EUROPEAN COMMISSION

Brussels,24.5.2018

SWD(2018) 264 final

COMMISSION STAFF WORKING DOCUMENT

IMPACT ASSESSMENT

Accompanying the document

Proposal for a Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment

and Proposal for a Regulation of the European Parliament and of the Council on disclosures relating to sustainable investments and sustainability risks and amending Directive (EU) 2016/2341

and Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 2016/1011 on low carbon benchmarks and positive carbon impact benchmarks

{COM(2018) 353 final}

{SEC(2018) 257 final}

{SWD(2018) 265 final}
{COM(2018) 354 final}
{COM(2018) 355 final}

Table of Contents

Table of Contents

List of Figures

List of Tables

List of Boxes

I. Introduction: Political and legal context

1.1. EU policy context

1.2. High-Level Expert Group on sustainable finance

1.3. The EU Action Plan on Financing Sustainable Growth

II. Problem Definition

2.1. What are the problems?

2.1.1. High search costs for end-investors    

2.1.2. Lack of incentives for relevant entities to consider ESG factors    

2.2. What are the problem drivers?

2.2.1. Lack of clarity and coherence regarding the consideration of ESG factors in the investment and advisory process as part of the duties towards investors/beneficiaries (Driver 1)    

2.2.2. Lack of ESG disclosure requirements for institutional investors, asset managers and investment advisors (Driver 2)    

2.2.3. Lack of clarity on what constitutes sustainable economic activities (Driver 3)    

2.2.4. Out-of-scope drivers    27

2.3. Consequences of the problem and how will they evolve?

III. Why should the EU act?

3.1. Legal bases

3.2. Subsidiarity: Necessity of EU action

3.3. Subsidiarity: Added value of EU action

IV. Objectives: What is to be achieved?

4.1. General objectives

4.2. Specific objectives

V. What are the available policy options, what is their impact and how do they compare?

5.1. What is the baseline from which options are assessed?

5.2. Methodology

5.3. What is the scope of the various initiatives?

5.4. Duties toward investors/beneficiaries with regards to ESG factors

5.4.1. Description of the policy options    

5.4.2. Pros and cons    

5.4.3. Impact on stakeholders    

5.4.4. Stakeholder’s views    

5.4.5. Comparison of policy options    

5.5. Increase transparency by disclosing how ESG factors are integrated in the investment and advisors' recommendation process and, for investments targeting sustainable objectives

5.5.1. Description of the policy options    

5.5.2. Pros and Cons    

5.5.3. Impact on stakeholders    

5.5.4. Stakeholder’s views    

5.5.5. Comparison of policy options    

5.6 Clarity on what are considered sustainable economic activities

5.6.1. Description of the policy options    

5.6.2 How will the taxonomy be developed and updated (Policy Option 3)    

5.6.3. Pros and cons    

5.6.4. Impact on stakeholders    

5.6.5. Stakeholders’ views    

5.6.6. Comparison of the policy options    

5.7. A methodology for low carbon benchmarks

5.7.1. Description of the policy options    

5.7.2. Pros and Cons    

5.7.3. Impact on stakeholders    

5.7.4. Stakeholders’ view    

5.7.5. Comparison of the policy options    

VI. Preferred options and overall impact

6.1. Description of the preferred options for each of the four initiatives

6.1.1. Duties toward investors/beneficiaries with regards to ESG factors    

6.1.2. Disclosure on ESG integration and sustainability products    

6.1.3. Taxonomy    

6.1.4. Low carbon and positive carbon impact benchmarks    

6.2. Links between the four initiatives and scope of requirements on asset managers depending on their investment style

6.3. Economic impact

6.3.1. Overall economic impact of the four initiatives    

6.3.2. Economic impact of preferred options on integration of ESG factors and disclosure    

6.3.3. Economic impact of preferred option on taxonomy    

6.3.4. Economic impact of preferred option on low-carbon indices    

6.3.5. Competitiveness and impact on third countries    

6.3.6. Impact on issuers    

6.4. Environmental impact

6.4.1. Overall environmental impact of the four initiatives    

6.4.2. Impact of preferred options on integration of ESG factors and disclosure    

6.4.3. Impact of preferred option on taxonomy    

6.4.4. Impact of preferred option on low-carbon indices    

6.5. Social impacts

VII. How will actual impacts be monitored and evaluated?

Glossary

Annex 1: Procedural information

Annex 2: Stakeholder consultation

Annex 3: Who is affected and how?

Annex 4: Sustainable finance trends in Europe

Annex 5: Implementation Timeline

Annex 6: Why relevant entities might not consider ESG factors

Annex 7: Overview of Sustainability-related initiatives

Annex 8: Taxonomy

Annex 9: Methodology for low-carbon indexes

References

List of Figures

Figure 1: ESG factors

Figure 2: Visualisation of the ten actions proposed by the Action Plan

Figure 3: ESG integration

Figure 4: Problem tree

Figure 5: carbon emissions

Figure 6: the scope of requirements on asset managers depending on their investment style

Figure 7: Sustainable investment strategies in Europe (in EUR trillion)

Figure 8: Sustainable investment strategies out of total AUM in Europe (in EUR trillion)

Figure 9: AUM on the European sustainable investment fund market (in EUR billion)

Figure 10: Policy option decision tree

Figure 11: HLEG EU sustainability taxonomy framework

Figure 13: Energy mix in major global equity indices

Figure 14: Emission scope and methodologies

Figure 15: Scope 1 & 2, Scope 3 Emissions and Avoided Emissions.

Figure 16: Lack of correlation between carbon intensity and the materiality of climate and environmental risks for credit worthiness at sector level

Figure 17: Lack of correlation between carbon intensity and value at climate risk according to equity research analysts, at company level within key sectors

List of Tables

Table 1: SRI and ESG disclosure – Legal obligation for institutional investors and asset managers in selected Member States

Table 2: Objectives and underlying problem drivers

Table 3: Methodology table

Table 4: Discarded option for duties towards investors/beneficiaries

Table 5: Pros and Cons of options on duties towards investors/beneficiaries

Table 6: Impact on stakeholders of options on duties towards investors/beneficiaries

Table 7: Stakeholder's views on duties towards investors/beneficiaries*

Table 8: Benchmarking policy options on clarity concerning ESG integration as part of duties towards investors/beneficiaries

Table 9: Summary of pros/cons of options on duties towards investors/beneficiaries

Table 10: Pros and Cons of options on disclosure

Table 11: Impact on stakeholders of options on disclosure

Table 12: Stakeholder's views on options on disclosure*

Table 13: Benchmarking policy options on disclosure on ESG integration and sustainability objectives

Table 14: Summary of pros/cons of options

Table 15: Discarded options for an EU environmental taxonomy

Table 16: Pros and cons for options on EU sustainability taxonomy

Table 17: Impact on stakeholders of options on taxonomy

Table 18: Stakeholders views on an EU taxonomy

Table 19: Benchmarking policy options on taxonomy

Table 20: Summary of pros/cons of options on taxonomy

Table 21: Pros and cons of the options on low carbon benchmarks

Table 22: impact on stakeholders of the options on low carbon benchmarks

Table 23: Stakeholder's views on low carbon benchmarks

Table 24: Benchmarking the options on low-carbon benchmarks

Table 25: Summary of pros/cons of the options on low-carbon benchmarks

Table 26: Summary of the preferred options

Table 27: Detailed overview of individual responses on duties towards investors/beneficiaries

Table 28: Detailed overview of individual responses on disclosure

Table 29: Detailed overview of individual responses on low carbon benchmarks

Table 30: Overview of benefits

Table 31: Overview of costs

Table 32: European sustainable investment funds by domicile

Table 33: Legislative initiatives within the SRI framework

Table 34: Market-led initiatives within the SRI framework

Table 35: Illustrative examples of Taxonomy – Option 2

Table 36: Illustrative examples of Taxonomy – Option 3

Table 37: Example showing difference between Option 2 and Option 3 Taxonomy

Table 38: Pros and Cons for sub-options on governance taxonomy for preferred policy option 3

Table 39: Detailed stakeholders' views on taxonomy

Table 40: Carbon footprint of S&P DJI's major global indices

Table 41: Examples of high carbon intensive sectors

List of Boxes

Box 1: Definition of "sustainable finance"

Box 2: ESG integration in the investment process

Box 3: Low-carbon benchmarks

Box 4: Existing taxonomies and national financial labels

Box 5: A social taxonomy as a second step to get to a complete sustainable taxonomy

Box 6: How does the taxonomy reflect EU standards and legal commitments in the area of environment and climate change?

