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Sustainable finance: challenges
Inconsistent rules on sustainability
The first steps towards more sustainable development have already been initiated. However, everyone agrees that this is just the beginning. As a consequence, the year 2022 is to mark the next milestone – after all, this year is characterized by the transformation from ambitious planning to ambitious implementation.
In this context, however, it quickly becomes clear that inconsistent rules on the concept of sustainability pose a major challenge.
The European Securities and Markets Authority (ESMA) has the following concerns:
- Pursuant to ESMA, there is a lack of clarity as to which specifications providers of financial products must rely on for product information.
- Furthermore, companies provide inconsistent information about sustainability on the capital market. According to ESMA experts, it is likely that it will take years before the EU rules on reporting by companies will be final and take effect in practice.
- In addition, ESMA reports that the specifications for ESG ratings (or exclusions) remain unclear. As a consequence, it is hard to measure the sustainability factor via benchmarks.
- ESMA uses investment funds as an example, since there is a lack of consensus as to when a product is considered sustainable. This shows that there is often a gap between the declared sustainability characteristics of funds and the actual investment strategy.
- The funds concerned are those that promote environmental and/or social characteristics (pursuant to Art. 8 of the European Sustainable Finance Disclosure Regulation (EU) 2019/2088) or that have sustainable investment as their core objective (pursuant to Art. 9 of the European Sustainable Finance Disclosure Regulation (EU) 2019/2088).
- Analyses by the German investment funds association BVI show that when the European Sustainable Finance Disclosure Regulation (EU) 2019/2088 came into force on March 10, 2021, the volume of sustainable mutual funds in the German market increased from EUR 91 bn to EUR 168 bn. A development criticized by ESMA as greenwashing.
Greenwashing as a result of inconsistent rules
Against this backdrop, ESMA observes that the rules for covering sustainable financial products are not applied uniformly in the EU area. There are fears that financial companies could deliberately use less stringent rules in certain EU countries to their advantage resulting in regulatory arbitrage.
Investors would be confronted with a lack of comparability as well as exaggerated and misleading sustainability promises in the securities business, which is also called greenwashing.
ESMA to tackle greenwashing: Sustainable Finance Roadmap
To counter this regulatory arbitrage, ESMA is calling on the NCAs in Europe to take a united approach. It therefore published its Sustainable Finance Roadmap on February 10, 2022, based on its Strategy on Sustainable Finance of February 6, 2020.
The Strategy on Sustainable Finance outlines how ESMA incorporates sustainability at the heart of its activities. In contrast, the Roadmap presents a structured and coordinated approach to address the various tasks in the sectors of investment management, investment services, issuer disclosure and governance, benchmarks, credit and ESG ratings, trading and post-trading, and financial innovation.
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Three overarching fields of action of the Sustainable Finance Roadmap
These tasks are then assigned to three overarching fields of action:
- Tackling greenwashing and promoting transparency
- Building NCAs’ and ESMA’s capacities
- Monitoring, assessing and analyzing ESG markets and risks
1. Tackling greenwashing and promoting transparency
- Greenwashing represents a complex phenomenon with various causes and manifestations. What all of these manifestations have in common is that they probably exert a negative influence on investors interested in sustainable investments.
- Accordingly, investors have to be absolutely protected. To this end, it is essential that the causes of greenwashing are fully analyzed and addressed through joint solutions across the EU.
- As one measure in this context, ESMA intends to provide advice to the EU Commission – for example, on how to apply the requirements of Article 8 of the SFDR or how to develop sustainability seals of quality.
2. Building NCAs’ and ESMA’s capacities
- Owing to the increased importance of sustainable finance, it is essential that NCAs as well as ESMA address and understand the regulatory implications of new rules and new market practices. Accordingly, new skills and knowledge must be acquired. Plans include a joint multi-year training program for employees in supervisory authorities.
- In addition, this is also to strengthen the exchange between the NCAs in order to create effective and comprehensive supervision.
3. Monitoring, assessing and analyzing ESG markets and risks
- Emerging trends, risks and vulnerabilities that have significant implications for investor protection and financial market stability need to be identified at an early stage. For this purpose, ESMA will rely on its data analytics capabilities to optimally perform and support its supervisory work as well as that of NCAs.
- In addition, ESMA intends to conduct specific activities in cooperation with other public entities:
- Establish climate scenario analyses for investment funds
- Add climate risks to stress tests of central counterparties
- Create common methodologies for climate-related risk analyses
- Examine the role of green FinTechs
- Develop tools for CO2 trading
The Sustainable Finance Roadmap stretches across the years 2022 to 2024. In order to implement its ambitious goals, ESMA has already launched initial activities.
At the same time, it also emphasizes that the Roadmap is a dynamic document. Accordingly, the fields of action as well as the sectors in particular need to be reviewed on an ongoing basis to ensure continuous adaptation to this rapidly changing environment.
Conclusion: transparency in financial markets required to achieve ambitious climate targets
ESMA’s Roadmap is seen as a milestone in sustainable finance. According to Verena Ross – Chair of ESMA – the measures “will play a key role […] in protecting European investors.” In the past, small investors in particular have been faced with the challenge of determining which financial products live up to the promised claims.
Transparency should provide a remedy here so that financial services providers do not choose the supposedly easier greenwashing option and investors are deceived with regard to the sustainability promise. Since this deception can also lead to investors losing confidence in the industry and deciding against sustainable investment behavior altogether, which would have devastating consequences for achieving the climate targets by 2030.
Accordingly, it is all the more important that ESMA and the NCAs provide uniform and unambiguous guidance regarding implementation – an implementation that poses major challenges for financial market players.
Therefore, the earlier these challenges are addressed, the more likely the holistic integration of the sustainability factor into corporate processes and structures will succeed. It can make sense to call on the support of external experts, as they have the necessary expertise with regard to the regulatory requirements.