At the end of December 2019, as part of a package of legislative reforms published by the European Commission (the “Commission”) in March 2018, the EU Regulation on sustainability-related disclosures in the financial services sector (Regulation (EU) 2019/2088) (the “Disclosure Regulation”) came into force, with most of its provisions due to take legal effect by March 2021. The push comes as regulators worldwide seek to pacify investor concerns and “green” the financial services sector ensuing the rise of Environmental, Social and Governance (“ESG”) considerations.
Amongst various measures, the Commission has announced a Delegated Regulation amending MIFID II Delegated Regulation 2017/565 to integrate ESG considerations into investment advice and portfolio management, as well as a Regulation on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation (EU) 2020/852). In particular, the Taxonomy Regulation introduces criteria for determining which economic activities can be considered environmentally sustainable, including by reference to climate change mitigation. It also introduces amendments to the Disclosure Regulation, which aims to standardise transparency measures on sustainability within the financial services sector. Amendments seek to impose additional requirements for ESG products with certain characteristics, as provided for under the Disclosure Regulation.
The Disclosure Regulation
Under Article 8 of the amended Disclosure Regulation, disclosure requirements apply to products that promote environmental or social characteristics, whilst disclosure requirements under Article 9 of the same apply to products that have sustainable investment as their objective. In effect, amendments to Articles 8 and 9 compel in-scope financial market participants to determine whether their products fall under the remit of either Article at an early stage, and to prepare for disclosures early on.
In-scope Financial Market Participants
Building on its package of reforms to prevent greenwashing (misleading stakeholders—usually via marketing—into believing that a company’s products are environmentally friendly) in the financial services sector, the Disclosure Regulation imposes transparency and disclosure requirements on financial market participants active in asset management, comprising AIFMs; UCITS managers; and firms falling under the remit of the MiFID I and MiFID II regimes.
These market participants are obliged to disclose information in relation to the integration of “sustainability risks” in investment and advisory decisions. The Disclosure Regulation defines a “sustainability risk” as “an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.”
When assessing the sustainability of a particular investment and making investment and advisory decisions, market participants covered by the Disclosure Regulation are required to take into account “sustainability factors”, defined as “environmental, social and employee matters, respect for human rights, anti‐corruption and anti‐bribery matters”.
More specifically, they must:
- Publish written policies on the integration of sustainability risks in investment decisions;
- Produce periodic reports with a consideration of principal adverse impacts of investment decisions on sustainability factors; including a statement on due diligence policies with respect to those impacts, taking account of their size, the nature and scale of their activities and the type of fund;
- Submit pre-contractual disclosures on how sustainability risks have been embedded across their businesses;
- Comply with pre-contractual transparency rules on sustainable investments; including regularly updating their websites with a clear explanation of any amendments to the published information;
- Publish an online description of the sustainable investments target and information on the methods used to assess, evaluate and monitor the efficacy of sustainable investments.
The Disclosure Regulation serves as a sea change in the regulatory landscape, requiring in-scope market participants to comply with a raft of transparency and disclosure measures geared towards sustainability. In doing so, the Commission’s legislative efforts strike a delicate balance in bolstering investor protection—reducing information asymmetries in principal‐agent relationships with respect to the integration of sustainability risks—without over-burdening market participants with onerous disclosure requirements.
An investment will only be deemed to be a “sustainable investment” if:
- It contributes to an environmental objective as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy; or
- Contributes to a social objective, such as an investment that contributes to tackling inequality or facilitates social cohesion or social integration, or an investment in human capital or economically or socially disadvantaged communities,
provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance.
A draft of more nuanced information (Technical Standards) to assist in-scope financial market participants was published on 4 February 2021. Although these Technical Standards are not expected to come into force until 1 January 2022, they shed additional light as to the content and presentation of disclosures and periodic reporting. They have now been submitted to the Commission for review, which is slated to take three months. If endorsed, the Commission must put the Technical Standards to the European Parliament and Council, who will take a position on the draft. If there are no objections, the Technical Standards will enter into force on 1 January 2022.
In-scope financial market participants must act quickly to identify any products falling under Articles 8 and 9 of the Disclosure Regulation. Importantly, they should review all marketing materials as part of determining whether any products are caught by the amended disclosure requirements, and undertake any necessary revisions to these materials in the interests of transparency.
The UK also seeks to implement its own green taxonomy, using the EU Taxonomy Regulation as its foundation. A UK Green Technical Advisory Group has been set up to review the scientific metrics in the EU Taxonomy Regulation and to assess whether they are suited to the UK. In order to support and benefit from the development of common international standards on taxonomies, the UK intends to join the International Platform on Sustainable Finance.