Box 7: An EU taxonomy: what it defines and how it will be used

Box 8: EU labelling for environmental policy

Box 9: Explanation of scope 1, 2 and 3 emissions

Box 10: Methodologies adopted by the Commission for calculation of carbon footprint

I. Introduction: Political and legal context

1.1. EU policy context 

The EU is committed to a development that meets the needs of the present without compromising future generations. Sustainability has since long been at the heart of the European project. The EU Treaties give recognition to its social and environmental dimensions. Governments from around the world chose a more sustainable path for our planet and our economy by adopting the 2016 Paris agreement on climate change and the United Nations (UN) 2030 Agenda for Sustainable Development (UN, 2015).

The 2016 Commission's Communication on the next steps for a sustainable European future links the Sustainable Development Goals (SDGs) 1 of the UN 2030 Agenda for Sustainable Development to the European policy framework to ensure that all EU actions and policy initiatives, within the EU and globally, take the SDGs on board at the outset. The EU is also fully committed to reaching the EU 2030 climate and energy targets 2 and to mainstream sustainable development into EU policies. Therefore, many of the European Commission’s policy priorities for 2014-2020 feed into the EU climate objectives and implement the 2030 Agenda for Sustainable Development. These include the Investment Plan for Europe, the Circular Economy Package, other environmental policies including those that protect natural habitats, keep air and water clean and ensure proper waste disposal, the Energy Union package, the Clean Mobility package, the Capital Markets Union and the EU budget for 2014-2020, including the Connecting Europe Facility funds related to the Trans European Transport Network (TEN-T) policy objectives and the Cohesion fund and research projects. In addition, the Commission launched a multi-stakeholder platform to follow-up and exchange best practices on Sustainable Development Goals implementation.

Achieving EU sustainability goals requires important investments. In the climate and energy space alone, it is estimated that an additional annual investment of EUR 180 billion is needed to meet climate and energy targets by 2030. 3 A substantial part of these financial flows will have to come from the private sector. Closing this investment gap means significantly and rapidly reorienting private capital flows towards more sustainable investments. Yet, most of the existing sustainability commitments do not explicitly address the role of the financial system in supporting projects in line with the strategic objectives.

A mix of measures is needed to meet the EU's immediate and longer-term objectives for sustainability policies. Having in place a strong regulatory framework is part of that, but not always sufficient. 4 To ensure a rapid and orderly transition to a sustainable economy, it is essential to also help reorient capital flows away from polluting to greener activities and therefore increase access to finance for the latter. 5 .

1.2. High-Level Expert Group on sustainable finance

The Commission established in December 2016 a High-Level Expert Group (HLEG) to develop an overarching and comprehensive EU strategy on sustainable finance. The HLEG published its final report on 31 January 2018 (HLEG, 2018). This report provided a comprehensive vision on sustainable finance for Europe and identified two imperatives for Europe's financial system. The first is to improve the contribution of finance to sustainable and inclusive growth. The second is to strengthen financial stability by incorporating Environmental, Social and Governance (ESG) factors into investment decision-making. Directive 2016/234 introduced ESG factors in the EU legislation by making a reference to the United Nations-supported Principles for Responsible Investment 6 . Although there is no universal definition of ESG factors within the investment industry, it is widely accepted that ESG factors are a universal concept that include a range of environmental, social and governance factors as illustrated in Figure 1. According to United Nations Environment Programme (UNEP) Inquiry and the United-Nation Backed Principles for Responsible Investment (UNPRI), ESG factors are broadly defined as follows: (i) Environmental (E) issues relate to the quality and functioning of the natural environment and natural systems; (ii) Social (S) issues relate to the rights, well-being and interests of people and communities; and (iii) Governance (G) issues relate to the governance of companies and other investee entities.

Box 1: Definition of "sustainable finance"

Figure 1: ESG factors

- climate change - greenhouse gas (GHG) emissions - resource depletion, including water - waste and pollution - deforestation - biodiversity loss - changes in land use - ocean acidification - changes to the nitrogen and phosphorus cycles	- human rights - working conditions, including slavery and child labour - freedom of association and freedom of expression - local communities - conflict areas - health and safety - employee relations and diversity - consumer protection	- executive pay - bribery and corruption - political lobbying and donations - board diversity and structure - shareholder rights - stakeholder interaction - tax strategy

Source: UNPRI (2018b)

The HLEG issued a series of recommendations, which it believes are essential building blocks of a sustainable European financial system. Among these recommendations, the HLEG calls for the establishment of a technically robust classification system at EU-level to provide clarity on what is 'green' or 'sustainable' – a so-called sustainability taxonomy. A second recommendation of the HLEG is to clarify that asset managers and institutional investors, such as pension funds and insurance companies, integrate ESG factors in their investment decision process and enhance disclosure to their end clients in that regard. The HLEG's report also recommends that investment preferences of end-investors on sustainability objectives be taken into account along the investment chain and in the advisory process. Another recommendation of the HLEG is on benchmarks, which are used to gauge the performance of financial products. In the HLEG's view, greater transparency and guidance on sustainable benchmarks is needed.

1.3. The EU Action Plan on Financing Sustainable Growth

To follow-up on the work of the HLEG and contribute to broader efforts to connect finance with the needs of the planet and society, the Commission published on 8 March 2018 an Action Plan on Financing Sustainable Growth (EC, 2018a). The proposed approach is part of the EU implementation of the Paris Agreement, which specifically committed (in article 2(1)(c)) to aligning financial flows with global climate objectives. It is also crucial to reduce the fall-out from possible stranded assets and ensure an orderly transition. Finally, it is also part of the EU implementation of the UN 2030 Agenda for Sustainable Development.

The Action Plan has three overarching objectives, namely: (i) reorienting capital flows towards sustainable investments to achieve sustainable and inclusive growth; (ii) managing financial risks stemming from climate change, resource depletion, environmental degradation and social issues; and (iii) fostering transparency and long-termism in financial and economic activity.

To achieve these goals, the Commission put forward ten actions (Figure 2), including those supported by this impact assessment. In particular, this impact assessment is related to action #1 (EU sustainability taxonomy), action #4 (investment advice to integrate ESG factors), action #5 (developing sustainability benchmarks), and action #7 (investors' duty to integrate ESG and increased disclosure, which touches also on parts of action #9). 9 Those actions are circled in red in Figure 2.

These actions should be seen as key parts of a broader and further-reaching strategy to make the European economy truly sustainable. The actions are complementary and mutually reinforcing in achieving the overarching objectives of the Action Plan and fostering transparency in particular, as further explained in this impact assessment. Specifically, establishing a framework to develop a common language on what sustainable activities are (action #1) will serve as a basis to launch other components of the Action Plan, such as action #2 on standards and labels and action #3 on investment in sustainable infrastructure projects. Clarifying the duties of care, loyalty and diligence of institutional investors, asset managers, insurance distributors and investment advisors (actions #4 and #7) will allow mainstreaming sustainability into risk management. In addition transparency will increase by improving disclosure on sustainability in investment decisions and advice (action #7 and part of action #9). Ultimately, these combined actions will help reorient capital flows towards sustainable investments.

As regards timing, some of these actions – and the taxonomy in particular – will require several steps to become fully operational and start contributing to the achievement of the most pressing EU policy priorities, especially on climate change. This is why those actions are being proposed in parallel. In turn, the need to follow these intermediate steps is also reflected in the analysis of the different policy options presented in this impact assessment. In some cases (actions #4, #5 and #7 and part of action #9), the expected impacts of the various policy options are assessed in this impact assessment in greater depth. For action #1, this impact assessment mainly focuses on the problems that the action is meant to address, on the overall approach and guiding principles underpinning the taxonomy, the procedural and governance arrangements envisaged to make it operational and, where relevant, the legislative and procedural safeguards to be respected while moving along the various implementation steps and from one building block to the next. A more detailed assessment would then follow once the relevant implementation measures are put in place, as well as the future uses of the taxonomy are agreed on. Section 6.1 provides a detailed description of the timeline and of the logical sequencing for the proposed initiatives.

