EU regulation package – detailed outlook for sustainability in the financial sector

As we know, the European Commission’s action plan has three main objectives (see also vdp Quarterly 2/2018):

1. More capital should be channelled into sustainable investments.
2. The financial system should be strengthened by including risks arising from climate change and social imbalances in the risk management process.
3. The transparency and long-term orientation of the financial sector should be increased.

Specifically, the Commission identifies ten areas where it considers action to be necessary. At the top of the agenda is the development of so-called taxonomies of sustainable assets, that is to say, a classification of assets that can be considered sustainable based on regulatory aspects, with an initial focus on “green” assets.

The draft regulation “on the establishment of a framework to facilitate sustainable investment” published on 24 May 2018 is to form the basis for the development of such taxonomies. The draft regulation defines six environmental objectives: climate change mitigation, climate change adaptation, protection of water resources, waste prevention and recycling, prevention of air pollution and protection of ecosystems.

For all objectives, the regulation is merely intended to define the basic criteria for an economic activity, with the technical requirements to be set out in detail via delegated acts. For the two objectives of climate change mitigation and climate change adaptation, the delegated acts are to enter into force on 1 July 2020. A Technical Expert Group on Sustainable Finance (TEG) made up of 35 experts is currently working on “technical” details for these taxonomies and is also considering Green Bond Standards, low-carbon benchmarks and improved corporate disclosure of climate-relevant information. Four sub-groups have been set up for this purpose, and the TEG is to present its report by June 2019.

The draft regulation and thus the taxonomies to be defined only apply to financial market products, i.e. banks’ lending business will not be included for the time being. It remains to be seen whether this will change during the political process. The draft regulation “Disclosures relating to sustainable investments” is intended to regulate disclosure obligations for sustainable financial market products, and political efforts are already being made to widen its scope substantially. In the opinion of the responsible rapporteur of the EU Parliament, the disclosure obligations for sustainability risks should also be fully applicable to institutions. Sustainability risks should become an obligatory component of the Supervisory Review and Evaluation Process (SREP), that is to say, the process for determining Pillar 2 capital add-ons.

As well as the central draft regulations on taxonomies and disclosure obligations, the European Commission has also submitted a proposal to amend MiFID to take sustainability aspects into account in product advice and a draft regulation on the definition of low-carbon benchmarks.

Adoption of the regulations is scheduled for 2019, although it remains to be seen whether the political process at European level can be completed in the first quarter of next year. If not, there is a risk that the plans will be significantly delayed due to the elections to the European Parliament in May 2019. In its work, the vdp is focusing mainly on taxonomies, Green Bond Standards and disclosure obligations. These aspects are very important for member institutions, as some are very active in financing green real estate and renewable energies such as wind farms, and also in issuing green bonds.