EU: ESMA sets out its long-term vision for sustainable investments

The European Securities and Markets Authority (ESMA) has published an opinion on the EU Sustainable Finance Regulatory Framework (Framework), setting out some potential long-term improvements, which it says will help facilitate investors’ access to sustainable investments. The opinion builds on the findings of ESMA’s progress report on greenwashing (see our earlier blog post) and the ESAs joint opinion on the review of the SFDR, with which it is broadly aligned (see our earlier blog post). 

Highlights

• The opinion looks to position the EU Taxonomy as the centre of the Framework (with ESMA notably pushing for it to replace the SFDR sustainable investment test longer term) and proposes a build out of the EU Taxonomy more generally, including prioritising the development of a social taxonomy.
   
• Further the opinion advocates strengthening the incorporation of transition in the Framework, including with a definition of “transition investments”, and with transition incorporated into any new product categorisation system.
   
• There are also calls for all financial products to disclose some minimum basic sustainability KPIs, as well as simple sustainability disclosures for certain financial instruments not captured by the SFDR.

Given its long-term horizon and high-level approach, the opinion does not go into the technical details of policy proposals.

ESMA’s key recommendations in detail

Making the EU Taxonomy the central point of the Framework and embedded into all Sustainable Finance legislation

• The EU Taxonomy should become the sole, common reference point against which sustainability performance should be measured and for it to become fully embedded into all relevant sustainable finance legislation. To reinforce consistency, ESMA notes that where a legal text, such as the SFDR or BMR, includes a concept of sustainability, this should be defined with direct references to the EU Taxonomy to embed a single definition of sustainability.  To fulfil this central role, the EU Taxonomy should be completed, including with a social taxonomy, although ESMA is aware that the full deployment of the EU Taxonomy will take time and effort.
   
• The SFDR definition of ‘sustainable investments’ should be phased out in due course as the EU Taxonomy is being completed. This is to remedy the current situation in which it is possible for a financial market participant (FMP) to use its own definition to construct a product. ESMA reiterates its support for the ESAs’ proposed approach in the joint ESAs opinion for the treatment of environmental and social sustainability in the interim phase and, in particular, making the key parameters of ‘sustainable investment’ of the SFDR more prescriptive.

Creating tools to support the transition

• ESMA sees merit in providing information on the share and revenue and Capital Expenditure associated with harmful activities that are in a transitioning trajectory or are decommissioning because their environmental performance cannot be improved. This is to support investors when making investments into activities which are in more urgent need of transition. 
   
• Incorporating a legal definition of “transition investments” to the Framework to provide legal clarity and support the creation of transition-related products.
   
• An overall mapping and assessment of current obligations of financial and non-financial undertakings in terms of transition planning and transition plan disclosures to ensure credibility and consistency. 
   
• Transition investing tools could be further enhanced, such as by raising the ambition of EU Climate Benchmarks minimum standards, developing a broader set of transition benchmarks covering various environmental objectives and creating high-quality EU labels for transition bonds and sustainability-linked bonds, based on the experience with the EU Green Bond Standard.

Transparency: All financial products should disclose some minimum basic sustainability information

• Developing minimum sustainability disclosures for all financial products consisting of a small number of simple sustainability key performance indicators (KPIs). The relevant indicators should convey in a simple way the notion of sustainability, be based on existing EU Taxonomy information, but also leverage off reported ESRS and SFDR datapoints that capture specific sustainability aspects. These KPIs should cover basic environmental and social sustainability characteristics and given their dynamic nature, be under regular review to reflect their evolving nature and ensure their continued relevance.
   
• An assessment should be conducted concerning which MiFID II financial instruments not captured by the SFDR should be subject to standardised minimum sustainability disclosures. The assessment should consider the ability of instruments to effectively contribute to channelling capital flows to sustainability objectives. ESMA emphasises that this proposal does not necessarily mean that these financial instruments should be brought within scope of the SFDR.
   
• There should be a layering of information to cater to different investor needs. ESMA suggests that the full set of sustainability disclosures should include a sub-set of ‘vital’ information for less sophisticated investors, while the entire set of sustainability information would be available to all professional and retail investors. Depending on consumer testing, this ‘vital’ information should include key sustainability metric and be placed in short consumer facing documents, like the PRIIPS KID.