Figure 2: Visualisation of the ten actions proposed by the Action Plan

Source: EC, 2018a, p. 19

II. Problem Definition

There is a lack of clarity and transparency on how ESG factors are currently being integrated in the investment decision and advisory process. Considering these factors is important for all investors because ESG factors could affect the long-term risk-return trade-off. 10 A recent European Commission consultation (EC 2016b) concluded however that markets "do not sufficiently internalise ESG risks and respond to ESG opportunities". In addition, certain investors have explicit ESG preferences that are not sufficiently addressed. For these investors, it is essential that their personal values 11 are considered in the advisory process and reflected in the investment product selection.

Insufficient integration of ESG factors in the investment and advisory process is related to two problems. End-investors face high search costs in order (i) to identify sustainable economic activities and (ii) to find out how ESG factors are integrated in the investment decision process. Hence, investors face imperfect information. Secondly, relevant entities 12 might not be properly incentivised or have the tools to consider ESG factors in the investment and advisory process.

Five drivers underpin the above problems, three of which stem from a regulatory failure, either because the design and implementation of existing EU law is not optimal, or because specific provisions on ESG disclosure to address the issue of imperfect information do not exist. These drivers are: (i) lack of clarity and coherence of EU rules on duties towards investors/beneficiaries with respect to ESG integration in the investment and advisory process; (ii) lack of disclosure regarding the level of ESG integration in the investment process; (iii) lack of clarity on what can be considered a sustainable economic activity. Two other drivers fall out of the scope of this impact assessment: (i) the lack of comparable and readily available ESG information from firms and issuers and (ii) short-termism. Although the last two drivers are important in nature, they refer to broader structural issues that are tackled by separate initiatives, as reflected in the European Commission's Action Plan (EC, 2018a). Regarding the lack of sustainability disclosure at the level of firms and issuers in particular, it is worth recalling that, as part of the requirements of the Accounting Directive, companies (including small issuers), have to report non-financial information as part of their management report 13 to the extent necessary for an understanding of the company' development, performance or position. Furthermore, as of 2018, large listed companies will have to disclose a non-financial statement containing material information on key environmental, social and governance aspects and how related risks are managed. 14 In addition, relevant legislation on public reporting by companies is currently being subjected to a fitness check by the European Commission. Possible follow-up actions on this problem driver will thus draw on the results of the fitness check, which are expected around mid-2019.

2.1. What are the problems?

2.1.1. High search costs for end-investors

As regards ESG information, retail and institutional end-investors face increased search costs due to imperfect information. The availability of ESG information is crucial to ensure that investors who have the intention to invest in accordance with ESG criteria will actually do so. 15 Those investors search actively for this information: they tend to look more for social and environmental information than for traditional financial information. 16 However, they might have difficulties in finding relevant ESG information. Currently, the search for this type of information is hindered by (i) a lack of transparency on how ESG factors and ESG preferences are integrated in the investment and advisory process, including a lack of ESG-related disclosure; and (ii) the existing ambiguity with respect to what can be considered a sustainable economic activity, coupled with a lack of harmonisation of the methodologies to assess for instance climate-related risks and opportunities in line with low-carbon investment strategies. Hence, investors are confronted with imperfect information, which makes it difficult to retrieve relevant ESG information. As a result, end-investors face unnecessarily high search costs.

Evidence from the public consultation (EC, 2018b) confirms that the available information for some sustainability factors is insufficient. In this consultation, the vast majority of end-investors indicated that they are unable to make informed investment decisions based on the available sustainability information. 17 In particular, information on environmental and social factors is lacking. Corroborating evidence is also provided in a recent study (EC, 2015) that concludes that, although many institutional investors claim to apply sustainable and responsible investment strategies, the final impact of the inclusion of ESG criteria on investment decisions is rarely disclosed. In line with these observations, the 2018 HLEG final report highlighted that, without consistent and readily available information, it is difficult for end-investors to compare the ESG features of different investments. A prerequisite for doing so is to have an unambiguous way of qualifying what can be considered to be a sustainable economic activity and to have appropriate tools to assess ESG investment performance.

These issues lead to behavioural biases that affect the investment decisions of end-investors. The availability and quality of ESG information from relevant entities is a key element to assess how ESG factors are integrated in the investment process, and to decide whether one would like to consider ESG factors when making an investment decision. In case investors are not properly made aware of sustainable investment options, they will be biased towards investing in the default setting (i.e. conventional investment without considering ESG factors). In addition, it will be difficult for them to develop their preferences towards ESG integration and make them known, given the lack or opaqueness of information, together with the perceived lack of impact. Finally, some studies note that it is unlikely that sustainability will become part of the financial decision making of end-investors, given that investment advisors do not discuss it, unless explicitly asked for by the client (Pilaj, 2017).

2.1.2. Lack of incentives for relevant entities to consider ESG factors 

Relevant entities are required to act with prudence and in the best interest of their clients. This implies that they have to act loyally and exercise prudence, skill, care and diligence, in managing funds for their clients or beneficiaries. These principles are captured by fiduciary duty obligations in common law jurisdictions or analogous concepts like investor or beneficiary protection (e.g. policy holder protection) in pieces of EU legislations that apply to different market participants managing assets on behalf of clients and/or providing investment advice.

From a legal perspective, the extent to which these duties are compatible with taking ESG concerns into account has been subject to considerable debate. 18 Nevertheless there is a growing consensus 19 that the consideration of ESG factors is compatible with fiduciary duties when:

·ESG factors have a financial material impact on the investment performance or valuation;

·It is reasonable to assume that taking into account ESG factors is supported unanimously by the beneficiaries;

·ESG factors are a distinctive element when comparing investments with otherwise similar characteristics.

EU legislation does not constitute a barrier to integrate ESG factors. While ESG factors are not explicitly mentioned in the relevant EU legislation – with the exception of the IORP Directive 20 – existing financial regulation provides scope to incorporate them, given that all factors that have a material impact on financial performance should be considered in the investment and advisory process. This view is also shared within the industry: the public consultation (EC 2018b) reveals that the vast majority of respondents do not view European or national regulation as a barrier to incorporating ESG factors in their investment decisions.

There is however an issue with the implementation of existing legislation. While there are no legal barriers to integrate ESG factors, many relevant entities do not consider these in a consistent way in their investment process, and the number of entities that do consider ESG factors is only increasing slowly (see Box 2). In a similar spirit, the Commission’s study (EC 2015) mentioned above indicated inter alia that the investment community should be incentivised to integrate environmental and resource efficiency issues into their decision-making process.

Box 2: ESG integration in the investment process

Taken together, the evidence above demonstrates that relevant entities lack incentives to consider ESG factors. This lack is fuelled by an absence of clarity and coherence in EU legislation and other possible determinants as discussed in Section 2.2.2 and Annex 6.

Generally speaking, the problems described above directly affect all relevant entities and end-investors and any improvements would require changes in their behaviour.  For relevant entities this could imply changing the way they execute their duties towards investors/beneficiaries, integrate ESG factors and disclose such information. Providers of investment advice might have a stronger incentive to incorporate ESG factors in their advice as ESG concerns become more part of industry practices. End-investors could adapt their investment behaviour in order to have a more comprehensive integration of ESG factors when making investment decisions.

Figure 4: Problem tree

2.2. What are the problem drivers?

As mentioned above, three drivers are directly relevant for the initiatives which this impact assessment supports, and are described in greater detail below.

