EU Policy Update: April

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The EU has gone consultation crazy this month, with a number of key sustainable finance initiatives being put out for market feedback. The biggest of these is the consultation on the Renewed Strategy – the next phase of the European Commission’s sustainable finance agenda, to be released later this year – which launched at the start of the month. The survey poses more than 100 questions on a whole range of topics from pay packages to the ability of passive investors to undertake ESG objectives thoroughly. For more information on the consultation, see RI's coverage here.

Disclosure and reporting 

And then, more recently, the European Supervisory Authorities launched an important consultation on ESG disclosure. Back when the EU agreed the fundamental rules around the Disclosures Regulation – which will require pension funds, insurers, asset managers, UCITS and others to become more transparent on ESG and sustainability – it identified six sets of standards that would need to be developed to provide the specifics on entity-level and product-level disclosure. What the ESAs published last week is a paper outlining their thinking on how those six standards should look, and they are now seeking feedback. Crucially, while the Disclosures Regulation relates to investors, there is also an open consultation on the planned overhaul of the Non-Financial Reporting Directive (NFRD), which is the equivalent set of rules for companies. If the Commission gets this right, it should mean that much of the information that investors will be obliged to disclose under the new regulation will be readily provided by companies covered by the NFRD, making it much easier to comply with the rules quickly and cheaply.  

However, according to ESMA, there is already “sufficient” environmental disclosure from many NFRD-reporting firms. The supervisor published an assessment this month of how 145 European issuers’ complied with the Directive last year. The study was part of a broader report titled Enforcement and regulatory activities of European enforcers in 2019 and concluded, bullishly, that “almost all issuers provided sufficient description of their policy for addressing environmental matters” and “around three quarters of issuers in the sample provided sufficient disclosure on their due diligence processes for environmental matters”. For some expert analysis of that report, see RI’s recent coverage from Frank Bold’s Filipe Gregor here. 

Benchmarks and indices

The Commission has also opened consultations on three sets of draft regulation relating to its work on sustainability in benchmarks. They cover requirements for index providers to explain how they “build ESG factors into their calculations”, rules on the extent to which benchmark statements are Paris-aligned, and eligibility criteria for the two new climate benchmark labels that have been developed by the EU. Interestingly, as RI reported at the time, this latter consultation includes a proposal to exclude tobacco companies from more ambitious climate benchmarks. 

In the meantime, ESMA yesterday bowed to pressure from trade groups and issued a No Action Letter, which said that national bodies “should not prioritise supervisory or enforcement action” against index providers that don’t meet the new benchmarking rules, because – although the rules came into force last month – it is difficult to comply when the exact details are still out for consultation, and therefore uncertain.  

One element still up for discussion is how the carbon profile of a company should be measured. It is a fiercely contested topic, which RI outlines here. One of the reasons it matters so much is because the EU’s decision on which approach it embeds into the Action Plan will be highly influential for investors. Last week, the Net Zero Asset Owner Alliance, which includes some of the most forward-thinking investors on climate in the world, said it favoured the “approach pursued by the EU within taxonomy-related developments", which – importantly, is not the one recommended by the TCFD.

For more on all of the work being done by the Commission and its Technical Expert Group on Sustainable Finance around benchmarks, register for RI’s next Action Plan webinar on May 13. 

Investor Duties and suitability tests

On investor duties, another key pillar of the EU Action Plan, the Commission told RI that it would launch a public consultation “very soon” on how it will amend existing directives such as UCITS, AIFM, Solvency II, IDD and MiFID II, to incorporate sustainability. Those changes will clarify the role of ESG in both explicit investor duties and in requirements for suitability tests.

The Ecolabel

And in another consultation, which closed at the start of the month, the latest version of the Ecolabel was put out for feedback. RI covers the proposals in more detail here but key new recommendations for the fund label include that it should consider capex as well as company revenues, and that it should widen to cover social criteria, exclusion lists and engagement criteria for certain types of funds. The Commission has engaged a German firm called Climate & Company and the Frankfurt School of Finance & Management to test the latest Ecolabel proposals on 100 “real life” green UCITS funds to see how applicable it would be. Those results are due in June 2020.

InfluenceMap has conducted an investigation into Ecolabel lobbying (the NGO published something similar on the green taxonomy, highlighting pushback from Japanese trade bodies – one reason why Japan might be mulling its own taxonomy). The Ecolabel research found that European industry groups including the European Fund Asset Management Association, the European Banking Federation and the European Association of Cooperative Banks are resistant to the introduction of mandatory criteria, while BlackRock allegedly suggested the minimum threshold for green assets in an Ecolabel fund should be 25% and there should be no exclusion criteria.

BlackRock and Banking

And this final point is just one reason why the EU’s recent decision to award BlackRock a contract to assess potential changes to banking rules to help sustainability was such a PR disaster for the Action Plan. The European Commission essentially asked the pantomime villain of ESG to advise it on the most controversial part of its entire sustainability strategy, in a decision that began as a headline in RI and became a story in the national newspapers and the subject of civil society campaigns. Yesterday, a group of NGOs wrote to the Commission asking them to cancel the contract, citing “numerous serious conflicts of interest for BlackRock”.

But, as one observer pointed out: “That mandate was always going to go to a big investor or similar. The Commission hasn’t actually broken any rules, and nor has BlackRock”.  Either way, its choice will put it under intense scrutiny when BlackRock’s final recommendations on the topic are published and the Commission has to decide what to take forward.

Human rights and environmental due diligence

There have been some big moves forward on due diligence in recent weeks, too. It is a topic that was beginning to be discussed in the context of the Action Plan earlier this year, but yesterday, the European Commissioner for Justice, Didier Reyders, announced he would develop legislation on mandatory sustainable due diligence for companies. The rules will cover environmental, human rights and governance topics, and will be introduced next year, he said during a conference hosted by the European Parliament’s Responsible Business Conduct Working Group. RI reported in January that DG Just, Reyders’ unit, which deals with justice and consumers, had asked the British Institute for International and Comparative Law to review due diligence in supply chains. In that report, it recommended mandatory disclosure, so it looks like Reyders has taken that advice forward at breakneck speed.  

As well as garnering major support from NGOs like Global Witness, which has been campaigning on this topic for a long time in Europe, the move is likely to please a number of big investors that just last week wrote to governments asking for tighter rules on mandatory human rights due diligence. 

COVID and a sustainable recovery

All of these initiatives have been brought into much sharper focus in the light of COVID-19 and discussions around the recovery strategies that will be needed in Europe and throughout the world to rebuild the economy. Sustainability has been a big part of that conversation in recent weeks, with representatives from around 20 EU Members States backing a campaign to put the European Green Deal at the centre of any recovery efforts. Earlier this week, the EUs Technical Expert Group on Sustainable Finance, which includes experts from some major investors and financial services bodies, released a statement echoing the politicians.

“As we prepare plans for economic recovery from the Covid-19 pandemic, governments and the private sector must be attentive to the details of what a resilient, sustainable and fair recovery looks like in practice – to ensure greater resilience to further environmental and social crises ahead,” it said.