On 8 March 2018, the EU Commission proposed a suite of far-reaching near-term reforms aimed at the promotion and regulation of “sustainable finance” in all its forms across the entire investment chain within the European Union (IP-18-1404). This short article explains the key elements of the Commission’s action plan.
Auteurs: Maccailein Campbell
The proposals flow in part from recommendations made by the High-Level Expert Group on sustainable finance set up by the Commission in late 2016, which reported in January 2018. They are designed to complement and drive the EU’s efforts to fulfill its commitments under the Paris Climate Change Agreement and the UN 2030 Agenda for Sustainable Development.
The Commission describes its plans, which cover the entire investment chain, as “comprehensive”, “far-reaching reform[s] that could set a global benchmark for sustainable finance” and “covering all relevant actors in the financial system”.
We consider that to be a fair characterisation of these important proposals. Cutting through the jargon, some important elements of the plan can be briefly summarised as follows:
1. Sustainable finance taxonomy: The Commission intends, as a priority step, to draw up what it calls a ‘sustainable finance taxonomy’ (the Taxonomy) (effectively a harmonised EU set of sustainable finance definitions to create a common language for sustainable finance). This sounds wishy-washy, but it isn’t. If developed as planned, the Taxonomy would result in EU-wide legal definitions of a range of climate, environmental and social concepts, such as what activities can properly be considered sustainable or contributing to climate change mitigation or adaptation, based on screening criteria, thresholds and metrics. Importantly, the Taxonomy would then be gradually integrated into relevant areas of EU legislation, such as those mentioned further below, for instance being used as a basis for classifying activities for the purposes of green bonds standards and sustainability labels on financial products.
The Commission says it will table a legislative proposal in Q2 2018 that will ensure the progressive development of this Taxonomy. A technical expert group is to be established to produce a first draft of the Taxonomy (initially focused on climate change mitigation activities) by as early as Q1 2019.
2. Standards and labels for green financial products: the Commission considers that sustainable finance products, such as green bonds, are currently insufficiently regulated to allow investors to make informed comparisons and choices. It considers that harmonised EU standards and labels would facilitate greater uptake of sustainable finance.
With this in mind, the Commission plans to consult on and produce a report on an EU green bond standard by Q2 2019, building on current best practices. To date, the labelled green bonds market has been largely self-regulated through the use of voluntary sustainability standards such as the Green Bonds Principles (published by ICMA) and the Climate Bonds Taxonomy, both of which have been widely adopted by the market. Self-regulation was seen as the best route to growing the green bonds market, for fear that top-down regulation could stifle the nascent sector. While the EU green bonds market is by no means mature, some would say that the time is now right for regulation to step in and build upon existing voluntary initiatives in order to scale up the European market and keep pace with developments in China (which is now the second largest green bond market in the world).
Within the framework of the EU Prospectus Regulation, the Commission says it will also specify by Q2 2019 the content of prospectuses for green bond issuances. This should help to tackle the perception among ESG (Environmental, Social and Governance) investors that the green bond market is susceptible to ‘greenwashing’.
Additionally, the Commission will explore extending the existing EU Ecolabel framework for certain financial products and applying to the framework the concepts and definitions to be adopted in the proposed Taxonomy referred to at 1 above. This illustrates the potential legal and commercial importance of that proposed Taxonomy.
In parallel with this, the Loan Market Association along with its Asia-Pacific affiliate, the APLMA, and with the support of the International Capital Market Association, have recently (Wednesday 21 March) published a set of green loan principles. These principles, which mark a first step towards establishing widely accepted principles in the green lending space, aim to create a high-level framework of market standards and guidelines, to provide a consistent methodology for use across the wholesale green loan market and to help preserve the integrity of the green loan market while it develops whilst allowing loan products to retain flexibility.
3. Amendments to MiFID II and IDD: the Commission wants to ensure that sustainability considerations are adequately taken into account in the provision of financial advice. It considers that investors’ sustainability preferences are not sufficiently taken into account at present when advice is given by financial advisors.
To this end, the Commission says that subject to conducting an impact assessment, it intends to amend the MiFID II and IDD delegated acts in Q2 2018 to ensure that sustainability preferences are taken into account in the suitability assessment when financial instruments and insurance products are recommended.
It also plans to invite the European Securities Markets Authority (ESMA) to include provisions on sustainability preferences in its guidelines on the suitability assessment, to be updated by Q4 2018.
4. Sustainability benchmarks: the Commission considers that current price formation indices and benchmarks inadequately reflect sustainability goals so are not appropriate for measuring the performance of sustainable investments. Those ESG benchmarks that have been developed are said to lack consistency and transparency, giving rise to greenwashing risks.
With this in mind, the Commission intends to make further use of the Taxonomy to harmonise benchmarks for calculating carbon impacts for issuers of low-carbon products, and also to adopt delegated acts within the framework of the Benchmarks Regulation on the transparency of sustainability benchmarks and methodologies used in the price formation of financial instruments and other relevant assets.
5. Integration of sustainability into ratings and research: the Commission bemoans an alleged lack of standardisation in ESG assessments by credit rating agencies and market researchers, and accordingly says it will explore mandating rating agencies to explicitly integrate sustainability factors into their assessments, and invite ESMA to include additional sustainability information in its own guidelines.
6. Legal clarification of institutional investors’ and asset managers’ fiduciary duties, as regards sustainability factors and risks: while many of the Commission’s proposals are non-legal in their current form, like the Taxonomy described above, this proposal would take legislative form. The Commission proposes draft legislation as soon as Q2 2018 to impose an express duty on institutional investors and asset managers to integrate sustainability considerations into their investment decisions, and be transparent about how they do so.
7. Sustainability and bank and insurance company capital requirements: the Commission identifies what it sees as the need for better reflection of the risks associated with climate change and other environmental factors in finance sector prudential requirements, again building off the development of the Taxonomy. It is to explore measures to include these factors in institutions’ risk management policies and the potential calibration of bank capital requirements by reference, again, to the proposed future EU taxonomy on sustainable activities.
8. Sustainability and non-financial reporting: the Commission also wants to enhance the transparency and consistency of corporate reporting on sustainability issues. It is launching a fitness check in Q2 2018 on the adequacy of the existing regime for non-financial reporting by listed and non-listed companies so far as concerns sustainability issues. Among other initiatives, it also proposes to revise non-financial reporting guidelines by Q2 2019 in line with, among other things, the new Taxonomy referred to in 1 above, again underscoring the significance of that Taxonomy proposal.
9. Sustainability and corporate governance: finally, also by Q2 2019, the Commission plans to analyse possible measures to require corporate boards to develop and disclose a sustainability strategy, including appropriate due diligence throughout the supply chain, and measurable sustainability targets, and the possible need to clarify rules according to which company directors are expected to act in a company’s long term interest (taking account of sustainability issues).
Of course, many companies already have detailed sustainability strategies in place. The significance of the Commission’s plans lies not only in levelling the playing field (by making the practice more widespread) but also in the potential for harmonisation in line with the Taxonomy and any adjustments to existing strategies that might entail.
As will be gathered from the brief overview above, the Commission’s proposals are ambitious, wide-ranging and immediate, with all of the above measures targeted for either completion or significant progress within a year from now.
It will also be appreciated from the above review just how significant the Taxonomy will be, as it will potentially feed directly into, and shape, the proposals on standards, labels, benchmarking, the scope of fiduciary duties, capital requirements and non-financial reporting.
Work on the Taxonomy will start first (as early as Q2 2018). Close stakeholder monitoring of and engagement in that process, and in the others that follow, is strongly advised for those potentially affected.
Client Alert 2018-072