2.2.1. Lack of clarity and coherence regarding the consideration of ESG factors in the investment and advisory process as part of the duties towards investors/beneficiaries (Driver 1)

The lack of incentives for relevant entities to consider ESG factors is related to several concerns, but the lack of clarity and coherence in EU legislation is a key factor. In the public consultation (EC, 2016b), institutional investors and other stakeholders reported that duties towards investors and beneficiaries —as they are articulated in the relevant financial legislation— are not sufficiently clear on how they have to consider financially material risks stemming from sustainability factors. More generally, stakeholders also indicated that they would welcome clarification regarding the fact that the integration of ESG factors in the investment process fits with their duties towards investors and beneficiaries. This uncertainty has also spurred considerable debate in the academic literature, 24 indicating that without a sufficiently explicit legal framework, the integration of ESG factors under the duties toward investors and beneficiaries is often not straightforward.

The current EU legislative framework does not prevent relevant entities from integrating ESG factors. However, the high-level nature of the relevant provisions contributes to a heterogeneous implementation. 25  As mentioned before, relevant entities are required to act with care, loyalty and diligence and in the best interest of their investors and beneficiaries, but practically none of the (sectoral) legal frameworks explicitly requires relevant entities to consider ESG factors in their investment decisions.

There is a lack of coherence in the obligations regarding duties towards investors and beneficiaries across sectors. Only IORP II explicitly states that occupational pension funds should consider ESG factors in their investment decisions, governance and risk management systems. 26 In addition, entities subject to the IORP Directive have to disclose how ESG factors are taken into account in their investment policy. For entities in other sectors there are no explicitly pre-scribed requirements.

ESG preferences are insufficiently considered in the advisory process. 27  The assessment of suitability under MiFID II 28 and IDD 29 does not foresee that information on non-financial objectives and preferences is gathered by investment advisors. Investment advice typically consists of two elements: (i) client profiling to understand a client's risk preference, investment objectives, financial situation and investment experience; and (ii) product selection in order to assure that the final investment products recommended to the client are in line with the client's profiling. In practice, product selection appears to be primarily driven by a client's risk profile, but ESG preferences are not systematically assessed. Suitability assessment questionnaires appear not to include questions on ESG preferences: a sampling of 19 questionnaires of mainstream retailers in five EU countries (France, Germany, Italy, Spain, and the United Kingdom) revealed that none of them contained questions on non-financial objectives and preferences. Overall, it might therefore be difficult for a client to communicate their ESG expectations clearly as they are not integrated in the client profiling and product selection process. 30 At the same time, investors are not sufficiently aware of ESG risks to enable them to raise their ESG expectations on their own.

In the public consultation (EC 2018b), end-investors also argued that inadequate consultation of retail investors and beneficiaries could lead to a misunderstanding of what constitutes "the best interests" of end-investors. A large majority of overall respondents think that insurance and pension providers should consult their beneficiaries on an annual/periodic basis with respect to their sustainability preferences. However, a majority of pension funds and insurance companies do not agree with this statement, mainly because of the lack of in-house expertise on sustainability factors and the potential costs to train their employees in this area. On the side of asset managers, a majority of respondents do agree with the approach.

Intermediaries might also shy away from raising ESG concerns themselves as there is doubt that commercial and marketing incentives would support the sale of ESG products (2Dii 2017). In the same spirit, anecdotal evidence from the Commission consultation (EC 2018b) mentioned that investment advisors refrained from discussing sustainability topics as it increased the complexity of their advisory work, whilst incentives to raise ESG issues were perceived to be low.

Overall, the evidence also points to a regulatory failure in terms of implementation regarding the consideration of ESG preferences/factors in the investment and advisory process. The analysis of current regulatory and market practice leads some stakeholders to conclude that the consideration of environmental objectives in the advisory process should be made mandatory (2Dii, 2017). In line with this, some respondents in the recent Commission public consultation (EC, 2018b) also called for more guidance by regulatory authorities in view of the complexity of the advisory process.

In addition, as part of their duties towards investors/beneficiaries, benchmarks used by asset managers and investors to track/measure the performance of a fund/portfolio should be appropriate and reflect the clients' investment style in accordance with their investment recommendation/investment mandate. In this regard, existing low-carbon benchmarks are not always appropriate neither for a passive investment strategy nor as a performance benchmark for an active low-carbon investment strategy. They cannot always be used as an objective tool to evaluate to what extent a low-carbon investment strategy pursues a low-carbon investment style during the lifecycle of an investment mandate. Asset managers who responded to a targeted consultation (see Annex 2 for more details) explained that they currently do not use a low-carbon index because they believe that: (i) the current methodologies do not reflect all sources of CO2 emissions; (ii) their clients (investors) have no confidence in the methodology employed by available low-carbon indices; and (iii) low-carbon indices reflecting their investment approach and style are missing. In addition, the level of disclosure on the benchmark an asset manager uses to assess the portfolio/fund performance is insufficient, especially as regards if and to which extent this benchmark is aligned with the sustainability objectives that the manager pursues.

Box 3: Low-carbon benchmarks

Based on relevant literature and stakeholders' views expressed in public consultations, other major obstacles to considering ESG factors as part of the duties towards investors and beneficiaries are: (i) possible heterogeneity of beneficiaries' ESG preferences; (ii) lack of reliable and comparable ESG information; (iii) lack of data and tools to analyse ESG risks; and (iv) the impact on costs and risk-adjusted performance. A discussion of these factors is provided in Annex 6. 

2.2.2. Lack of ESG disclosure requirements for institutional investors, asset managers and investment advisors (Driver 2)

Information disclosed by relevant entities does not allow end-investors to assess how relevant entities consider ESG factors in their investment and advisory process. This lack of transparency follows from the fact that this kind of information is not very detailed or easily accessible for end-investors or is not comparable. End-investors may thus have insufficient elements to make informed investment decisions. Indeed, as suggested in the HLEG’s final report (2018), a lack of consistent information hinders investors and others from considering ESG-related issues. End-investors can only make an informed sustainable investment choice if they can assess both the financial characteristics and ESG features of a financial product. The existing ESG-related information is not sufficient for a sustainability assessment of their investment, nor are existing rules considered to be sufficient to address this issue (Nilsson et al. 2010).

Although the feedback from the public consultation (EC, 2018b) indicates that the availability of ESG-related information has improved recently, it also shows that there is still ample scope to further improve the quality and quantity of ESG information. In this respect, the majority of respondents argued that, to guarantee transparency, relevant entities should disclose how they consider sustainability factors within their investment process. According to respondents, more disclosure is required to identify whether risks stemming from sustainability issues are properly addressed, as well as to ensure that investors' ESG preferences are reflected in the investment and advisory process. They suggested that this information should be disclosed in semi-annual/annual reports and in pre-contractual information documents. Websites and, to a lesser extent, marketing materials were mentioned as other useful means of disclosure.

There is also a lack of coherence in the prevailing national legal obligations on ESG disclosures. The various national legal obligations regarding Socially Responsible Investments (SRI) and ESG disclosures for a selected group of Member States are summarised in Table 1. The table shows large differences. Firstly, countries like Austria, Luxembourg, Portugal and Sweden have no legal obligations for any of the institutional investors or asset managers. A second group of countries only regulates one of the relevant groups. Given that pension funds generally have long-term investment policies, for which ESG risks are more relevant, pension funds seem to be a natural first choice to impose ESG disclosure requirements. A third group of countries, like France, Denmark and Italy impose disclosure measures for all entities. Although countries like France and Denmark impose the same disclosure rules for different entities, the cross-country variations in disclosure requirements remain. Yet, it should be noted that IORP II requires Member States to ensure that entities subject to the Directive disclose the relevance and materiality of ESG factors. As the transposition deadline is January 2019, not all Member States will have necessarily implemented those rules already.

Table 1: SRI and ESG disclosure – Legal obligation for institutional investors and asset managers in selected Member States

Source: EFAMA (2016) 

(*) No specific legal obligation but self-regulation: Swedish Investment Fund Association Guidelines covering transparency and comparability of asset managers dealing with sustainability issues.

(**) No specific legal obligation but asset manager should disclose how it delivers stewardship responsibilities on behalf of its clients (UK Stewardship Code). 

