Q&A: What to look out for on the sustainability regulatory agenda for 2023

The European regulatory landscape continues to move at a very fast pace. To make sure investors understand the implication of its key developments, it’s important not to get lost in the regulatory maze.

Here we explain the latest updates keeping EU policymakers and the whole financial industry busy: from the latest on greenwashing, to the EU taxonomy and the key consultation on the Sustainable Finance Disclosure Regulation (SFDR) review, and what they all mean for investors.

What are the key regulatory agenda events in 2023?

1. European Supervisory Agencies call for evidence on greenwashing

Elisabeth Ottawa, Schroders’ Head of Public Policy, Europe said: The regulatory agenda for 2023 is a very heavy one. We had a real kickstart in January, when we were invited to submit our response to the call for evidence on greenwashing from the European Supervisory Agencies (ESAs). This is based on a request by the European Commission, and the objective is to clearly define greenwashing and better understand the phenomenon, its scale and its potential risks. A progress report was expected in May of this year but this will be delayed to September 2023, while the final report is expected for May 2024. The reason of the delay is that there is a large number of quite extensive responses - it has been a highly debated issue.

What has been Schroders’ response to the consultation?

Elisabeth Ottawa: Our position is that greenwashing is similarly detrimental as other types of misleading practices that could occur relative to traditional financial attributes such as risk or performance. The current principle underpinning requirements in MiFID (fair, clear and not misleading) is applicable to greenwashing and hence should already give supervisors a strong enforcement tool. However, for this specific case, we should bear in mind that for greenwashing we're still dealing with a quantitative lack of data, and data of low quality or reliability. Also, sustainability continues to be subject to significant scientific research. And last but not least, we have different interpretations by clients and by investors as to what is sustainable, for example, on the question around nuclear and gas.

Why is this important?

The result of this consultation can shape how our and your ESG work is perceived and ultimately feed into the SFDR review that will kick off in September.

2. ESMA guidelines on sustainable fund names

Elisabeth Ottawa said: The next thing that came up was our response to the consultation on fund name guidelines from the European Securities and Markets Authority (ESMA).

It’s important that fund names don’t create expectations that the underlying investments can’t meet. However, we believe that ESG fund names, like any other promoted feature of an investment product, are already subject to the “fair, clear and not misleading” MiFID principle which should be enforced consequently. We would therefore recommend allowing the market to stabilise and digest recent and upcoming changes regarding the interpretation of SFDR, particularly the definition of sustainable investments. Ultimately, if you apply a threshold of sustainable investments for fund names, you're really comparing apple with pears given different calculation methods.

Why it matters The draft guidelines, if approved, would have a disruptive impact on products, including existing ones.

3. Consultation on the four remaining environmental objectives in the EU Taxonomy

Elisabeth Ottawa said: This consultation sets out the technical screening criteria for the four remaining environmental objectives of the six in the EU Taxonomy. These are: the transition to a circular economy; sustainable use and protection of water and marine resources; pollution prevention and control; protection and restoration of biodiversity and ecosystems. The technical screening criteria, which detail how activities contribute to an objective while not causing significant harm to the other objectives and meeting minimum safeguards related to human and labour rights, have already been set out for the first two objectives (climate change mitigation and climate change adaptation).

These new criteria will identify which economic activities contribute substantially to these four environmental objectives, in addition to whether those activities might cause significant harm to any of the other environmental objectives.

The Commission proposal will be issued in June, and this would mean that from 2024, companies will report taxonomy eligibility for these four additional objectives based on 2023 data, and then from 2026 onwards, they will actually need to report taxonomy alignment.

Nathaële Rebondy, Schroders’ Head of Sustainability, Europe said: It's very important to keep this update in mind when it comes to the MiFID preferences and the alignment to the taxonomy, because the reality is that the availability of data remains scarce.

Companies currently have to report on the eligibility of their activities to the two climate related objectives, and will have to start reporting on alignment in 2024. This means that data providers are using estimates, which are based on different methodologies and therefore different levels of alignment for the same company. This the reason why we have decided to avoid reporting on taxonomy so far because we believe that the data is not stable or reliable enough.

