The transition towards a greener and more sustainable economy has become a priority for the European Union (EU). ESMA aims to ensure that the financial markets support and promote this shift by ensuring the integration of environmental, social and governance (ESG) factors across its core activities.
The EU has launched the transition to a low-carbon, more resource-efficient and sustainable economy by launching a dedicated action plan on sustainable finance which aims to re-orientate finance towards sustainability. Its key actions include:
- establishing an EU classification system – or taxonomy – for sustainable activities;
- establishing EU labels for green financial products;
- increasing the transparency of companies on their environmental, social and governance (ESG) policies; and
- A proposal for amending the benchmark regulation, creating a new category of benchmarks comprising low-carbon and positive carbon impact benchmarks.
ESMA WORK ON SUSTAINABLE FINANCE
As part of the review of its founding Regulation ESMA must integrate ESG factors into its activities and will publish its strategy on this in 2020.
ESMA’s current work on sustainable finance is focused on delivering the elements included in the European Commission (EC) Action Plan, as detailed below. ESMA also participates in the EC’s Technical Expert Group on Sustainable Finance (TEG), which includes experts from both the private and public sector, to assist the implementation of the Action Plan.
Areas covered by ESMA's work on Sustainable Finance:
- integrating sustainability risks and factors for investment firms (MiFID) and asset managers (UCITS, AIFMD);
- ESG disclosure by market participants and financial advisors;
- integrating ESG factors in credit ratings disclosure;
- undue short-termism;
- issuers' disclosure; and
- new climate-related benchmarks.
INVESTMENT FUNDS AND FIRMS
This work stream aims at integrating sustainability risks and factors in a number of policy areas, by amending the relevant applicable legislation. ESMA was tasked with delivering technical advice on integrating sustainability risks and factors in MiFID II and in the UCITS and AIFMD Directives. Following a public consultation, ESMA submitted its advice on 30 April 2019 for amendments to the relevant rules applying to investment firms and investment funds.
ESMA recommended amending relevant requirements to ask all UCITS management companies and AIFMs to:
- consider sustainability risks in their internal processes, systems and controls;
- devote sufficient resources to the integration of sustainability risks; and
- ensure that senior management is responsible for the integration of sustainability risks.
Fund managers should also consider sustainability risks in their due diligence processes.
ESMA’s technical advice on MiFID II covered the following topics:
- General organisational requirements: ESMA proposed to incorporate ESG considerations within firms’ processes, systems and controls in order to ensure the investment and advisory process correctly takes them into account. For example, firms will be expected to ensure that staff involved in the advisory process possess skills, knowledge and expertise for the assessment of sustainability risks;
- Risk management: ESMA to require firms to consider sustainability risks when establishing risk management policies and procedures, including for their Compliance function and Internal Audit;
- Conflicts of interest: ESMA proposed that investment firms should disclose those types of conflicts of interest whose existence may be detrimental to the interests of a client, which stem from the distribution of:
- investments in companies that adopt environmentally sustainable practices, are socially responsible, and/ or have good corporate governance; or
- financial instruments that provide exposure to sustainable investments, social investments, and/or good governance investments;
- Product governance: ESMA proposed requiring manufacturers and distributors to consider clients’ ESG preferences within the target market of investment products and within the mandatory product review process.
ESMA is also working on updating its guidelines on product governance and suitability assessments.
ESG DISCLOSURES BY MARKET PARTICIPANTS AND FINANCIAL ADVISORS
In March 2019, European co-legislators also agreed to a Regulation on ESG Disclosures applicable to a broad range of financial market participants, including UCITS management companies, AIFMs, and MiFID investment firms providing portfolio management, with the aim to improve disclosures to end-investors. Under the Disclosure Regulation, EBA, EIOPA and ESMA must deliver a number of joint Technical Standards, relating to:
- Public disclosure of principal adverse impacts of investment decisions on sustainability factors, such as environmental and social matters, this will apply to market participants on a comply or explain basis, except for companies with more than 500 employees for which the obligation is mandatory; and
- product specific disclosure (at a pre-contractual, public and periodic reporting level) showing how products fulfil environmental or social characteristics or meet sustainable investment objectives.
The work is on-going and ESMA will shortly publish a Consultation Paper with its proposals.
CREDIT RATING AGENCIES
Following the Consultation run in the first half of 2019, ESMA has developed guidelines to improve the quality and consistency of the information that accompanies credit rating actions, in particular by:
- requiring greater transparency around whether ESG factors were a key driver of the credit rating action; and
- providing detailed guidance as to what information CRAs should disclose when they issue a credit rating.
The purpose of the guidelines is to ensure a better level of consistency in terms of the critical information included in CRAs’ press releases and allow the users of ratings to better assess where ESG factors are affecting credit rating actions.
In addition to the guidelines ESMA has also published a report assessing the level of consideration of ESG factors in both specific credit rating actions, and the credit rating market in general.
The EC, under its Action Plan on Sustainable Finance, asked the three ESAs to collect information on potential undue short-term pressures on corporations from the financial sector.
ESMA held an open hearing in February 2019 to gather stakeholders’ views. ESMA conducted a survey on areas under its remit aimed at gathering evidence regarding the existence of undue short-termism and its drivers. Moreover, with a view to gathering further evidence and complementing its advice, ESMA engaged with market stakeholders. Presentations given are available here.
ESMA’s advice will be delivered to the EC by the end of 2019.
The Non-Financial Reporting Directive (2014/95/EU) requires large public interest entities with over 500 employees to disclose certain non-financial and diversity information. The Directive was further supplemented by the EC’s non-binding guidelines to help companies disclose relevant non-financial information in a more consistent and comparable manner. ESMA coordinates supervisory activities in this area and has included non-financial information as part of its European Common Enforcement Priorities (2018 ECEP Statement and 2019 ECEP Statement) and reports results on a yearly basis ( 2018 Annual Report ).
Drawing on this work and on the lessons learnt in the first years of implementation of the Directive, ESMA provided feedback to the EC, with the aim to further strengthen the legislative framework and achieve more transparent and enforceable non-financial statements. ESMA is arguing that a more stringent set of requirements, thus promoting consistency in disclosure and enforcement practices would help fill the transparency gap that currently exists between financial and non-financial disclosures.
ESMA is also investigating the area of non-financial information as part of the work being conducted to address the EC’s request for advice on undue short-termism in financial markets.
NEW CLIMATE RELATED BENCHMARKS
The creation of new benchmarks that consider the carbon footprint of underlying assets will assist investors looking to invest into sustainable finance products. The Action Plan creates two new categories, or labels, of climate-related benchmarks:
- the EU climate transition benchmark which brings the resulting benchmark portfolio on a decarbonisation trajectory; and
- the EU Paris-aligned benchmark which brings the resulting benchmark portfolio's carbon emissions in line with the Paris Climate Agreement goal to limit the global temperature rise to 1.5C° compared to pre-industrial levels.
For these two new benchmarks, the EC has mandated an industry-led expert group to define certain requirements such as the methodology, weighting method of the underlying assets, and the criteria for the choice of the underlying assets. In addition, each benchmark will have to provide an explanation of how the methodology reflects ESG factors.
Furthermore, following the agreement of the Low Carbon Benchmarks legislative package, the ESG disclosure will not be limited to these two new benchmarks. All benchmarks except for interest rate and currency benchmarks, within their benchmark statement, should disclose whether they pursue ESG objectives. As such, as of 31 December 2021, all benchmarks except for interest rate and currency benchmarks should include information on their degree of alignment with the Paris Agreement.