2.2.3. Lack of clarity on what constitutes sustainable economic activities (Driver 3)

While there is a consensus on what falls under each of the broad ESG concepts (see Figure 1 in section 1.2.), such high-level consensus is however not sufficient to increase investments into sustainable economic activities. In the recent public consultation (EC 2018b), stakeholders indicated that there are too many standards without a single, commonly-accepted framework.

Clarity is needed on the conditions that economic activities need to fulfil in order to qualify as positively contributing towards sustainability. However, at present, a coherent and uniform classification system of what constitutes a sustainable economic activity, for the purposes of sustainable investment, does not exist at EU level. 32  A number of market-based practices or market-led initiatives have emerged in recent years. 33 These, however, are not always comprehensive and do not necessarily reflect all the EU's environmental and sustainability priorities. At Member State level, some EU countries have built on these market initiatives to develop classifications for climate-related or environmental economic activities, to serve as a basis for national standards and labels. 34

This parallel development of market-based and national practices is likely to give rise to divergent classifications, also because these kinds of initiatives are pursuing a specific national policy agenda, are targeting only particular topics, or are based on commercially-driven priorities. In turn, this fragmentation can confuse investors, especially retail investors who would like to invest into sustainable or 'green' activities, but are faced with financial products that are based on divergent criteria as to what qualifies as a green activity. If the activities classified as green in one Member State are different from the activities classified as green in another Member State, consumers face difficulties in comparing and understanding the cross-border differences between green financial products. Therefore, they will be discouraged from investing into these kinds of assets across borders, hindering cross-border sustainable investment. 35  

Moreover, the coexistence of diverging classifications of economic activities with varying scopes and based on different criteria and metrics also leaves room for greenwashing. Greenwashing refers to the practice of marketing financial products as green or sustainable, when in fact they do not meet basic environmental standards. This phenomenon can have a direct negative effect on the functioning of the internal market for the following reasons: It can undermine investor confidence in the concept of sustainable investment and, greenwashing can result in unfair competitive advantage.

Box 4: Existing taxonomies and national financial labels

2.2.4. Out-of-scope drivers

The problems that are central to this initiative are also influenced by other factors, such as: (i) the lack of readily available and comparable ESG information by firms and (ii) short-termism. These factors are considered to be out-of-scope as they are related to a broader structural issue (i.e. short-termism is an issue that goes beyond sustainability concerns and that is embedded in investment industry practices) or focus on the behavior of firms that surpasses this initiative's scope. In addition, they are/will also be addressed via other initiatives of the Commission, as reflected in the Commission's Action Plan. 36

2.3. Consequences of the problem and how will they evolve?

The lack of incentives to consider ESG factors in the investment decision will persist, even though, the problem is likely to become less prominent over time. Although the consideration of ESG factors by the industry currently remains moderate, the inclusion of sustainability factors in the investment decision process is likely to increase, but only at a slow pace. A growing number of relevant entities believe that integrating ESG factors is consistent with their responsibilities towards investors/beneficiaries, reflecting the trend towards further ESG integration as discussed in section 2.1. The evidence in Box 2 showed that the number of respondents considering environmental factors increased by 8% over the period 2015-2018. At the corresponding compound annual growth rate of 3.9%, it would take more than 10 years before 75% of the industry would consider environmental factors in their investment decisions.

Even if this trend continues, national initiatives will not lead to a coherent and comprehensive approach. While a few Member States 37 already require institutional investors and asset managers to consider ESG factors in their investment decisions, most Member States have not taken any action in this area (EC, 2015). If other Member States decide to do so in the future, this is likely to result in different approaches across the EU. The coexistence of heterogeneous approaches is likely to increase market fragmentation, limit transparency for end-investors, and ultimately hamper capital flows towards the achievement of EU sustainability objectives.

Similarly, no significant change is expected with regard to the integration of ESG factors in the advisory process. Although investors might become more aware of sustainability concerns over time and raise them in the advisory process, it is unlikely that this would lead to a significant change if the need for ESG integration is not structurally embedded in the advisory process.

High search costs for end-investors will largely persist, as information on the inclusion of ESG factors in the investment decision and advisory process will depend on national rules in Member States and/or on voluntary disclosure by the relevant entities. Although increased awareness from investors regarding the relevance of ESG factors and the reputational benefits of (voluntary) communication on ESG integration may lead to enhanced disclosure by relevant entities, the information is likely to remain high-level and not harmonised. Transparency will remain limited, and this will hinder end-investors’ ability to compare the ESG features of different investments and choose appropriate investment products to pursue their ESG/climate-related strategy.

In addition, the ambiguity regarding what can be considered a sustainable economic activity, is expected to persist. As explained in the baseline scenario (Section 5.1), market-based or marked-led initiatives 38 with different scopes are likely to be further developed and compete with classifications developed by public bodies in the future (e.g. the EIB).Without EU action, no coherent and univocal classification system on sustainable economic activities for the purposes of sustainable investment in the medium to long-term will emerge. 39 For investors that intend to invest in sustainable economic activities it will thus remain difficult to identify such assets in a consistent fashion. Overall, this is likely to limit the possibility of redirecting capital flows towards sustainability goals and to close, among others, the investment gap to achieve the EU's sustainability objectives.

Similarly, the same conclusions can be applied to the tools available for investors to support the development of sustainable finance. Different categories of low-carbon indices with various degrees of ambition have emerged in the marketplace. Despite the differences in objective and strategy, all of these benchmarks are commonly promoted under the uniform denomination of low-carbon benchmarks. Those divergent approaches to benchmark construction would result in fragmentation of the market since users of benchmarks would not have clarity on whether a particular low-carbon index would be considered merely as a decarbonised version of a standard market capitalisation benchmark or as a benchmark aligned to the 2°C global temperature target of the Paris Agreement (see Box 3). Without EU action, low-carbon benchmarks will still not be objective nor appropriate for investors who would like to pursue a low-carbon strategy that aligns with the goal of limiting global warming to below 2°C. Thus, they will not sufficiently contribute to the urgent shift towards a highly energy-efficient, low-carbon economy. In addition, due to the lack of transparency and existing discrepancies between the methodologies of low-carbon benchmarks, investors will have no objective tool nor sufficient information to assess if the investment strategy of a fund/portfolio is consistent with the benchmark used.

In turn, the trends described above would not sufficiently curtail the documented behavioural biases in the investment and advisory process: distortions in the investment decision process and savings allocation (FCA 2016) might be somewhat smoothed out, but they will persist. It should be noted that certain pieces of recent EU legislation that integrate ESG dimensions could alleviate some of the behavioural biases. 40  

Putting things into a larger perspective, insufficient ESG integration and lack of clarity as to what constitutes a sustainable economic activity is also a hurdle for directing capital flows towards sustainable investments: too high search costs, and a lack of awareness regarding ESG will result in an untapped pool of money that is not directed towards sustainable investment. Improvements in this area are likely to result in additional flows to such investments through: (i) the attraction of new sustainable investments; and by means of (ii) the rebalancing of existing portfolios towards sustainable investments.

Although the exact impact is difficult to quantify, even small changes will be economically significant. Given the important role of the asset management industry in financing the economy, the industry will also play an important function in contributing to the EU sustainable objectives. Based on EFAMA estimates, the asset management industry in Europe had EUR 22.8 trillion of total assets under management in 2016 and attracted EUR 300 billion in new investments (EFAMA 2017). Hence a 0.5% shift towards sustainable investments due to the rebalancing of existing portfolios and the attraction of new flows would increase the amount of sustainable assets by EUR 115.5 billion. Similarly, the insurance sector in Europe in 2016 had approximately EUR 10 trillion of total assets invested. A shift of only 0.5% in the allocation of its investments towards sustainable investments, either through rebalancing or through directing new premiums towards these investments would increase these investments by EUR 50 billion.