Another important point regarding the four remaining environmental objectives is that the technical screening criteria that are proposed in this consultation apply to a number of sectors, but these are the ones for which the Commission thought that it was easier to define the significant contribution and have all the screening criteria. Several other sectors will be addressed at a later stage and that's notably the case for agriculture, forestry or fishing, which are very important from a biodiversity perspective. So there is more to come.

Why it matters

Elisabeth Ottawa: Sustainability preferences partly rely on percentages of taxonomy alignment. But it’s clear that data from companies isn’t yet complete nor reliable, so any sustainability preference referring to a percentage of taxonomy alignment is built on sand.

4. The revision of the SFDR Regulatory Technical Standards

Elisabeth Ottawa said: These are the technical elements based on SFDR, detailing how we as asset managers should disclose ESG product features. We will also participate in this consultation and take this as an opportunity to call for simpler and shorter templates; that is, for more user-friendly information to be disclosed to clients.

Why it matters This is about client facing material, and can indirectly hence impact product design.

5. Proposal by the European Commission on ESG ratings and data providers

Elisabeth Ottawa said: ESG ratings and data providers have been a bit of a blank area in the whole sustainable finance agenda, but a very important one. We expect a proposal by the Commission in June, requiring more transparency on methodologies used and mitigating conflicts of interest within ESG rating providers.

Why it matters This impacts reliability and the outcome of ratings and hence the classification of assets, and therefore it has an impact on investments.

6. Public consultation of a fully fledged SFDR review.

Elisabeth Ottawa said: The consultation will cover items such as whether SFDR should remain a disclosure regulation, or have labels and categories built into it, similar to the UK, or if there will be a more prescriptive definition of sustainable investment. Outcomes will therefore pave the way for an updated SFDR and hence speaking up is very important – we are already participating in the discussion and will, of course, take part in the consultation.

Nathaële Rebondy said: Since the Commission has decided not to be prescriptive on methodologies and definitions on sustainable investing in the SFDR, it's really onto the asset managers to be clear and transparent about what they are using and doing to demonstrate sustainable investments. For example, one important clarification that was made regarding sustainable investments is that it can be measured at the level of a company and not only at the level of a specific activity. This was a very important clarification for products that are disclosing under the Article 9, because they need to have 100% sustainable investments. And so if the Commission had decided to limit the calculation of sustainable investments to the specific activities at the company level that are contributing, then it would have been the end of Article 9. So that was a very welcome proposition.

Another clarification will touch on the reduction of carbon emissions, and this can be either a characteristic of a product under Article 8, or a very specific objective under Article 9. The Commission also said that it was agnostic in terms of how to invest either passively or actively, which was also an important consideration.

Which of these developments do you believe will be the most impactful?

Elisabeth Ottawa said: I think it will be very interesting to see what happens with the draft proposal on ESMA guidelines for fund names, because if they really move ahead with this, it's going to be very disruptive for the industry. That’s because ESMA would to a certain extent “overrule” SFDR and hence limit the room for manoeuvre for the SFDR review. ESMA would have already moved the goalposts and EU legislators would have difficulty moving away from this approach.

POLL RESULTS

This Q&A is an extract of a Schroders webinar held on 26 April with an audience spanning across fund selectors, portfolio managers, and ESG specialists in Europe. The below summarises the answers to two live polls during the webinar on how sustainability regulation is affecting the audience’s work and their clients.

POLL #1: Which sustainability preference option is the most used within your entity and your client base?

The result shows that, when it comes to expressing sustainability preferences, using a percentage in sustainable investments is the most popular option. Compared to the same poll last summer, we can see that there's still a preference for sustainable investments generally, alongside an increase in the preference for principal adverse impacts and taxonomy alignments.

POLL #2: How are you responding to the moving regulatory environment and how are you avoiding greenwashing risks?