The Substance of the TEG Legislative Proposals

    Robert Vicsai, Board member, Swesif

    By signing the Paris agreement on climate change and the UN-led 2030 Agenda, the EU made the commitment to work towards developing a more sustainable society. The European Commission introduced the concept of the European Green Deal, described as a roadmap for a sustainable European economy, with the objective to transform environmental challenges into opportunities in all policy areas. In June 2018, the European Commission set up the Technical Expert Group (TEG) to develop frameworks to support this green conversion. Swesif Director Robert Vicsai, helps to explain what the new EU regulations mean for the financial industry.

    The TEG’s three legislative proposals

    The EU taxonomy is a standardised classification system that allows the assessment of the environmental sustainability of a given economic activity in the context of a company. The Taxonomy has six environmental objectives: climate change mitigation, climate change adaptation, the sustainable use and protection of marine environments, the transition to a circular economy with improved waste management and recycling, pollution control and biodiversity protection. The European Commission will continue to identify and define economic activities that can be described as aligned with sustainable development in a step-by-step manner.

    “The purpose of the taxonomy, within the framework of the financial market, is to help financial players and investors make informed investment decisions based on the clarifications of the framework,” says Robert Vicsai. “The taxonomy is also expected to form the basis for future standards and labels for sustainable financial products,” he continues. To be classified as environmentally sustainable, an activity must make a significant contribution to at least one of its objectives, while not harming any of the other objectives. No activity is excluded in advance except for fossil energy production.

    Sustainability-related disclosure in the financial services sector. “This reporting regulation will provide a deeper level of transparency on the sustainability of financial markets. The demands are wide-ranging and the EU’s expectations regarding the integration of financial actors into ESG issues are far-reaching. Investors will have to be able to show, inter alia, how their investments take account of predefined sustainability factors, to account for the fulfilment of these objectives and to assess the impact of any negative externalities”, Vicsai continues.

    Harmonised rules on sustainability reporting in the EU improve the comparability of financial products. It is the first step, and the regulation is a minimum requirement for all financial actors. Furthermore, the regulatory framework will apply to all supervised financial advisers with more than three employees.

    The EU Regulation on benchmarks (Benchmark Regulation) proposes a new reference value defining where emissions are considered low-carbon. “The new standard will provide investors with improved information on the carbon footprint of an investment portfolio. It will also be possible to better align portfolios with the Paris agreement’s objective of limiting global warming to below 2 degrees Celsius”, says Robert Vicsai.

    Instilling a sense of urgency

    The new regulatory framework is comprehensive and will require a great deal from financial market players. The taxonomy is about 600-pages long and should be seen as a reference document rather than a file to read from cover-to-cover for most people. A manual on how to use taxonomy is also available.

    The various professional bodies in the market must decide for themselves how the taxonomy is to be used. In the same way, companies must come up with what they have to do. “All financial actors will be affected, just as everyone was affected when the UN’s Global Objectives for Sustainable Development and the Paris Accord were signed. This is a strategic shift rather than a compliance exercise,” Vicsai comments.

    In a blog post, Fiona Reynolds, CEO of PRI, describes the importance of a strategic perspective on the issue.

    “The taxonomy matters – most importantly because it is a serious effort by financial regulators to mandate disclosure against a sustainability target, rather than a financial one. In this case, the climate change mitigation target is Europe’s commitment to net-zero carbon emissions by 2050,” she wrote in the post.

    Details under development

    The EU Commission has instructed the European Supervisory Authorities (ESAs) to jointly develop technical standards (Level 2) and specify details on how the disclosure regulation information is to be reported. Local regulators will be able to impose more stringent requirements than the regulation prescribes. At the moment, Level 2 of the disclosure regulation will impose far-reaching reporting requirements that may be difficult to interpret for individual actors.

    “The new regulatory framework demands robust and structured reporting, which will bring about a completely new reality for most market players,” Vicsai stresses. The financial institutions concerned will have to systematically account for how they integrate sustainability into their investment and advisory decisions and how it affects customers. “The new rules will hopefully also prevent non-sustainable actors from pretending to be just sustainable,” Vicsai hopes.

    The disclosure regulation is a minimum requirement, and the technical criteria will be more detailed. However, in short, the regulation means that:

    1. The company’s policy for integrating sustainability risk shall be accessible on the company’s website and kept up to date.
    2. The information documents shall indicate the conditions applied for the integration of sustainability risks into investment decisions and advice, respectively.
    3. The information documents shall indicate the extent to which the risks are deemed to have a relevant impact on the yield of the product provided or recommended.
    4. Transparency shall be exercised as to whether the company’s remuneration policy is consistent with the integration of sustainability risks. It shall not be possible to disregard sustainability risks to obtain higher bonuses.

    For management strategies and financial products with an explicit sustainability-related objective, specific disclosure requirements will be introduced regarding the conditions and the way sustainability is integrated into the investment decisions and advice, respectively. There must also be information on how to ensure the objective of sustainable investment, how to achieve the objectives, including methods and underlying data and indicators for measuring the achievement of the objectives.

    “You don’t have to report on specific sustainability risks unless you market your funds as sustainable. However, if your product is not sustainable, you will have to clearly state that you will NOT take sustainability risks into account in your management. It resembles the warning on a cigarette packet,” Robert Vicsai explains.

    Before the COVID-19 pandemic, the disclosure regulation was expected to apply from March 2021, and the Financial Supervisory Authority was expected to provide the technical criteria by the end of 2020. This timeline is not as clear or as likely as before.

    “However, asset managers and institutional investors need to get down to work on the regulations as soon as possible. It is clear that the EU intends to change the way in which the financial market works on sustainability from scratch,” Vicsai concludes.

    This article was originally published on Swesif’s website on 20 May 2020 in Swedish.

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