IPSF) on a Common Ground Taxonomy between the EU, China, and Singapore. Though harmonization is a complex and lengthy process, achieving a globally aligned taxonomy could provide a solid foundation for interoperability in sustainable finance.

Technology also holds immense promise as an enabler of interoperability. Advanced platforms and tools, including AI and machine learning, are revolutionizing how companies handle sustainability reporting. These technologies streamline data collection, analysis, and compliance with multiple frameworks, reducing complexity and operational burdens. For instance, some firms tackling SFDR compliance have managed to cut recurring work on Article 8 or 9 reporting by as much as 80%—a game-changer for fund managers overseeing vast portfolios.

Interoperability is essential for sustainable progress

Sustainability is a global challenge at its core. As the world confronts pressing issues such as climate change and social inequality, enhanced interoperability in sustainability regulations is essential for facilitating the transition. Fragmented regulations hinder progress, leading to inefficiencies and diminishing trust among both consumers and investors.

While we see some progress being made, businesses and investors may have to get used to operating in the world with some degree of regulatory fragmentation. In the meantime, having access to transparent and robust data about the sustainability performance of your operations, supply chain or investments is a crucial step to navigating such a complex landscape.