Exclusive: The European Commission’s Action Plan on Financing Sustainable Growth

Ambitious proposals cover taxonomies, credit ratings, investor duties and more

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The European Commission plans to create “legally-enforceable” guidelines for sustainability, as well as EU labels for financial products, European green bond standards, changes to Mifid II and new investor rules on ESG. It is also considering the creation of a new credit ratings agency to pioneer sustainability assessments, and better scrutiny of ESG ratings and sustainability indices/benchmarks.

The slew of proposals have been laid out in the long-awaited Action Plan on Financing Sustainable Growth, which it describes as “a blueprint for international fora”. The document addresses the ‘big-picture’ on sustainability and achieving the Paris Agreement, before honing in on the Commission’s concrete plans to foster long-termism, financial inclusion and climate-resilience. The urgency of the challenge – for both scientific and political reasons – is clear from the deadlines set throughout the report, many of which are within the next 18 months.

Credit ratings and ESG scores

One of the Commission’s most interesting plans is to engage stakeholders on “the merits of establishing a new credit agency that would fully include long-term risks and sustainability in line with the objectives of this action plan”. It said this was prompted by “the need for wider reflection and more transparency on the way in which ESG factors are taken into account by credit ratings agencies”. No further details were provided, but the report said an update on progress in this field will be provided by the third quarter of next year. Over the same timeframe, it has asked the European Securities Markets Authority to complete an assessment of current ESG practices among credit ratings agencies, and to integrate ESG information into its own guidelines – or add new rules “where necessary”.

Also by Q3 2019, the Commission will publish a “comprehensive” study on sustainability ratings and research, assess the methodologies used and looking at the issue of objectivity or independence. The Commission noted that the lack of standards in the area was a challenge, and “some stakeholders argue that the focus of sustainability research providers on very large issuers has a negative impact on the attractiveness of smaller issuers for institutional investors”.

Investor duties

From the offset, the HLEG report urged lawmakers to clarify expectations under fiduciary duty, broadening it to cover sustainability considerations, and to ensure investors understand it is their responsibility to reflect the values of their end clients. The Action Plan echoes this sentiment, saying that “institutional investors and asset managers still do not systematically consider sustainability factors and risks in the investment process” or “sufficiently disclose to their clients if and how they consider these sustainability factors in their decision making”. As a result, the Commission will table a legislative proposal by the end of the second quarter that aims to ensure ESG factors are consistently considered and the processes and decisions are disclosed. “This will ultimately contribute to a shift towards responsible investment practices,” it concluded. For more on what the Action Plan might mean for the investment community, see our coverage here.

For more information on investor duties, see here, or listen to our recent webinar on the topic.h6. Investment advice

Investment firms and insurance distributors are also in the firing line in the Action Plan, which claims “investment preferences as regards to sustainability are often not sufficiently taken into account in the advice given”, adding that “this situation does not allow current and potential clients to clearly reflect their preferences regarding sustainable investments in their investments portfolio.”

To tackle this, the Commission plans to update the MIFID II and IDD delegated regulations in coming months to “ensure that sustainability preferences are taken into account” when banks, investment firms and insurers choose which products to offer clients. The Commission has also asked the European Securities Market Authority to “include provisions” on the topic in its guidelines, to be published by the second quarter of this year.

The European Supervisory Authorities

The ESAs are clearly a major component in the Action Plan, and the report asks them to complete a number of tasks relating to prudential requirements, provisions for sustainability preferences, credit ratings and short-termism. It makes sense that the three bodies – the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA) – are so important, as they control a big chunk of the EU’s financial markets. As a result, the Commission will make a formal proposal that the ESAs get a bigger budget from 2020, specifically to enable them to deal with environmental and social risks and integrate sustainability factors into their work. More broadly, the Commission claims the ESAs “should play an important role in identifying and reporting risks that ESG factors pose to financial stability” as well as considering longer-term risk horizons and pushing the financial markets to be better aligned with sustainability objectives. It suggests this could be done by working with the European Systemic Risk Board to develop “a common EU methodology for relevant scenario analysis,” which could in turn become climate or environmental stress testing.

The ESAs should also provide guidelines on how sustainability can be accounted for in EU financial services legislation, and should promote the application of ESG provisions through exchanges of best practice.

