Sustainable finance is a trend set to stay

EU developments

In May 2018, the European Commission published the Sustainable Finance Action Plan comprised of three legislative proposals which seek to facilitate the redirection of capital towards sustainable investments.

Sustainability disclosures

The regulation on disclosures relating to sustainable investments and sustainability risks increases the transparency of the integration of sustainability risks and objectives into the investment decision making process. The purpose of the regulation is to facilitate the comparison of products by the end investor. It was agreed by the co-legislators in March 2019 and will be formally published in Q3 2019 with the first requirements expected to apply in January 2020. The regulation applies to a broad scope of financial market participants, including investment firms, alternative investment fund (AIF) managers and UCITs management companies. It imposes general requirements on these financial market participants to disclose if and how they take account of the impact of their investment decisions on sustainability as well as the risks of sustainability on their returns. There are additional disclosure requirements for financial products which are promoted as having sustainable characteristics or objectives.

Low-carbon benchmarks

The regulation amending Regulation (EU) 2016/1011 on low-carbon benchmarks and positive carbon impact benchmarks establishes two new categories of benchmarks – EU Climate Transition and EU Paris-aligned benchmarks – which intend to provide investors with better information on the carbon footprint of their investments. The co-legislators reached agreement on this regulation in February 2019, and it is expected to be formally published in Q3 2020.

The taxonomy

The proposal for a regulation establishing a framework to facilitate sustainable investment seeks to introduce a harmonised taxonomy for determining which economic activities can be considered sustainable investment targets. In the medium term, the Commission intends to establish an EU EcoLabel which will also be based on the taxonomy.

The taxonomy proposal is the only of the three proposals which has yet to be adopted by the co-legislators and adoption is not expected until the end of 2019. Initially billed as the foundational framework of the Action Plan, the taxonomy will now simply complement the other two proposals which can take effect independently of the taxonomy.

UK developments

In April 2019, the Prudential Regulation Authority (PRA) published a Supervisory Statement (SS3/19), which seeks to enhance and align the approaches of banks and insurers in managing financial risks related to climate change (climate change risks).

The purpose of SS3/19 is for the PRA to set out its expectations for banks and insurers in relation to climate change risks. In SS3/19, the PRA highlights that these risks are distinctive in nature and present unique challenges. Accordingly, banks and insurers should deal with them strategically.

There are many key points to note from SS3/19, including that firms' responses to climate change risks should be proportionate to the nature, scale and complexity of their business.

Additionally, it should be noted that, in many ways, these risks should be viewed and treated in the same way as other risks by institutions, with a caveat. For example, boards need to ensure that the risks are fully understood, that roles and responsibilities are appropriately allocated and there is oversight of the way these risks are monitored, managed and governed. However, at the same time, it should be recognised that, for instance, the time horizons are different, so boards should also be adopting a much longer-term view.

Risk management frameworks, policies, procedures and management information also need to incorporate climate change risks. Firms that are within scope of SS3/19 should read it, benchmark what they are already doing against it and implement changes where necessary.

Another key point is disclosure. While banks already have to make disclosures about material risks as part of their Pillar 3 disclosure, the PRA is looking to banks to take account of what they are doing now and determine whether any enhancements are required. It is worth bearing in mind that disclosure frameworks will be evolving, with what good looks like changing over time. Institutions are being encouraged to engage with wider initiatives like the Task Force on Climate-related Financial Disclosures (TCFD).

In October 2018, the FCA published its Discussion Paper (DP18/8) on green finance and climate change.

One key area of focus of DP18/8 is disclosure, particularly the sorts of disclosures that issuers might need to make to adequately inform investors of the impact of climate change risks on investment in those issuers. Some of the key challenges identified included consistency, comparability and how to know what disclosures should include. The FCA sought views on questions including what constitutes materiality, how consistency can be achieved, and the possibility of referring to external standards like the TCFD. The FCA also specifically asked whether to introduce a new requirement for firms to report publicly on climate change risks and how they impact firms, customers and business models. Other questions included details of firms' key priorities and concerns in this field and what they viewed as some of the challenges and barriers.

The period for responses to DP18/8 has closed. Firms should pay close attention to what follows, as it will be important to see what feedback is published in relation to DP18/8.

Implications for asset managers

On the whole, the asset management industry is embracing the sustainable finance developments and is, in some cases, driving the work-streams. Nonetheless, the recent wave of legislation will require significant adaptions to pre-contractual disclosures and decision-making processes. The industry is keen to preserve and permit varying degrees of sustainability in investments to ensure that the client's ability to choose is not curtailed and to prevent capital withdrawal from certain sectors.

New ESG insight page

We have launched a new ESG page on our Asset Management Regulation knowledge hub. This page is called “ESG insight”. ESG insight contains resources and materials to guide asset managers through the evolving regulatory landscape on ESG. Features include

• Videos from our financial services team discussing UK and EU regulatory developments on ESG
• A library of ESG related papers from international, EU and UK regulatory authorities
• Regular updates on regulatory developments relating to ESG and
• Briefing slides on the EU measures on sustainable investment disclosure rules and classification system (taxonomy) of sustainable economic activities.

Access to ESG insight is by way of registration via the Norton Rose Fulbright Institute portal. For more information, or to register or log in to the Institute, please click here.

Once you are logged in to the Institute, to access ESG insight please click the Knowledge hubs tab at the top of your screen, selecting the first link on the drop-down menu, Asset Management Regulation. Access to ESG insight can then be found from this page.