ESMA proposes anti-greenwashing improvements to Sustainable Finance Framework
The European Securities and Markets Authority (ESMA), Europe’s financial regulator, has published a set of recommendations to ensure the EU’s Sustainable Finance Framework prevents greenwashing.
While recognising that the framework, a legislative package aiming to incentivise private investment in the transition to a green economy, is a global “pioneer”, the Authority believes it could be further improved to increase coherence and usability, as well as to prevent greenwashing.
What is the Sustainable Finance Framework
The Sustainable Finance Framework is a set of legislative measures introduced by the EU to mobilise private capital with the purpose of achieving the objectives of the European Green Deal.
It hinges on an evolving set of regulations and principles, including:
- The EU Taxonomy, a classification of economic activities contributing to the sustainable transition adopted in 2020: requires large companies and financial market participants to report on the proportion of their activities that can be considered “sustainable” under the taxonomy’s definitions.
- The Sustainable Finance Disclosure Regulation (SFDR), which requires financial market participants to disclose their environmental, social and governance impacts and targets, and how these are integrated into their portfolio allocation model.
- The Corporate Sustainability Reporting Directive (CSRD), which mandates sustainability disclosures for about 40,000 firms across the EU, supporting data comparability for investors.
In addition, the framework comes with a number of tools, including the EU Climate Benchmark regulation and the EU Green Bond Standard.
ESMA’s recommendations, published on July 24, looks to simplify the framework to enhance interoperability across all levels of the sustainable investment value chain (from issuers and ESG rating firms to asset managers and retail investors) – and amid a tsunami of sustainable finance regulations.
Strengthening the EU Taxonomy
The Authority’s main proposal is to make the EU Taxonomy “the sole, common reference point for the assessment of sustainability” by embedding it in all sustainable finance legislation.
At the moment, investors can abide by at least two different definitions of sustainable finance: the one set out in detail in the Taxonomy, and that of the Sustainable Finance Disclosure Regulation, which was developed beforehand and offers too much flexibility around contribution to sustainability objectives, ESMA argues.
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“Making the EU Taxonomy the sole common reference point of the framework would promote convergence in financial products offered in EU capital markets and facilitate comparability. Using the science-based EU Taxonomy to assess sustainability would bolster robust assessments and mitigate greenwashing risks at the same time,” it adds.
However, making the Taxonomy the centrepiece of the Sustainable Finance Framework would require expanding its remit to cover all activities that can contribute to environmental sustainability, as well as those with the potential to improve and harmful activities that should be “decommissioned”.
Expanding and simplifying financial sector disclosures
ESMA also makes a number of recommendations around sustainability reporting and communication. For instance, all financial products should disclose “minimum sustainability information”, to facilitate comparability. These would include environmental and social elements, such as GHG emissions, biodiversity impacts, Taxonomy alignment, human and labour rights.
But the EU should implement different tiers of disclosures to be provided to different types of investors depending on their needs and capabilities. The Authority suggests developing a subset of “vital” sustainability disclosures to be provided to retail investors and placed in consumer-facing documents, while the entire set of sustainability information would still be available to all professional investors.
In addition to this, ESMA supports the idea of financial product categorisation (going further than its existing fund labelling guidelines), to help investors understand the sustainability profile of financial products in a consumer-friendly way.
Finally, the Sustainable Finance Framework should further support transition finance, by including a clear definition of transition investments and requiring investors to disclose the share of revenue and CapEx associated with harmful activities – whether these are transitioning to greener practices or decommissioning. “The objective of providing this information is to support investors when making investments into activities which are in more urgent need of transition,” ESMA explains.
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