III. Why should the EU act?

3.1. Legal bases

Article 114 of the Treaty on the Functioning of the European Union (TFEU) confers the European Parliament and the Council the competence to adopt measures for the approximation of the provisions laid down by law, regulation or administrative action in Member States which have as their object the establishment and functioning of the internal market. Article 114 TFEU allows the EU to take measures not only to eliminate current obstacles to the exercise of the fundamental freedoms, but also to prevent the emergence of such obstacles, including those that make it difficult for economic operators, including investors, to take full advantage of the benefits of the internal market. Thus, Article 114 of the TFEU gives the EU the right to act since, in line with the problem definition outlined in section 2, the options that will be assessed by this impact assessment will aim at (i) ensuring a more uniform approach in the way relevant entities consider ESG factors in the investment and advisory process, and (ii) reducing the search costs of end-investors regarding what are sustainable economic activities and the extent to which ESG factors are integrated in investment decisions.

More specifically, the lack of clarity and coherence in EU legislation regarding the consideration of ESG factors in the investment and advisory process as part of the duties towards investors/beneficiaries (driver 1) results in a heterogeneous implementation of these duties across the EU. At EU level, the duties towards investors and the obligations in the advisory process are set out in the AIFMD Directive 2011/61/EU, the UCITS Directive 2009/65/EC, the MiFID II Directive 2014/65/EU, the Solvency II Directive 2009/138/EC, and the Directive on Insurance Distribution 2016/97/EU. The legal bases for the EU to act are provided and delineated by these directives, which require delegated acts to be adopted in specified areas to ensure that the obligations set out in the directives are implemented in a consistent way across the EU. As the IORPs II Directive 2016/2341, based on Articles 53, 62 and 114(1) TFEU, currently does not require adoption of delegated acts in these specified areas, it will have to be amended. This impact assessment, when analysing concrete options to provide more uniform conditions on the integration of ESG factors in the investment and advisory process, considers the extent to which harmonisation is necessary, always with the principles of subsidiarity and proportionality in mind and with the objective of ensuring cross-sectoral consistency.

The lack of ESG disclosure requirements on institutional investors, asset managers and investment advisors on the integration of ESG factors (driver 2) and the lack of disclosures on exposures to sustainability objectives as well as the lack of coherence in the prevailing national legal obligations in these regards result in insufficient and inconsistent information – and therefore not comparable – information for end-investors. This is detrimental to the functioning of the single market. Several EU financial services Directives would therefore require amendments. In consequence, the legal bases for the EU to act are: (i) Article 53(1) TFEU for amendments to the UCITS Directive 2009/65/EC, the AIFMD Directive 2011/61/EU and the MiFID II Directive 2014/65/EU; (ii) Articles 53(1) and 62 TFEU for amendments to the Solvency II Directive 2009/138/EC; (iii) Articles 53, 62 and 114(1) TFEU for amendments to the IORP II Directive 2016/2341; and (iv) Article 114 TFEU for amendments to Regulations 345/2013 on European venture capital funds and 346/2013 on European social entrepreneurship funds.

The lack of clarity on what constitutes a sustainable economic activity (driver 3) is explained by current divergences at national level in the classification systems and criteria used to define sustainable economic activities. This fragmentation hampers the proper functioning of the internal market in the context of sustainable investments. Article 3(3) of the TFEU says: “The Union shall establish an internal market. It shall work for the sustainable development of Europe […] and a high level of protection and improvement of the quality of the environment.” Article 114 of the TFEU gives the EU the legal basis to address this fragmentation, adding that proposals that concern environmental protection and consumer protection have to take as a base a high level of protection. Taxonomies put forward by private initiatives do not offer a suitable and uniform basis for measures aimed at incentivising sustainable investment. This is visible in the French example, with the TEEC label employing a taxonomy that diverges from existing market-led classifications.

Different categories of low-carbon indices with various degrees of ambition have emerged in the marketplace. While some benchmarks are content with lowering the carbon footprint of a standard investment portfolio (the 'decarbonised benchmarks'), others aim to select only components that make a contribution to the attainment of the 2° objective set out in the Paris Agreement (the 'positive carbon impact benchmarks'). Despite the differences in objective and strategy, all these benchmarks are commonly promoted under the uniform denomination of low-carbon benchmarks. The lack of minimum standards for low-carbon benchmarks and the use of a uniform denomination of low-carbon benchmarks result in inappropriate tools for institutional investors and asset managers to reflect their low-carbon investment strategies. In order to ensure the proper functioning of the internal market and ensure a high level of consumer and investor protection, it is appropriate to lay down a regulatory framework for low-carbon benchmarks at Union level. Article 114 of the TFEU gives the EU the legal basis to address the fragmentation of the methodologies of low-carbon benchmarks by modifying the Benchmark Regulation.

In addition, the lack of publicly available information on the extent to which the methodology of those benchmarks administrators takes into account ESG objectives prevents end-investors from assessing the consistency in terms of sustainability between the benchmark and the portfolio. In consequence, the legal basis for the EU to act is Article 53(1) TFEU for amendments to the UCITS Directive 2009/65/EC and the MiFID II Directive 2014/65/EU.

3.2. Subsidiarity: Necessity of EU action

The problems and their drivers, as identified in section 2, could possibly be addressed through individual action by Member States. Nevertheless, individual action by Member States is likely to only partially address the identified issues (notably because some Member States may legislate, while others would not) and create additional fragmentation due to diverging regulatory approaches.

Asset managers, insurance companies, pension funds, portfolio managers and investment advisers are largely working across borders in the EU. Therefore legislation applying to those market players is largely harmonised at EU level. Action at EU level as regards investors' duties and transparency towards end-investors is thus warranted in order to ensure coherence and to further improve the functioning of the single market. More specifically, while EU legislation already defines 'fiduciary obligations' of asset managers, institutional investors and investment advisors and disclosure requirements at EU level, the interpretation of these requirements as regards sustainability factors leaves large flexibility in terms of implementation. Specification of these requirements is warranted to avoid fragmentation, inconsistency and unpredictability in the functioning of the internal market. It would also help prevent an uneven playing field and multiplying compliance costs for an industry, which is largely working across borders.

Responses to the public consultation on investors' duties largely support an intervention at EU level. The exact interpretation of 'duty' or 'duties' differs among EU jurisdictions for various reasons, including different legal traditions, cultural understanding and approaches taken in this area. Therefore, several stakeholders called for legislation at EU level, which embeds this duty in law and provides clarity to relevant entities. They recommended that the EU introduces legislation which requires integration and disclosure of sustainability factors in the investment and advisory process.

The existing lack of clarity on what constitutes a sustainable economic activity could be exacerbated by parallel and uncoordinated attempts by Member States in that field. Given the commitments to environmental and climate policy goals, both at international (e.g. Paris Agreement) and at Union level, it is very likely that in the future more Member States will explore the option of setting up labels for sustainable financial products, for which they would use self-tailored, divergent taxonomies. This means that in the future, the cross-border barriers to the functioning of capital markets for the purpose of raising funds for sustainable projects will grow further: The multiplication of classification systems would increase market fragmentation and raise competition issues, making it more difficult and costly for investors to understand what is considered a sustainable investment. The criteria or classification of what constitutes a sustainable activity for the purposes of investment should therefore be harmonised at Union level. This would make it easier for economic operators to attract capital across the Union for sustainable investments. It would also constitute a first step towards addressing greenwashing and help investors identify more easily which criteria were used to deem a financial product 'green' or sustainable.

The vast majority of stakeholders consulted on the introduction of an EU classification system for the purposes of identifying sustainable economic activities saw the need for regulatory intervention at EU level as opposed to letting national or market-led initiatives shape these classification systems. These respondents also considered that a sustainable classification system at EU level would be helpful to fulfil their investors' duties and take into account ESG factors in their investment decision process. A common classification system is thus needed not only to empower the EU to accurately measure and track progress towards the achievement of its policy objectives, but also to allow market participants to reap the benefits offered by a single market for sustainable investment, and increase capital flows towards sustainable investments, when addressing barriers to cross-border investment in sustainable economic activities.

