Despite the inevitable lull in EU policy making following recent elections, there has been no similar let up in sustainability-related missives from EU regulators.

Over the last 10 weeks or so, the ESAs have published a joint Final Report on Greenwashing, a Joint Opinion with recommendations on SFDR amendments, an EIOPA Opinion on sustainability claims and greenwashing and an ESMA Final Report on Guidelines for Funds’ Names with ESG or sustainable terms.

The latest is an ESMA Opinion, published yesterday, with recommendations for improving the ‘usability and coherence of the EU sustainable finance framework’.  Five of the key recommendations in the Opinion are summarised below and range from replacing the SFDR sustainable investment definition to introducing a ‘sustainability KID’ for retail investors to moving beyond sustainable finance and developing a transition finance framework.  Whether or not any of the recommendations are taken on board is of course, similar to most all Green Deal-related initiatives, entirely in the hands of the newly elected/established EU legislative bodies.

Develop the Taxonomy to include social and environmentally harmful activities

ESMA recommends developing the Taxonomy to cover:

• all activities capable of contributing substantially to its environmental objectives (the current edition is limited to those activities considered to have the highest potential to substantially contribute to GHG emission reduction based on their share of the overall emissions and emission-reduction potential);
• harmful activities that have the potential to improve; and
• harmful activities which do not have the potential to improve and should be decommissioned.

Phase out SFDR sustainable investment definition and define sustainability by reference to the Taxonomy only

ESMA recommends phasing out the SFDR sustainable investment definition and instead relying solely on the Taxonomy for the assessment of sustainability across all EU sustainable finance legislation.  However, recognising the infeasibility of this while the Taxonomy remains under development, an interim measure of introducing further prescription in the current SFDR definition is recommended e.g. by referencing the Taxonomy, where possible, or specific PAI indicators or ESRS data points to define contribution to a sustainable objective.

Create a transition finance framework

The initial focus of EU efforts to funnel private investment in support of its Green Deal was clearly on funding sustainable activities, as distinct from activities which are in the process of becoming sustainable i.e. transition activities.  It is now abundantly clear that transition activities are not only essential to achieving the Green Deal climate targets but also have as much, if not more, of a requirement for funding as activities which are already sustainable.

It’s not surprising therefore, that ESMA recommends significantly increasing the focus on transition finance within the existing framework, with specific recommendations for:

• defining transition investments which “could be understood as those that are compatible with and support the transition, i.e., aligned with headline EU and global objectives. With regards to environmental objectives, those headline objectives are identified under Article 9 of the Taxonomy Regulation. Alignment with these objectives would mean improvement in the environmental performance of the underlying assets in a timeframe that is aligned with the contribution expected from the said assets under a transition scenario that delivers on the objectives of limiting global warming to 1.5^oC above pre-industrial levels, the objective of climate change adaptation and other environmental objectives of the EU. For activities covered by the EU Taxonomy, this alignment may be assessed by reference to Taxonomy reporting and the gradual achievement of Taxonomy alignment over time. For other activities and assets outside of the scope of the Taxonomy (e.g., sovereign bonds, shares and bonds of companies active outside of the EU) this alignment may be assessed by reference to commonly accepted sectoral and/or regional transition pathways.”
• adopting transition-related disclosure rules e.g., as part of the development of the Taxonomy (per 1. above) or by complementing existing CSRD transition plan disclosures; and
• adopting new, and increasing the ambition of existing, transition investment tools e.g. setting additional constraints on the sectoral allocation of the Climate Benchmarks to ensure the decarbonisation of the benchmarks relies on a minimum amount of actual GHG emissions reduction by constituents over a given period of time.

Sustainability disclosures for all SFDR products and a ‘sustainability KID’ for retail investors

ESMA recommends all products, irrespective of whether they have a sustainable investment strategy, be required to at least report on a small number of key sustainability metrics which, by way of example, might include GHG emissions, impact on biodiversity, human and labour rights, and Taxonomy alignment.

In addition to the existing range of SFDR disclosures, ESMA recommends developing a ‘vital’ sustainability information document for retail investors based on the PRIIPs KID.  The contents of the sustainability KID should be subject to consumer testing but should include the above mentioned key sustainability metrics.

Voluntary labelling regime with science-based eligibility criteria and label-specific reporting obligations

ESMA advocates for sustainable product labels with eligibility criteria based on the Taxonomy and transition product labels with criteria which might include an actual reduction in sustainability impacts of investee companies e.g. reducing emissions over a period of time.  ESMA also indicates that sustainable and transition product labels could replace the current investment-specific MiFID sustainability preference options.

In addition to the above, the ESMA Opinion includes recommendations for the application of the ESMA Funds’ Names Guidelines’ expectations to more/all SFDR products, extending the scope of the forthcoming ESG Ratings Regulation to also include ESG data products, clarifying the role of depositaries in monitoring SFDR disclosures and introducing an EU-level stewardship code for asset managers and institutional investors.

If you have any queries on the above or would like to discuss any of the issues raised please contact Nessa Joyce, any of the Asset Management & Investment Funds team or your usual William Fry contact.