ESMA's opinion, published earlier this week, setting out its long-term vision for the EU sustainable finance regulatory framework, contains a number of significant proposals to the Commission, following the recent final ESA reports on greenwashing and the Joint ESA Opinion on the Sustainable Finance Disclosure Regulation (SFDR).
The key theme that underpins both the ESMA opinion, and last month's Joint ESA Opinion, is that the complexity of the EU sustainable finance framework, and the lack of common reference points, is creating inconsistency and a need for extremely detailed disclosures. Simplification, harmonisation, comparability and tailored disclosures are critically important to making the framework workable for both retail and professional investors.
Read our insights on the ESA's recent final reports on greenwashing here.
Key recommendations to the European Commission in the Joint ESA Opinion included:
- The introduction of a product classification system, based on regulatory categories or sustainability indicators. Categories should be simple with clear objective criteria/thresholds. At a minimum, "sustainability" and "transition" categories should be included. A sustainability indicator could refer to environmental sustainability, social sustainability or both.
- Options for product categorisation and sustainability indicators should be consumer tested and consulted on – this should help reduce the requirement for extensive and detailed sustainability disclosures.
- Sustainability disclosures should cater to different investor needs, and different distribution channels should be considered. The ESAs want the Commission to prioritise essential information for retail investors (whereas professional investors may benefit from more detailed information).
- Consideration should be given to whether other products should be brought into SFDR's scope.
In its opinion this week, ESMA made the following recommendations to the Commission:
- EU Taxonomy: This should become the sole, common reference point for assessing sustainability, be embedded in all sustainable finance legislation, and be completed (in particular, the social taxonomy element). All sustainable finance legislation that contains a sustainability concept should define it by reference to the EU Taxonomy.
- SFDR: The SFDR definition of "sustainable investment" should be phased out – ESMA's view is that supervised entities have too much discretion on how to apply that definition, leading to inconsistencies. Acknowledging that fully deploying the EU Taxonomy will take time, ESMA supports the ESAs proposed approach to the treatment of environmental and social sustainability in the meantime (in particular, making the parameters of the "sustainable investment" definition more prescriptive).
- Transition investments: A definition of "transition investments" should be developed. ESMA suggests that current obligations of both financial and non-financial undertakings in terms of transition planning and transition disclosures be mapped and assessed to ensure consistency and avoid overlaps. It also suggests that a broader set of transition benchmarks be developed, and that EU climate benchmarks become more ambitious. Building on the work done to develop the EU green bond standard, it also encourages the development of standards for transition bonds and sustainability-linked bonds. From a disclosures perspective, it suggests a requirement to provide information on the share of revenue and CapEx associated with harmful activities (those that are always significantly harmful, or significantly harmful) that are on a transition trajectory or are being decommissioned on the basis that their environmental performance cannot be improved.
- Transparency: ESMA wants to see all SFDR financial products disclose specific sustainability information on basic environmental and social sustainability characteristics (to improve transparency and comparability) regardless of the relevant product's stated sustainability ambition.
- MiFID II Financial Instruments: An assessment should be carried out on which MiFID financial instruments should be subject to standardised minimum sustainability disclosures – ESMA is not necessarily suggesting that those financial instruments be brought within SFDR's scope.
- 'Vital' Information: The full set of sustainability disclosures should include a sub-set of "vital"information for less sophisticated investors. Layering disclosures in documents distributed electronically might be useful to enhance accessibility
- Product Categorisation: In line with the Joint ESA Opinion, a product categorisation system (for sustainable and transition investments offered to retail investors) should be introduced, with two key component parts: eligibility criteria (catering to the outcomes that investors are looking for) and transparency obligations (with information for investors are those outcomes).
- Grading: The potential for a grading system should be further explored (the Joint ESA Opinion also looked at the potential advantages and disadvantages in introducing a sustainability indicator). ESMA notes the considerable methodological challenges that would involve.
- Marketing: Rules should be introduced to ensure alignment between the name of a product, the related marketing material, and the products sustainability profile.
- ESG Data Quality: With data quality and volume continuing to be a key theme (and noting that the ESRS are expected to improve both quality and reliability), ESMA wants to see ESG data products brought within the regulatory perimeter.
- Conduct of Market Actors: A stewardship code could be implemented for market actors such as asset managers, institutional investors, benchmark administrators and investment service providers.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.