In a similar manner, the lack of minimum standards and requirements regarding methodologies for designing sustainable (and in particular low-carbon) benchmarks results in confusion among benchmark users and end-investors, preventing them from fully benefiting from the single market. In order to address potential instances of greenwashing, Member States are likely to adopt different rules that would help avoid ambiguity regarding the aims and targeted impact underpinning different categories of low-carbon indices. In the absence of a framework providing minimum standards that ensure the accuracy and integrity of the main categories of low-carbon benchmarks, it is likely that differences in Member States' approaches would create obstacles to the smooth functioning of the internal market (for the provision of low-carbon indices that serve as low-carbon performance benchmarks). The majority of respondents to a targeted consultation on benchmarks thought that some harmonisation of the methodology for correctly assessing carbon emissions is needed at European level as it would support the development of reliable low-carbon indices to assess/track the performance of European low-carbon financial products. Half of them also believe that a harmonised EU approach would increase the use of low-carbon indices and, as a result, the supply of low-carbon investment strategies.

3.3. Subsidiarity: Added value of EU action

Several Member States already require in their legislation on duties towards investors/beneficiaries that ESG factors are integrated/considered (see section 2.3). However, most Member States have still not taken action. Legislation at EU level would therefore create a level playing field and help prevent divergence between Member States.

As regards a classification system to define what constitutes sustainable economic activities, it will be more effective for the EU to adapt its legislative framework at an earlier stage, before other Member States start to develop national legislation in this area. It would also limit greenwashing risks, assist consumers in identifying sustainable economic activities for the purposes of investment, and facilitate cross-border sustainable investments. The variety of potential uses of a sustainability classification system developed at EU level further demonstrates the added value of EU level intervention (see also Box 5 in section 5.6.1.).

Due to the fact that many asset managers, insurance companies, pension funds, portfolio managers and investment advisors already work at an EU if not global level, action at EU level will provide economies of scale, compared to a scenario where investors would face: (i) different interpretations of duties towards investors/beneficiaries, and disclosure obligations as regards ESG throughout the Member States, (ii) different classification systems, and (iii) inconsistent methodologies for building low-carbon benchmarks.

IV. Objectives: What is to be achieved?

4.1. General objectives

The general objectives of the initiatives supported by this impact assessment correspond to the three overarching goals of the Commission Action Plan on Financing Sustainable Growth. In particular, these initiatives aim to directly contribute to the Action Plan's goals of (i) managing financial risks stemming from climate change, resource depletion, environmental degradation and social issues; and (ii) fostering transparency. They are to do so by addressing the two main problems identified in section 2: (a) high search costs for end-investors to identify what are sustainable economic activities and to which extent ESG factors are integrated in investment decisions, and (b) the lack of incentives for relevant entities to consider ESG factors in the investment and advisory process.

Increased transparency and reduced search costs will create a more favourable investment environment, where investors can make sustainable investment decisions more easily. As a result, once additional building blocks will be put in place, 41 the proposed initiatives will also help reorient capital flows towards achieving sustainable growth. The magnitude of the reoriented capital flows will depend on the actual demand for sustainable products among investors operating in this more favourable environment, and on the implementation of the various initiatives supported by this impact assessment. Therefore, the impact on investment flows will be assessed at a later stage, as explained in Section 5 below.

4.2. Specific objectives

These general objectives translate into three specific objectives, which address the problem drivers described above, as reflected in the table below:

1.ensure clarity and a coherent approach across sectors and Member States as regards the integration of ESG factors by the relevant entities in their investment/advisory process;

2.increase transparency towards end-investors by improving ESG-related disclosure requirements;

3.provide clarity at EU level on what are sustainable economic activities.

Table 2: Objectives and underlying problem drivers

V. What are the available policy options, what is their impact and how do they compare?

5.1. What is the baseline from which options are assessed?

As explained in Section 1, in its Action Plan on Financing Sustainable Growth, the Commission has put forward ten actions, some of which are supported by this impact assessment. As indicated in the Action Plan, the preferred approach to develop those actions will draw on the outcome of the present assessment. Hence, the baseline scenario takes as a starting point the possibility of not acting at EU level.

The potential initiatives described in the Action Plan are part of a comprehensive EU package of measures to carry out the EU's climate and sustainable development agenda, in line with the UN 2030 Sustainable Development Goals and the Paris Climate Agreement. Other measures — such as EU energy and climate policy under the Energy Union Strategy or the environmental policy acquis — do not explicitly focus on the financing aspect. Finance as a catalyst for progress towards a greener economy is currently under-exploited, and limited progress is normally expected within this area in the short-term, even though access to finance is widely considered a key pre-requisite to ensure compliance with environmental and climate objectives. This situation was also acknowledged by the explicit call for targeted action from the High-Level Expert Group.

Under the baseline scenario, no policy action would be taken to encourage the consideration of ESG factors by institutional investors, asset managers and investment advisors in their investment decision-making process and investment advice. Additionally, disclosure on how these actors consider those factors would continue to depend on existing rules and voluntary disclosure. Furthermore, classification of what are sustainable economic activities would remain predominantly market driven and not harmonised across the EU.

Relevant market entities could make use of the following ESG information disclosed by issuers. This additional information would —at least with regard to large issuers— facilitate the integration by asset managers and institutional investors of ESG factors into their investment decision-making process and the disclosure of this information. As explained in Box 2, the number of financial market participants considering environmental factors is estimated to have increased by 8% over the period 2015-2018 – which corresponds to a compound annual growth rate of 3.9%.

Given the rate of progress and divergences observed within the market, the baseline scenario would imply that the current problem drivers as discussed in section 2.2 would not be addressed. We refer to section 2.3 for a discussion of the consequences of the problems and how they would evolve.

In summary:

1.EU rules would remain insufficiently clear and not fully aligned across sectors on how the relevant entities need to consider ESG factors as part of their duties toward investors/beneficiaries.

2.Disclosure on how institutional investors, asset managers and investment advisors consider ESG factors in their investment decisions and recommendations would continue to be insufficient.

3.The lack of clarity on what are sustainable economic activities in the EU would persist.

As regards point 1, institutional investors, asset managers and investment advisors will still lack regulatory incentives to integrate ESG factors in their investment decision/advisory process (governance arrangements, risk management, investment strategy, asset allocation, suitability assessment and product selection process). This notably means that there will not be regulatory incentives to assess the risks related to ESG factors and, where relevant, take them into account in the investment decision/advisory process, with potentially economic, legal and reputational consequences. In addition, investment advisors and insurance distributors will also lack regulatory incentives to discuss and take into account their clients' preferences as regards ESG, with the result that end-investors' preferences in this field will continue not to be systematically discussed. Fragmentation in market practices on ESG integration in investment/advisory processes will thus persist. Overall, this will lead to distortions in investment decisions and reduced opportunities for ESG investments.

In addition, investors who would like to invest with impact through the selection of assets that contribute to the 2°C trajectory objective, will still not have the appropriate tools (benchmarks) to assess the performance of their low-carbon funds/portfolio. The lack of minimum standards for the methodologies to develop low-carbon indices would continue to affect their comparability and relevance. In addition, it will not incentivise companies to align their corporate strategies with climate goals.

With regard to point 2, relevant entities will still lack regulatory incentives to disclose to their clients in a transparent way how they integrate ESG factors in their investment decision/advisory process, making it more difficult and costly for end-investors to make informed decisions. Even though the reputational benefits of external communication on ESG integration may create incentives for more voluntary disclosures, such disclosures will not be systematic, coherent nor harmonised. Transparency on ESG factor integration will thus remain limited.

A related issue that is likely to persist is greenwashing of products/services that pursue ESG objectives. Eurosif (2016) for example, finds that roughly half of surveyed assets under management are said to subject to an ESG investment strategy. However, the strategy used to make these products/services environmental-friendly is mostly based on exclusionary screening policies, 42 which are easy to implement, but may not always contribute to sustainability in the way that is advertised. There is a risk that investors and beneficiaries will continue to perceive a certain level of sustainability and environmental impact in their investment, whilst that often may not be the case.

Finally, as regards point 3, most Member States would likely remain without any classification in place or adopt a selected international classification by tailoring it to national policy priorities. As a result, divergence of definitions as to what constitutes a sustainable economic activity, for the purposes of investment, is likely to further increase. Market-led or market-driven classifications of sustainable economic activities and those provided by international bodies (that serve as baselines for Member States) would likely expand their scope, but progress would likely remain limited to subsets of environmental factors. Given the slow pace of development that has been observed over the last decade, it is likely that no substantial improvement in the coherence of different classifications would be achieved within the medium to long term.

