ESMA Releases Sustainable Roadmap 2022-2024

Challenge

Key Issues

3 Key Considerations in addressing these challenges

Fast-evolving regulatory framework that is unequally covering the various parts of the sustainable investment value chain

Inconsistencies across regulatory requirements, complexity for investors and ultimately investor protection and greenwashing concerns

Tackling greenwashing and promoting transparency - with the lack of a consistent definition of greenwashing, it is generally a reference to market practices intentional and unintentional, whereby the disclosed sustainability profile of an issuer and the characteristics and / or objectives of a financial instrument or a financial product either by action or omission do not properly reflect the underlying sustainability risks and impacts associated to that issuer, financial instrument or financial product

Diversity in the interpretation and application of sustainable finance legislation

Risk of inconsistent application across the EU and resulting detrimental consequences for the good functioning of markets, including the risk of regulatory and supervisory arbitrage, and for the protection of investors

Growing demand for ESG investments not matched by adequate transparency and comparability on the real sustainability impact of the financial products

Impact on underlying sustainability profile of issuers and on the methodologies underpinning ESG ratings and data in general leading to misrepresentation and wrongful disclosure and mis-selling of ESG-labelled products to final investors which can create reputational and financial risks for the actors involved and a loss of trust in sustainable finance products which in turn may also trigger financial stability concerns

Building NCAs’ and ESMA’s capacities - supervisory bodies must also build up expertise in sustainable finance. Training initiatives at both national and European level as well as sharing supervisory experiences among NCAs. In addition to building up NCAs’ skill sets, sharing supervisory experiences and agreeing on common supervisory standards

The EU climate neutrality targets imply that several economic activities will be on a transition path to becoming sustainable within a certain timeframe

Transparency on such transition efforts is necessary to support sound decision making by investors when assessing different opportunities in the sustainable investing space

Need to further develop ESMA’s and NCAs’ expertise, experience and resources on sustainable finance and its implications for supervision

Build expertise within the supervisory authorities regarding the application of sustainability reporting standards

Monitoring, assessing and analyzing ESG markets and risks. Leveraging on the data-analytical capabilities that already exist in other areas of capital markets legislation, it will be key to engage in activities such as climate scenario analysis for investment funds, CCP stress testing and establishing common methodologies for climate-related risk analysis with the other European Supervisory Authorities (ESAs) and other EU institutions and bodies such as the ECB and the European Environment Agency and, where relevant, with international standard-setting bodies

Increasing risk of misalignment between investors’ ESG preferences and products being offered

Due to limited financial education on ESG-investing and lack of expertise on ESG matters by actors in the investment value chain, notably financial advisors, investors may not be offered the correct products by the relevant service providers

Fast-evolving ESG markets requiring regular monitoring in a structured and coordinated way

More effective and efficient access, consolidation and usage of structured and unstructured ESG data, as well as the development of methodologies for the assessment of the financial impact of ESG related risks, for example climate risks

Sector focus

Related risks and sustainability considerations

Investment management

·         Unequal understanding of the type of products which are subject to Articles 8 and 9 of the SFDR may lead fund managers to disclose inconsistently under these articles and effectively cause greenwashing in some cases

·         Lack of information on limitations related to methodology or data used in ESG disclosures may contribute to the heightened risk of greenwashing

·         Mismatch between the emphasis placed on ESG characteristics in the presentation of an investment product and the strategy that is actually implemented

Investment services

·         Risks arise with regard to how conduct of business rules such as suitability/product governance and information requirements should be applied when selling ESG products, therefore investor education is also important

Issuers’ disclosure and governance

·         Greenwashing risk stemming from incorrect or omitted information in non-financial statements and prospectuses as well as from a lack of transparency on the limitations of the methodologies and data used to prepare disclosures

·         At present, the shortcomings arising from the limited harmonisation in sustainability reporting practices by the Non-Financial Reporting Directive (NFRD) trigger issues across the entire investment chain in terms of poor comparability and relevance of the data stemming from issuers’ disclosures

·         Whilst the Corporate Sustainability Reporting Directive (CSRD) aims to address these disclosure issues, the first set of reports may not apply until 2024, until then, the current sub-optimal status of sustainability reporting will remain

Benchmarks

·         Greenwashing risk relates to disclosures made by benchmark administrators about the impact of their ESG indices, when these are either just applying exclusions or constructed using ESG ratings

·         Greenwashing would arise from the lack of methodology requirements, and hence comparability options, that would enable benchmark users to compare different benchmarks claiming to have a strong ESG profile.

Miscellaneous challenges

·         Ratings (credit ratings and ESG ratings).

·         Trading and post-trading.

Financial innovation

Link between financial technology and ESG data needs to be considered, as well as the use of natural language processing and other financial technology to support the challenges across ESG.