Definitions and labels

It is no secret that top of the Commission’s sustainability agenda is the creation of what it describes as a “legally-enforceable” sustainability taxonomy. It will establish a Technical Expert Group on Sustainable Finance, tasked with coming up with a first version of the taxonomy by the start of next year. This will be focused on climate mitigation, but will be widened by adaptation by Q3 2019. The taxonomy will be updated to keep up with the market using Delegated Acts – explain. For more information on the taxonomy, see RI’s previous coverage, or listen to our webinar on the topic.

The taxonomy will be the basis for a number of other initiatives laid out in the Action Plan, including the extension of the existing European Ecolabel to cover financial products. The label will focus on retail products, including investment funds, and the Commission says it “will consider the possibility to expand the labelling scheme to social financial products, including socially responsible investment funds”. A label will also be created for European green bonds, based on an EU Green Bond Standard which will be developed by the Commission’s technical group next year.

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The next financial plan for the EU (known as the Multiannual Finance Framework) begins in 2020, so this is when many of the budgetary changes are proposed for. One of the major ones in the Action Plan is the creation of an EU investment vehicle dedicated to sustainable investment and infrastructure. “The single fund will clearly identify investment priorities as well as radically simplify interaction between investors, beneficiaries, the EU Commission, and implementing partners like the EIB and National Promotional Banks, as well as possible new partners such as foundations and philanthropic organisations,” it said. Until then, it will emphasise its support for sustainable infra through its European Fund for Strategic Investments, which now has an investment target of €500bn, 40% of which must be aligned with the Paris Agreement.

The Commission highlights the lack of technical assistance available as a major problem for sustainable infrastructure projects trying to get off the ground and attract private investment. As a result, it proposed in December a pilot project to offer support tools to those developing sustainable infrastructure, which it hopes will start next year and run to 2023.

Indices and benchmarks

The Action plan warns that traditional benchmarks “reflect the status quo” and therefore don’t capture sustainability issues and goals. “As such, they are not appropriate to measure the performance of sustainable investments,” it adds. Dedicated ESG benchmarks suffer from a lack of transparency, which it says has “affected their reliability”. “This creates greenwashing risks and insufficient incentives to invest in sustainable assets.”

As a result, the Commission says that by the end of the second quarter, it will adopt delegated acts to challenge the transparency of those benchmarks’ methodologies and help the investment community to assess them better. In addition, it is considering “the possibility of creating a designated category of sustainability benchmarks (timing to be decided) to be effective once the EU sustainability taxonomy is enabled”. No further details were provided.h6. The creation of a ‘central point’ for sustainable finance

The Commission will bring together the ESAs with the new technical committee on sustainability, the European Investment Bank and the European Environmental Agency in a bid to start tracking the flow of sustainable assets in the EU, including investments into sustainable infrastructure. This was proposed in HLEG’s interim and final reports, where it was referred to as ‘the observatory’. By Q3 next year, this institution (referred to as a ‘platform’ in the report) will be established as a “central point” with a “more stable governance structure”, including public and private sector members. It will collect data to perform research and analysis, to update thinking on sustainable finance in Europe and work to support the achievement of the Action Plan’s objectives, advising the Commission on relevant topics, the report said.

Capital requirements

Investments that help to reduce climate risk “may need a different prudential treatment” in the context of banks and insurers, the Commission writes. These projects should be identified using the legally-enforceable taxonomy being developed by the Technical Working Group, and it’s likely the Commission loosen capital requirements for them, in a move dubbed the Green Supporting Factor. It stresses there will have to be a risk correlation underpinning this. The Action Plan proposes extending this to other environmental and social activities in due course. On insurance, the Commission will ask the European Insurance and Occupational Pensions Authority for its view on the impact of prudential rules on sustainability and long-term investments. It will consider the response ahead of the 2020 review of Solvency II. The Commission is also looking at whether the latest Basel recommendations, put forward in December and due to be transposed into EU law, have any negative impacts on European banks lending to green projects.

For more information on the Green Supporting Factor, see RI’s coverage or listen to our recent webinar.

Transparency and long-termism

The Action Plan sees transparency and long-termism as being most readily dealt with through corporate disclosure and corporate governance moves.