The new European Commission must focus on ESG integration in mainstream risk management

Responsible Investor’s latest instalment of The EU Action Plan: What Matters To Me

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For one week only, RI reopens its ‘The EU Action Plan: What Matters To Me’ series, providing insights from market experts on the implications of the EU Action Plan on Sustainable Finance. Today, ShareAction’s Eleni Choidas urges the new Commission to think more carefully about how to incentivise mainstream market players and products when it comes to ESG. You can hear directly from the European Commission and the Technical Expert Group in our dedicated Action Plan webinar series here.

The past few weeks have seen a frenzy of Commissioner-designate hearings in the European Parliament, and for those working on sustainable finance, this has brought an intense scramble to put together the pieces of the next Commission’s policy priorities.
The policy routes through which sustainable finance will be tackled in the new Commission appear slightly more fragmented than the previous administration. This is to be expected: with sustainability being recognised as a key priority in Ursula von der Leyen’s political guidelines, there is a top-down mandate for the topic to be integrated across different portfolios. It still remains to be seen exactly where and how the completion of the original Action Plan will take place, and whether this will be partly accomplished in the expected Green Finance Strategy, Sustainable Europe Investment Plan, and the much-lauded European Green Deal, under the auspices of Frans Timmermans. In the coming months, we expect all these strands will tie together.
Some priorities, identified by civil society, industry and policymakers would appear to be logical next steps – in particular tackling the glaring data gap necessary in ensuring financial actors have the data necessary to drive sustainable investments, through a proposed review of the Non-Financial Reporting Directive. The quality of data and real economy outcomes will certainly take centre stage.
When considering the state-of-play as it stands, it’s clear that the great successes of the Action Plan, which include the recently adopted Disclosure and Benchmarks Regulations, and ongoing negotiations on the Taxonomy, are missing one key element: the regulatory incentives for financial actors across the investment chain to integrate ESG risks in their mainstream risk management, beyond just green or sustainable products. While investors at the forefront of sustainable investment may consider sustainability risk as a discreet category needing to be embedded in regulation as a highly redundant move, it is one of the key regulatory tools remaining to promote the creation of a level-playing field that is now needed to take this agenda forward.
It may be useful to tackle this issue by looking at the gaps left by some of the otherwise great successes of the Action Plan:
While the clarification of technical standards around ‘green’ economic activities is indeed a game-changer that will ensure better transparency towards end-investors, the question remains whether this will truly be the trigger to stimulate articulation of what also constitutes ‘non-green’, and have this equally embedded into law. Furthermore, whether it will actually incentivise the move from the latter to the former remains to be seen. The recent work done by The Guardian, ProxyInsight and InfluenceMap, showing that the world’s three top asset managers, Blackrock, State Street and Vanguard, still hold more than $300bn in fossil fuels, shows how crucial such a move is.It is necessary for this segment of the market to be under more scrutiny, which should accompany the dizzying boom of ESG products. In addition, the Disclosure Regulation itself has a limited scope: while it created mandates for financial institutions to disclose how they are considering ESG risks and impacts, the final text achieves this through a comply-or-explain mechanism for market actors with under 500 employees. In addition, it is unclear the extent to which ESG integration will need to pre-date these disclosure requirements for financial actors of any size.
As such, although both these regulations closely orbit the mainstreaming of ESG risks in core investment functions – in a way that would cover the ‘non-green’ market segment that actually needs this mandate – they both ultimately fall short.

Regulation still needs to create the incentives for a level-playing field in sustainable investment, in which laggards are given strong incentives to integrate ESG risks, while frontrunners are rewarded

Regulation still needs to create the incentives for a level-playing field in sustainable investment, in which laggards are given strong incentives to integrate ESG risks, while frontrunners are rewarded, all the while ensuring the gap between the two is decreased in a proportional manner.
A key opportunity remains, as the Commission is now preparing to submit amendments that are expected to mandate the integration of ESG risks in mainstream investment decision-making for all actors ranging from insurance companies to alternative investment fund managers. The European Supervisory Authorities submitted ambitious technical advice to the Commission earlier in the year on how to do exactly that. Importantly, under the same package of legislation, the Commission is expected to tackle how end-investors are consulted about their sustainability preferences, and ensure that they are asked both about their ESG risk appetite, as well as their “impact” appetite – aligning these asks with the Disclosure Regulation’s focus on both these dimensions. This will be a key change, triggering a process through which end-investors will themselves shape market behaviour from below, and be in a position to apply more pressure on their providers to invest sustainability.
Achieving this level playing field is a tall order, but these changes would play a key role by addressing the core part of the market and the main investment duties of investors. Creating ‘economies of scale’ in which market conditions will be ideal for sustainable investment to flourish, will likely only be accomplished in an ecosystem of further regulatory changes, including a fair carbon tax, a review of the Non-Financial Reporting Directive that will ensure meaningful data is disclosed by issuers, and more. Many pieces are still needed for this puzzle to be completed.
Nonetheless, it remains that the European Commission finds in front of it a strong opportunity to take a bold next step, and ensure that the duties of investors vis-à-vis sustainability are finally clarified across EU Regulation.
However the new Commission decides to tackle sustainable finance, this should remain a key priority.

Eleni Choidas is European Policy Manager for NGO and campaign group ShareAction.