Report: A Finance Watch guide to the next ‘sustainable finance agenda’

The next ‘sustainable finance agenda’ could be a jump board to a sustainable economy in the EU. Finance Watch’s new report maps out gaps in the current sustainable finance framework and formulates recommendations to finalise this crucial regulatory ecosystem during the next mandate.

A silent regulatory revolution

The sustainable finance agenda is an unprecedented progress in making financial institutions play a role in the transition of the real economy. Yet, this ongoing revolution is facing major challenges: its complexity and early implementation inconsistencies are fueling fears over competitiveness in a tense geopolitical context. 

One final stretch to reap the fruits

Even as corporate pressure grows, the next EU policymakers must resist the push-back. Europe has already taken important actions for private finance to support the transition and can’t waste this one chance to finish the work. Properly done, this framework could help turbocharge the European economy on tomorrow’s sustainable markets.

No weak link in the information chain

The newly created disclosure rules across the entire economic chain suffer from heterogeneous interpretations and inappropriate practices at one stage can contaminate the entire information chain. Policymakers now must fix weak links and remove ambiguity at every step of the information flow for sustainability-related information to stay accurate, clear and not misleading, the precondition for an effectively sustainable finance.

Setting the right sustainability targets

But disclosure requirements alone will not work unless underpinned by an obligation for companies to set the targets and act on them. Keeping on improving corporate sustainability, setting consistent transition plan requirements and adapting institutions’ capital requirements to consider sustainability risks will be key to lengthen corporate time horizons. 

Levelling the playing field

Finally, no level playing field is possible without proper enforcement of the law: this supposes adapting supervisors’ mandates and toolboxes (including sanctions) to their new missions and a better coordination with international standard setting bodies.

A guide for policy experts 

This report proposes amendments to major pieces of sustainable finance legislations (including SFDR, Taxonomy, CSRD, SRD II, CSDDD, CRR/CRD, Solvency II) and to the role and mandate of the ECB, the EBA, the ESMA and the EIOPA. It is meant as a guide for policy experts working on the next sustainable finance agenda. Our team remains available for any question or clarification (contact the author here). For usability purposes, we have extracted our file by file recommendations in the following expand box.

To address the limitations identified across this report, we propose that the Commission adapts a series of legislative texts during the next mandate and brings the following amendments/developments:

Taxonomy Regulation

  1. Reinforce the Taxonomy Regulation by further detailing the social dimension and introducing the concept of environmentally harmful economic activities, and subsequently develop technical criteria for the latter to identify the concerned economic activities.

CSRD

  1. Clarify the expected content and format of transition plans to facilitate the comparability of companies’ transition plans and their use by financial undertakings to develop and implement their own plans.
  2. Clarify the expected content and format of transition plans specifically for financial institutions, taking into account the use of the progress measurement tools and climate transition actions to facilitate the comparability of their transition plans.
  3. Strengthen the ISSA 5000 expectations for assurance service providers to assess the fairness and credibility of transition plans disclosed as per the CSRD.
  4. Define minimum requirements in the CSRD for the use of ESG ratings in sustainability reporting.

SFDR

  1. Clarify the concept of sustainable investment in SFDR through the inclusion of minimum criteria and the distinction between the notion of sustainable investment and the notion of transition finance.
  2. Define the concept of considering principal adverse impact with minimum criteria or, alternatively, consider principal adverse impacts indicators solely as a list of mandatory indicators to be reported, both at entity and product level. In the latter case the notion of sustainability-related preferences in MiFID and IDD will need to be subsequently adapted.
  3. Design a new SFDR classification providing the distinction between products committing to invest in sustainable activities and products committing to support the transition of companies towards sustainable activities. SFDR should specify minimum criteria for each category of products.
  4. Redefine a key set of metrics—including on transition finance—that should be consistent between the SFDR product templates, the PRIIPS Key Information Document and the client sustainability preferences. Such metrics should be used for a wider range of financial instruments and should  be easily understood by less-versed investors.
  5. Resolve the confusion on the limited potential of climate and sustainability benchmarks for contributing to the transition of the real economy through a review of SFDR and the inclusion of additional conditions on engagement and physical holding of investments for ETFs to be considered as pursuing a sustainable objective.

PRIIPS

  1. Adapt the key information document to ensure consistency between the SFDR product disclosure requirements and sustainability preferences, as defined in the IDD and MiFID delegated acts.

Benchmark Regulation

  1. Reinforce the methodology for benchmarks to be qualified as EU PAB and EU CTB, as described in the Benchmark Regulation delegated acts, and ensure an absolute decarbonisation of investments.
  2. Foster transparency and define minimum standards for climate and sustainability benchmarks that are not qualifying as EU PAB and EU CTB.

MiFID/IDD

  1. Adapt the definition of sustainability preferences in the ESG MiFID and ESG IDD delegated acts to allow clients to express a combination of preferences that would not be considered as alternatives.
  2. Develop a mandatory questionnaire template to ensure that the way sustainability preferences are collected is not misleading for clients, including the questions and possible answers. Such template should include a standard list of principal adverse impacts that may be considered, if the notion of consideration of principal adverse impacts remains after the review of SFDR.
  3. Develop stricter guidelines, both for IDD and MiFID, that, among others, introduce minimum requirements for the ‘standard sustainability criteria’ that may be proposed by investment firms.

SRD II

  1. Amend SRD II to require ESG investors to publish their plans to engage investee companies based on comparable format and to vote against the management of investee companies that do not adopt and implement credible transition plans. Give supervisors a mandate to monitor climate-oriented engagement and enforcement powers over ESG investors.
  2. Broaden the scope of the SRD II to cover other capital providers than shareholders and introduce climate covenant duties for the lending activities.

CRR/CRD/Solvency II

  1. Amend Article 91 of CRD, the joint guidelines 2021/06 from EBA and ESMA on fit and proper requirements and Article 42 of Solvency II to ensure that directors and board members have the necessary expertise and experience on sustainability matters in order to be able to act in the long-term interests of the company and adopt and implement credible transition plans.
  2. Reinforce identified staff variable remuneration requirements in the prudential legislative texts or in the EBA guidelines 2015/22, which should include definition of the required weight of the achievement of transition plans in the KPIs employees’ scorecard, the expectations for preset intermediary thresholds and the introduction of mandatory clawback mechanisms for sustainability factors.
  3. Evolve the prudential framework to implement precautionary forward-looking approach to climate-related financial risk and time horizons commensurate with the materialisation of this risk.
  4. Implement capital requirements for climate-related financial risks to safeguard financial stability; in particular, develop a new borrower-based macroprudential tool to address the risk of fossil fuel–related finance.
  5. Implement a realistic assessment of the economic consequences of climate change, based on climate science and robust economic models.

Transversal amendments

  1. Clearly establish the role of supervisors, in particular the role of ECB and ESAs for monitoring transition plans given the interconnection between prudential laws, the CSDDD and the CSRD, and provide them with an adequate mandate to carry out their duties.
  2. Stipulate pecuniary sanctions for infringement with transparency provisions as uncertainty remains whether SFDR and Taxonomy breaches would systematically fall in the sanction framework of the Unfair Commercial Practice Directive.

Read (and share) the report