The European Commission notes that we are increasingly faced with the catastrophic and unpredictable consequences of climate change and resource depletion. Urgent action is needed to adapt public policies to this new reality, it says, and the financial system has a clear role to play. With the aim of re_orientating private capital to more sustainable investments, it proposes a series of actions that seek a comprehensive shift in how the financial system works.
Referring to the recent report by the High-Level Expert Group on sustainable finance (see here), the Commission observes that environmental and social considerations are often not sufficiently taken into account in investment decisions. Current levels of investment are not sufficient to support an economically and socially sustainable economic system. Europe has to close a yearly investment gap of nearly EUR 180 billion to achieve EU climate and energy targets by 2030. The EU has pledged to make at least 20% of its budget directly climate-related.
The Commission notes in particular that the increase in weather-related natural disasters means that insurance companies need to prepare for higher costs. Between 2007 and 2016, economic losses from extreme weather worldwide rose by 86%.
The Action Plan aims:
- to re-orientate capital flows towards sustainable investment in order to achieve sustainable and inclusive growth;
- to manage financial risks stemming from climate change resource depletion, environmental degradation and social issues; and
- to foster transparency and long-termism in financial and economic activity.
It proposes the following actions:
- Establishing an EU classification system for sustainable activities
Given its complex and highly technical nature, this will take time to achieve. There will be a legislative proposal in Q2 2018, and a technical expert group will be asked to report by Q1 2019 on climate change mitigation activities.
- Creating standards and labels for green financial products
Surveys suggest that retail investors increasingly want their investments to take into account ESG factors, but the lack of labelled financial products may be a hindrance. By Q2 2019, the technical expert group will report on an EU green bond standard, building on current best practices, and the Commission will specify prospectus requirements for green bond issuance. It will also explore the use of an “Ecolabel” for certain financial products.
- Fostering investment in sustainable projects
The capacity to develop and implement sustainable projects varies across the EU and between sectors. The Commission will take further measures to improve the efficiency and impact of relevant instruments, such as rolling out the EU External Investment Plan and establishing a single investment fund for all EU market-based instruments.
- Incorporating sustainability when providing financial advice
By Q2 2018, the Commission will amend the MiFID II and IDD Level 2 Delegated Acts to require sustainability considerations to be taken into account in the suitability process, and ESMA will be invited to include specific provisions in its guidelines by Q4 2018 (MiFID II suitability requirements - read more). It is unclear how the Level 2 requirements and Level 3 guidance can be amended in such short order, especially given that the Level 1 directives do not mention ESG.
- Developing sustainability benchmarks
By Q2 2018, the Commission will adopt Delegated Acts to the Benchmarks Regulation, on transparency of methodologies and benchmark features. As for action 4, it is unclear how and whether this can be done in such a short timeframe. The Commission will also issue an initiative for harmonising benchmarks comprising low-carbon issuers.
- Better integrating sustainability in ratings and market research
The Commission will explore with stakeholders the merits of amending the Credit rating Agency Regulation, invite ESMA to assess current practices and include ESG information in its CRA guidelines, and undertake a comprehensive study by Q2 2019.
- Clarifying institutional investors' and asset managers' duties
The Commission will issue by Q2 2018 a legislative proposal to clarify institutional investors' and asset managers' duties. It will explicitly require the integration of sustainability considerations into the investment decision-making process and increase transparency for investors.
- Incorporating sustainability in prudential requirements
The Commission will explore the feasibility of including ESG risks in institutions' risk management policies and the calibration of banks' capital requirements. EIOPA will be asked to provide by Q3 2018 an opinion on the impact of prudential rules for insurers on sustainable investments.
- Strengthening sustainability disclosure and accounting rule-making
The Commission is launching a fitness check of EU legislation on public corporate reporting; by Q2 2019 it will revise the guidelines on non-financial information; by Q3 2018 a European Corporate Reporting Lab will be established under the auspices of EFRAG; the legislative proposal under Action 7 will include a requirement for institutions to disclose how they consider sustainability factors in their strategy and investment decision-making processes; and EFRAG will be requested to assess the impact of new IFRSs on sustainable investments.
- Fostering Sustainable corporate governance and attenuating short-termism in capital markets
By Q2 2019, the Commission will assess the possible need to require corporate boards to develop and disclose a sustainability strategy and to clarify rules according to which directors are expected to act in the company's long-term interest.
This Action Plan comprises a number of substantial proposals, with tight delivery times. It makes only brief mention that a coordinated, global effort is crucial.
It remains to be seen whether the timescales are achievable. What is certain, though, is that banks, insurers, asset managers, pension funds and other institutional investors should pay very close attention to how these proposals progress, as they could require significant changes to firms' processes, governance and disclosures.