The thorny issue of greenwashing, the practice of making false or misleading claims in relation to the sustainability credentials of an investment product, is to be addressed by new financial regulations.
“As far as the asset management and fund industry is concerned, several regulations related to environment, social, and governance (ESG) are taking place more or less at the same time,” says Christophe Lemarie, head of product development with Amundi. “The aim of these regulations is, firstly, to direct investment to finance a greener economy and, secondly, to increase the level of transparency in communication to ensure a clear understanding of ESG products and to avoid misinterpretations. The key regulations that we all have in mind are the Sustainable Finance Disclosure Regulation (SFDR), the Taxonomy Regulation, and Markets in Financial Instruments Directive (MIFID).”
According to Louise Dobbyn, a partner in Matheson’s Financial Institutions Group and member of the firm’s ESG advisory group, SFDR is a European regulation introduced to improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by providers of certain financial products and services, such as investment funds.
“SFDR requires these financial market participants to disclose to their clients and customers how ESG factors are integrated both at firm and product level,” she says. “The Taxonomy Regulation is considered the backbone of ESG regulation at a European level, and is intended to play a critical role in the fight against greenwashing. The Taxonomy Regulation aims to create an EU-wide classification and reference system which will enable businesses and investors to objectively assess the degree of ‘sustainability’ of economic activities.”
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This taxonomy will provide financial market participants with an effective common language for environmentally-sustainable activities and encourage financial investments to businesses engaged in or moving towards more sustainable activities, says Dobbyn.
“The Taxonomy Regulation will also serve as the starting point for other EU sustainability projects in the financial sector, such as the EU Ecolabel, which will be given to financial products with a minimum of 60 per cent of the investments aligned with the Taxonomy Regulation. Interestingly, while the Taxonomy Regulation currently only covers environmental objectives, there are proposals to extend the taxonomy to cover social objectives, such as the protection of human rights, in the future.”
The Corporate Sustainability Reporting Directive (CSRD) applies to listed and to certain large companies and requires these companies to report against common EU sustainability reporting standards, providing reliable, comparable and relevant information on sustainability risks, opportunities and impacts. “If introduced, a much greater number of companies across the EU will be brought within the sustainability reporting regime, in line with SFDR and the Taxonomy Regulation, for the very first time,” says Dobbyn.
Christophe Lemarie points to a particular requirement of MiFID. “It requires all distributors to ask their clients if they are looking for a product with an ESG dimension, and if yes to propose appropriate products,” he says.
“As a result of these regulatory changes and enhancements individual investors are now engaging more with their advisers on ESG matters and are becoming increasingly aware of the benefit of ESG when selecting an investment product. Investment management companies are also developing more products that integrate ESG characteristics, bringing a lot of new innovative fund options to investors in this space.”
Interest in ESG investing was on the rise in any case, says Lemarie. “We are already seeing a move towards sustainable investments. In a survey to Irish savers this year Amundi found that 61 per cent support investments that improve the planet, and we are hoping to see that figure continue to grow.”
That interest will be amplified by the new rules, according to Louise Dobbyn. “While the trend of ESG investing was well established for some time prior to the recent EU initiatives, the European Commission’s new rules are aimed at enabling investors to identify environmentally sustainable investments based on EU-wide standards and to ultimately support the EU economy’s transition towards sustainability.”
The disclosure requirements will also put pressure on investee companies to be fully transparent about their environmental impact and ultimately to change their practices. “The combination of increasing investor demand for ESG products and a standardised legal and regulatory framework should ensure continued growth in ESG investing in the coming years, to the extent that sustainable investing, where both financial and non-financial impacts are considered, will become the norm,” she adds.
And there are other regulations coming down the track that will affect all forms of investment. “Companies in the financial services sector are working in a very highly regulated environment and there is more coming all the time,” says Donna Noonan, Irish Financial Services Skillnet network manager and a member of the Expert Group on Future Skills Needs financial services group.
“There is the Dora directive which sets new requirements for the security of network and information systems and the Mica directive applies to cybersecurity,” she says. “And then there is the senior executive accountability regime. That’s going to be a big one. All these new regulations drive training. We have come together with the Sustainable Finance Skillnet and the compliance institute to deliver the world’s first professional diploma in sustainable finance for compliance professionals to help meet that need.”
While these regulations have been seen as broadly positive by the industry, there are some concerns. “The market has welcomed the initiative to introduce a common language and common standards for defining sustainability, providing investors with the necessary information to make informed investment decisions, but the speed of implementation has given rise to some issues,” says Dobbyn.
“This framework involves the implementation of a large amount of extensive and technical rules and requirements within a short timeframe, and therefore, as can be expected, the transition has presented a number of significant challenges for financial market participants in practice, both from an operational and compliance perspective,” she adds.
“Specific pain points commonly reported in the market include the phased introduction of the initiatives, leading to a lack of alignment of the requirements applicable to different market participants, delays to the implementation of some elements of the framework, a lack of the necessary data to support the disclosure and reporting obligations and legislative ambiguities.”