Building a Portfolio

The European Commission Sustainable Finance Proposals, Explained

On May 24, 2018, the European Commission put forth new sustainable finance proposals that could have a broad impact on institutional investors.

While a growing number of financial institutions tout the environmental, social, and corporate governance (ESG) factors that play into their investments, to date, regulations around what those investments look like or to what extent they have the impacts intended have not been universally agreed upon or implemented.

The new sustainable finance proposals would require “all financial entities that manage investments on behalf or their clients or beneficiaries . . . to inform them about how their activities are impacting the planet or their local environment.”

Moving Sustainable Finance Forward

Under the rules, asset managers, pension funds, and insurers would need to report not only on the procedures they have in place to integrate ESG risks into their investment and advisory processes, but also on the expected impact on financial returns.

The regulations would include:

  • A classification system for evaluating whether an economic activity is environmentally sustainable. To be created by bringing an analysis of market practices together with the guidance of experts, this taxonomy is aimed at helping investors make better decisions.
  • Additional guidance for—and disclosures by—institutional investors. The proposed rules would standardize not only how ESG criteria are incorporated into institutional investment decisions, but also how organizations report on their compliance with those rules.
  • Benchmarks to make it easier to measure carbon footprints. These benchmarks would help investors ensure that their portfolios are in line with the Paris Agreement’s 2°C goal.
  • Better advice to clients on sustainability. Revisiting guidance already in place, the goal of better tailoring advice to individual client needs is to “help a broader range of investors access sustainable investments.”

“Today’s proposals will increase transparency of sustainable finance and the investment opportunities it offers, so that investors have reliable information available to enable the transition to a low-carbon, resource-efficient, and circular economy,” Jyrki Katainen, the Commission’s vice president responsible for jobs, growth, investment, and competitiveness, said in a statement announcing the proposals.

The draft proposals will go before the European Parliament and European Council for approval and could begin going into effect by the end of next year.

A Warm Reception and a Growing Trend

ESG advocates have begun welcoming the shift in rules.

“The announcement [of the draft proposals] signals new opportunities for investment managers to develop new products for green assets as the world looks to transition from a high-carbon to a low-carbon economy,” Fiona Reynolds, CEO of the Principles for Responsible Investments, said in a statement.

The potential regulatory changes follow a general shift among institutional investors toward the adoption of ESG principles. Increasing the accessibility and credibility of impact investing by standardizing terminology and measurement could help that momentum build.

In fact, it might be necessary for doing so: Nearly half of institutional investors recently polled by Aon said that the lack of agreement around terms and definitions stifles responsible investment efforts, while more than half said that better or more consistent data on ESG factors would make responsible investing more accessible.

The European Commission isn’t the only regulatory body contemplating new rules that codify ESG investing. ESG is one of areas that many worldwide regulators are homing in on—with the United States standing out as a notable exception, according to a June report by KPMG.

“The US administration believes the raft of post-crisis regulation has encumbered its asset management industry,” write the report’s authors. “There is a desire to deregulate and take a path that forks from that of other countries, which are forging ahead with the implementation of new rules.”

Still, the authors note that the general global consensus seems to show that ESG and socially responsible factors—and the potential portfolio risk that they help manage—are becoming increasingly important for asset managers and institutional investors to consider. The European Commission’s proposal would help guide and frame that consideration.

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