The introduction of a product categorisation system 

• Establishing a product categorisation systemthat includes strong categories for sustainable and transition investments. The establishment of categories would enable investors to assess and compare between different, complex products and support them to focus and identify those that have explicit sustainability or transition objectives. This system would have two key parts, notably: 
  
  
  • a set of clear, science-based, binding, and measurable ‘eligibility criteria’ which should cater to the outcomes that retail investors seek; and 
     
  • ‘transparency obligations’ that will apply to the products to make sure that information is provided to investors on the outcomes sought. These should be concrete and, where possible, quantifiable and enable investors to assess whether the product meets its objectives. 

ESMA considers that the transparency obligations for the categories would build on existing and upcoming disclosure requirements. Moreover, ESMA is of the view that categories could be voluntary. Only products that meet the eligibility requirements would qualify for the categories. Regular reviews of the categories and their eligibility requirements would be needed to maintain their relevance for investors, but this would be weighed against the need for regulatory stability.

• ESMA sees the implementation of a grading system as an appealing way in the long-term to aggregate complex sustainability information in order to illustrate the sustainability profile of a product to investors. This would be in line with the joint ESAs opinion which suggests the introduction of sustainability indicators. However, like the ESAs, ESMA acknowledges that developing a grading system comes with significant methodological challenges to capture the multiple dimensions of sustainability, but expects it to be feasible to address them in the future once the EU Taxonomy is completed. 
   
• Aligning the rules on the content of marketing material, the product’s name and its sustainability profile to help investors distinguish between different products should be incorporated in the Framework. Reiterating the views set out by the ESAs in their joint opinion, ESMA considers that certain sustainability-related terms should only be used in names when products meet certain sustainability characteristics. Additionally, information in a product’s marketing material should be consistent with the product’s sustainability profile.  ESMA explains that products not falling into the categories would face restrictions on using certain ESG or sustainability related terms in naming and marketing. These considerations could also be useful for benchmarks, where the absence of a definition of ESG benchmarks could potentially lead to disclosures that could be seen as inaccurate or misleading.
   
• ESMA suggests that the implementation of product categories would provide a good basis to discuss investors’ “sustainability preferences” under MiFID II. These should be defined, among others, based on a consumer-friendly product categorisation system, which could help advisors in their dialogue with investors.

Bringing ESG data products into the regulatory perimeter

• ESMA is of the view that it is important to bring ESG data products into the regulatory perimeter to ensure that ESG data is reliable and comparable. ESMA believes that the Commission should consider addressing ESG data issues in a holistic way to establish a regulatory regime that would provide a basis for the quality and reliability of ESG data products. This could entail setting out appropriate definitions of what constitutes ESG data products, define the duties and responsibilities of ESG data product providers and set out disclosure, conflict of interest and quality requirements.

Conduct of Sustainable Investment Value Chain (SIVC) actors

• Due diligence obligations for both the financial and non-financial sector should be well-defined with responsibility being on not only issuers but on all SIVC actors. 
   
• The Framework should fully support the concept of active engagement with investee companies, requirements for clear goal setting, measuring of progress, escalation mechanism and reporting on achievement of goals. ESMA believes that active engagement with investee companies is a powerful tool to drive change and transition. As part of its review of the Shareholders Rights Directive, ESMA has asked the Commission to consider requesting more specific disclosure of information sources, including ESG data and has made proposals designed to facilitate shareholder engagement and participation. 
   
• The Commission could consider putting in place an EU level stewardship code, leveraging off existing stewardship codes in other jurisdictions. This would reflect the Framework and constitute a valuable tool for smaller market actors.

ESMA reiterates throughout the opinion that these policy proposals should be subject to consumer and industry testing to ensure they are appropriate for retail investors as well as the feasibility and workability of those solutions.

ESMA’s opinion published on 24 July 2024 is available here.

ESMA’s press release is available here.

Watch our latest video with Alexander Vogt and Nicola Zeibig to explore ESMA's long-term vision for sustainable investments.