by Nathalie Dogniez, EMEA ESG Leader
We currently observe a very strong focus on ESG within Asset management - ESG is moving from a niche player activity to a mainstream solution within asset management. The appetite for the ESG investment approach is driven by market demand, originally (and still strongly) coming from institutional investors but increasingly also from the retail side. New generations of investors are more and more environmentally conscious and believe financial return isn’t completely detached from environmental or social impact. These investors ask for more sustainable products and want to know more about the ESG product on the market.
As a result, asset managers now realise that ESG is an opportunity to truly engage with their investors. At the same time, performance analysis is not at the expense of financial performance, to the contrary. Consequently, asset managers are now investing in developing their ESG capabilities and product offering.
In this context, how is the recent EU Action Plan likely to influence these current trends?
In this article, we provide an overview of the current measures discussed under this Action Plan, and their potential impact for asset managers, management companies and fund products, whether they have (or no)t ESG at the core of their strategy.
On 8 March 2018, the EU Commission issued its Action plan on Financing Sustainable Growth, also known as the ‘Action Plan’. This initiative originated from the Capital Market Union action plan and is part of their broader efforts to connect finance with the specific needs of the European and global economy, for the benefit of the planet and our society. The EU defines "Sustainable Finance" as the process of considering the environmental and social impact in investment decision-making, leading to a growth of long-term investments and sustainable activities. While the plan recognises the key role of governance, there’s a clear focus on environmental and social considerations.
The main objectives of the Action Plan are:
The plan includes ten action points, three regulations in the areas of taxonomy, disclosure and low carbon benchmark. It also covers amendments to the existing MiFID2, UCITS and AIFMD level 2 regulations, alongside other consultations and non legislative measures.
To provide technical expertise and support in the areas of environmentally sustainable activities taxonomy, low carbon benchmark, sustainable investments and risks disclosure and EU green bond standards, the EU Commission set up a technical expert working group (TEC).
1. Disclosure proposal
Transparency is a key feature in ESG investment and a major concern of the EU regulator. It’s not surprising that one of the first initiatives is to further regulate disclosure. The proposal makes a clear distinction between disclosure on sustainable risks (applicable to all financial products) and further disclosures applicable to sustainable investments.
Sustainable investments are being defined as investments in economic activities that contribute to an environmental objective or a social objective or investment in companies following good governance practices. Environmental activities are being defined under the taxonomy proposal as described below.
The scope of this disclosure proposal is currently being discussed in trialogue as the EU Parliament has proposed. The objective is to significantly expand the scope of the proposal in term of products under scope, due diligence requirements and definition of sustainability risks - extending the definition of the risks, from the risks « to » the portfolio (risk of negative impact on portfolio financial return) to include the risks « from » the investments to society (environmental or social risk).
Availability of data on the underlying companies is already a key concern for the industry, which could be amplified if asset managers are imposed further disclosure requirements, on areas where reliable data is not yet available or complete. The EU Commission is aware of the data challenge and has tasked the TEG to work on it. The TEG has issued a first report suggesting ways to improve disclosure on climate-related information, within the current Non-Binding Guidelines governing the disclosure of ESG matters by companies.
2. Taxonomy or « framework » proposal
The difficulty of defining what is a sustainable product, and what is an ESG investment, is a recurring debate amongst the industry. In fact, it’s inherent to the nature of ESG and related investment approaches. Different approaches are indeed being pursued by asset managers in order to meet the demand of investors, depending on whether the latter are more or less ESG aware. Such approaches range from negative screening (such as norm-based exclusion), ESG integration, positive screening (Best-in-Class), engagement (also called shareholder activism), Thematic investing (investing in environmental or social projects/sectors) and impact investing (where investors are ready to sacrifice part of their financial performance as societal impact is more important for them). ESG products usually combine several of these techniques.
The taxonomy proposal does not aim at defining or classifying the ESG approaches but tries to define sustainable investments through a focus on the activities financed by the financial product, starting with defining environmentally sustainable activities. Whilst this approach may fit nicely with thematic investing, it remains unclear how certain ESG approaches such as integration or Best-in-Class will be dealt with.
The initial proposal includes a phased agenda: from June 2020 to December 2022 to define the activities fitting under the EU environmental objectives, starting with climate change mitigation and adaptation in the first phase.
The TEG recently issued a consultation on the usability of the taxonomy, which was the opportunity for the industry to raise concerns about the narrow approach adopted.
3. Proposal on Low carbon benchmark and positive carbon impact benchmarks
This text proposes to amend the EU Regulation 2016/1011 (Benchmark regulation) in order to include low carbon and positive carbon benchmark definition as well as to impose ESG factors disclosure requirements.
4. Amendments to MiFID2 suitability tests - ESG preferences
This proposal will amend MiFID2 suitability tests requirements, requiring to systematically enquire about investors ESG preferences. Whilst amendments to a level 2 text could go relatively fast, timing will the aligned to the finalization of the disclosure proposal.
5. Amendments to MiFID2, UCITS and AIFMD to include sustainability risks
Following the mandate granted by the EU Commission, the ESMA has issued two consultations on possible amendments to MiFID2, UCITS and AIFMD level 2 in order to include reference to sustainability risks within organizational requirements, operating conditions and resources, risk management and product governance requirements. Such changes would depend on all management companies, AIFM and MiFID firms to review processes and resources as well as including sustainability risks within risk management processes.
Other initiatives to follow up
ESG matters have never attracted so much attention than in the past months reflecting both investors’ appetites and asset managers’ willingness to invest in this area. EU legislators have the ambition to further accelerate this trend and to further establish Europe as front runner in this field. But some of the current proposals need adjustments to deliver the objectives, particularly to ensure that true ESG products will find their way within the sustainable investment as currently defined under the proposal.
And many of the new requirements will affect all the players, whether they manufacture ESG products or not. These won’t be able to hide away from the sustainability risks and disclosure requirements. Implementing ESG requirements shall not though be perceived as a pure compliance exercise but as a business opportunity to engage with current and future investors.
AWM EMEA ESG Leader, PwC Luxembourg
Tel: +352 49 48 48 2040
Partner, PwC Luxembourg
Tel: +352 49 48 48 2335
Partner, PwC Luxembourg
Tel: +352 49 48 48 4137