On 24 May 2018, the European Commission published three proposals for regulations aimed respectively at introducing (i) a taxonomy to identify environmentally-sustainable economic activities, (ii) criteria regarding the way financial market participants should disclose how they integrate environmental, social and governance ("ESG") factors in their investment decision-making process, and (iii) rules applicable to benchmarks relating to the carbon footprint. The Commission also launched a consultation in order to assess how best to include ESG factors in the "suitability tests" carried out by investment firms and insurance distributors.
Background
In December 2016, the European Commission set up a high-level expert group on sustainable finance to identify measures that financial institutions and supervisory authorities should take in order to protect the stability of the financial system from risks related to the environment. The group published a detailed report on proposed reforms in January 2016 (https://ec.europa.eu/info/sites/info/files/180131-sustainable-finance-final-report_en.pdf).
Based on this report, on 8 March 2018 the Commission published an action plan on "financing sustainable growth" (http://europa.eu/rapid/press-release_IP-18-3729_en.htm). Within the framework of this action plan, on 24 May 2018 the Commission published three proposals for regulations and launched a consultation.
Taxonomy of sustainable activities
The first proposal is for a regulation on the establishment of a framework to facilitate sustainable investment (https://ec.europa.eu/info/law/better-regulation/initiatives/com-2018-353_en). This proposal will introduce, through delegated acts, a classification system ("taxonomy"), identifying, based on standard criteria, whether an economic activity is sustainable. This taxonomy will make it possible to determine to what degree investments in undertakings active in these sectors can be considered to be sustainable.
The proposal identifies six European Union environmental objectives:
- mitigation of climate change;
- adaptation to climate change;
- sustainable use and protection of water and marine resources;
- transition to a circular economy, waste prevention and recycling;
- prevention and control of pollution; and
- protection of healthy ecosystems.
An economic activity will be considered as sustainable when such activity (i) contributes substantially to at least one of the above objectives, (ii) does not significantly harm any of the five other environmental objectives, and (iii) is carried out in compliance with minimum social and governance rules. These rules will be specified by the delegated acts.
Integration of the ESG criteria by financial market participants
The second proposal for a regulation relates to disclosures of sustainable investments and sustainability risks (https://ec.europa.eu/info/law/better-regulation/initiatives/com-2018-354_en). It aims inter alia to require insurances undertakings, investment firms and UCITS or AIF management companies (classed as "financial market participants") to draw up and publish on their website information regarding their policies on the integration of sustainable risks in their investment decision-making process.
Insurance intermediaries and investment firms providing advice regarding insurance-based investment products and investment advice respectively would be required to publish on their website policies regarding their integration of the ESG risks within the framework of their activities.
This proposal also envisages amending the IORP II Directive (Directive 2016/2341 of 14 December 2016 on the activities and supervision of institutions for occupational retirement provision) in order to allow the European Commission to adopt, through delegated acts, measures aimed at ensuring that:
- the "prudent person" rule takes the ESG risks into account; and
- environmental, social and governance factors are included in internal investment decisions and risk management processes.
Low-carbon benchmarks
The third proposal for a regulation aims at regulating two benchmarks: the low-carbon benchmark and the positive-carbon impact benchmark (https://ec.europa.eu/info/law/better-regulation/initiatives/com-2018-355_en). The low-carbon benchmark would be based on a standard "decarbonising" benchmark of activities; the positive-carbon impact benchmark would allow an investment portfolio to identify participation in the effort required by the Paris Agreement to limit global warming to less than 2°C. The positive-carbon impact benchmark is the most ambitious one.
These new rules would be inserted in Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts. This would facilitate undertakings providing indices used as benchmarks to publish standardised information regarding the carbon footprint of companies and investment portfolios and prevent "greenwashing" by applying a transparent and comprehensive method to assess the carbon footprint.
Consultation on the integration of the ESG criteria within the framework of the provision of advice
The Commission has also launched a consultation to assess how best to include ESG considerations in the advice provided by investment firms and insurance distributors to their clients. In this respect, the aim is to amend the delegated acts implementing MiFID II (Directive 2014/65/EU of 15 May 2014 on markets in financial instruments) and IDD (Directive 2016/97 of 20 January 2016 on insurance distribution) in order to take into account the client's preferences in relation to sustainability within the framework of the "suitability test".
Timeline
The Commission envisages the approval of the three proposals for regulations by the Council and the Parliament in May 2019 and the adoption of the delegated acts (including those related to the taxonomy of sustainable activities) between 2019 and 2022.
As regards the integration of the ESG criteria within the framework of the provision of advice, the delegated acts implementing MiFID II and IDD should be amended after the consultation. The Commission will invite the ESMA to include provisions on sustainability preferences in its guidelines on the suitability assessment for the last quarter of 2018.