18 months ago we alerted readers that, as a result of the Paris treaty on climate action, policy makers were beginning to turn their attention to how they can encourage or require institutional investors and asset managers to adopt strategies that will support countries in meeting their new commitments. We predicted that new regulation would ensue. After a consultation and a report by the High-Level Expert Group, the European Commission has now released a package of legislative proposals and further consultation.
The largest part of the package is a Regulation to establish the criteria for determining whether an economic activity is “environmentally-sustainable” – the taxonomy. It will apply to the following types of financial market participants:
This focus on the first factor of ESG (environmental, social, governance) is very marked. In contrast, the 'social' and 'governance' factors receive only short references in the separate Regulation on disclosures. Moreover, the text on 'social' investment is not the same as and does not refer to the definition in the EuSEF Regulation.
Extract from the draft Regulation on disclosures, Article 2:
“(o) ‘sustainable investments’ mean any of the following or a combination of any of the following:
The Taxonomy Regulation sets out six environmental objectives:
For an activity to be environmentally-sustainable, it must contribute substantially to one or more of these objectives, not significantly harm any of them, and comply with minimum safeguards and technical screening criteria, which will be set out in a Delegated Act.
It is notable that the main body of the rules (Articles 3-12) will not apply until six months after the relevant Delegated Acts have entered into force – that is, between July 2020 and December 2022. Given the considerable amount of work still to be undertaken by the Commission and the European Supervisory Authorities (ESAs) on the taxonomy, there is an overarching question whether it is too soon to begin discussing the various other requirements – set out in four further Regulations.
One of the additional Regulations covers disclosures by the financial market participants listed above. It is to be underpinned by various Delegated Acts and Regulatory Technical Standards.
The disclosures cover:
Readers will note that the articles frequently refer to “financial products”, which will likely cause interpretation and implementation issues in the context of portfolio management (a service).
Another Regulation amends the Benchmarks Regulation to include references to “low-carbon benchmarks” (one which has less carbon emissions compared to a standard capital-weighted benchmark) and “positive carbon impact benchmarks” (for which the underlying assets are selected on the basis that their carbon emissions savings exceed the assets’ carbon footprints). Again, this Regulation will be underpinned by Delegated Acts.
The last two – short – Regulations insert into the MiFID II and IDD Delegated Regulations requirements for intermediaries to seek information about and to have regard to clients’ ESG preferences.
This is a substantial package of proposals, with very many more pages to come in the form of Delegated Acts and Regulatory Technical Standards. The specific reference to the Taxonomy Regulation not taking effect until the various Delegated Acts are in place may be welcome by national regulators and the industry, but there is much work to be done in articulating what all these requirements actually mean in practice. Overall, the package constitutes a major set of new regulatory requirements that will impact many types of institution. It seems that a legislative pause for the industry to embed “business as usual” is unlikely to be granted in the short term.
It is important that asset managers, fund managers and institutional investors engage in the European debate, to have a regular dialogue with their clients and beneficiaries on sustainability issues, and to evolve their investment strategies, product options and disclosures for a world in which sustainable finance is the regulatory norm, not a “nice to have”.
Questions for CEOs
1 European Social Entrepreneurship Funds
2 European Venture Capital Funds