In the absence of a common framework to understand what constitutes a sustainable economic activity, for the purposes of investment, the greenwashing issue would become even more sensitive. Due to an increasing variety of labels and standards available on the market, it would be difficult as well as costly for investors and beneficiaries to know whether the products they invest in meet their expectations. This would hamper not only demand for sustainable investments, but also trust in financial institutions.

5.2. Methodology

To identify the policy options for each of the three problem drivers identified in section 2 (and the corresponding specific objectives in section 4), three options were considered: (i) a non-legislative approach, (ii) a "light" regulatory approach, and (iii) a more comprehensive regulatory approach. For each of the problem drivers, the most realistic policy options were assessed. An overview is provided in the table below.

Table 3: Methodology table

X = discarded; ✓= assessed.

5.3. What is the scope of the various initiatives?

Before describing in detail the possible different options for each of the four initiatives considered in this impact assessment, and without pre-empting the choice of a preferred option, it is worth underlining that the four initiatives being assessed - because they are addressing different problem drivers - will not apply to the same universes of investments, and thus will have different scopes in terms of financial entities, financial products/services and economic sectors impacted. (Section 6.1. describes in more detail the exact scope of the preferred option for each of the four initiatives in terms of financial entities, financial products and economic sectors impacted).

The initiatives related to Drivers 1 and 2 (namely the requirement to integrate ESG factors in the investment decision and advisory process and to disclose this information) would be expected to have an impact on all types of investment, whether sustainable or not. Therefore, these initiatives would have an impact on all financial products offered and services provided to end-investors by the relevant financial entities. They would make consideration of ESG integration mainstream in all investment decisions and advisory processes of these entities - without however 'forcing' investment into sustainable economic activities. As a result, all economic sectors could be impacted. Note that ESG integration as commonly interpreted by market participants in the context of duties towards investors/beneficiaries, refers to the environmental/social/governance risks that could affect the financial returns of the product/services offered/provided by the relevant entities.

The initiative's proposal to address Driver 3 (to provide clarity on what constitutes a sustainable economic activity by setting out a framework for developing an EU taxonomy) could, by definition, have a direct impact on investments and financial products deemed sustainable. The universe of investments, financial products and thus financial entities affected by this specific initiative would therefore be much more limited than those affected through the initiatives addressing problem drivers 1 and 2. Only economic activities considered or marketed as 'sustainable' would be impacted by this initiative. Thus, it would not correspond to the broad set of ESG factors that could affect an investment’s financial performance as is the case under the initiative aiming at clarifying the duties towards investors.

The initiative aimed at setting minimum standards for the methodologies used to develop low carbon indices would have an indirect impact on those investments and financial products deemed to be and identifying themselves as ones that contribute to the lowering of carbon emissions (including the financial entities that offer them). The universe of investments, financial products and thus financial entities affected by this specific initiative would therefore be even more limited.

5.4. Duties toward investors/beneficiaries with regards to ESG factors

5.4.1. Description of the policy options

Option 1: do nothing. 

See baseline scenario in section 5.1.

Option 2: clarification of existing EU rules on duties towards investors/beneficiaries (non-legislative approach)

This option would provide clarification that the existing duties of relevant entities towards investors/beneficiaries do not prevent, but even support the integration of material ESG factors in the investment decision-making process and in the advisory process, even though this is not explicitly mentioned in most existing EU rules. More specifically, it would clarify, via a Commission communication or recommendation, how existing EU rules are to be interpreted vis-à-vis the integration of ESG factors in the investment process and advisory process as part of the duties towards investors/beneficiaries.

Under this option, relevant entities would be encouraged to follow (on a voluntary basis) the interpretation or recommendation of the Commission. This option would also provide further encouragement to Member States and industry bodies to align their rules and principles/practices with the interpretation provided by the Commission.

The use of non-binding tools and self-regulation grants relevant entities a high level of flexibility with regard to the integration of ESG factors in existing processes/procedures in the areas of risk management, investment strategy, asset allocation, governance and suitability assessment. This option could build on or refer to existing work by international bodies (e.g. OECD) and current (best) market practices. As compliance with the communication or recommendation would be voluntary, public authorities would have no power to enforce them.

Option 3: explicitly require the integration of ESG factors in the investment process and the advisors' recommendation process as part of duties towards investors/beneficiaries (light regulatory approach)

The current applicable rules do not explicitly refer to ESG factors and this leads to different interpretation of duties towards investors/beneficiaries with respect to ESG factors integration and creates legal uncertainty on whether and how these should be considered.

ESG integration is increasingly performed but it is not a widespread practice as it is hampered by the existing legal uncertainty. Some entities, in fact, do not analyse these factors, either because they do not have the tools and the ESG-related knowledge to do it or because they confuse ESG integration with ethical investing, which implies accepting lower risk-adjusted returns, which would not be in the best interest of their clients/beneficiaries.

This option would clarify that relevant entities, in order to act in the best interest of clients and coherently with the mandate, need to consider also ESG factors within the processes and procedures they have already in place to assess all relevant financial risks.

This option would specify that relevant entities are required to consider ESG risks as drivers of value in their investment process or investment advice as part of their duties towards investors/beneficiaries. More specifically, it would detail how and where material ESG risks are to be integrated within the procedures in the areas of investment strategy, risk management, asset allocation and governance, as they do for financial risks. This option would not prescribe how and where relevant entities need to invest, while performing their duties to investors/beneficiaries. If, as a result of their assessment, they find out that ESG factors have no material impact on the financial performance, they will not take them into account in their investment decisions/advisory recommendations. However, where asset managers and institutional investors pursue a low carbon emission objective, they will be required to designate an appropriate benchmark, such as the EU low carbon or the positive carbon impact index as a reference benchmark.

For investment advisors, individual portfolio managers and insurance distributors, this option would also detail how and where ESG preferences are to be integrated within the suitability assessment and the product selection.

The sectoral EU frameworks (i.e. the AIFMD Directive 2011/61/EU, the UCITS Directive 2009/65/EC, the MiFID II Directive 2014/65/EU, the Solvency II Directive 2009/138/EC, Directive IDD 2016/97/EU) with the only exception of the IORPs II Directive 2016/2341, already foresee empowerments to specify the details of the relevant entities' duties in the area of governance, asset allocation, investment strategy, risk management, the suitability assessment and the product selection. Under this option, the current duties laid down by the above mentioned sectoral EU frameworks 43 would be further specified through level 2 measures either (i) making use of the existing empowerments or (ii) introducing new empowerments (under Directive 2016/2341) having regard to the following areas:

·Corporate governance: the integration of specific ESG considerations within governance arrangements and policies of relevant entities (e.g.: board responsibility, including a ESG specific committee and/or board member(s) in charge of approving ESG risk limits and overseeing their implementation; internal control functions responsible also for checking the effectiveness and adequacy of procedures, measures and policies specifically considering ESG factors integration; skill, expertise and knowledge on ESG factors, remuneration; ESG financial expertise).

·Investment strategy: the integration of specific ESG considerations in the product investment strategy. 

·Risk management: the identification, measurement, management and monitoring of the risks stemming from ESG factors within the overall risk management process. The risk assessment should not only be limited to financial risks. The quality and depth of the assessment of ESG factors depends on the investment policy (it varies according to asset classes: currency, for example, would be more difficult to assess than equity), the investment strategy (volatility-based strategies are more difficult to assess then equity long-short), and the available information.

·Asset allocation: the integration of material ESG risks into the asset allocation and ongoing monitoring of the portfolio.

·Suitability assessment: the integration of ESG factors into the suitability assessment process with the client. Firms providing investment advice would introduce ESG–related questions as part of client preferences, objectives and risk appetite. Based on the client’s profile, they would offer or recommend products (for example, collective investment funds, insurance-based investment products) and/or services that reflect ESG considerations. 

·Product selection process: investment advisors should take into account ESG factors when assessing the range of financial instruments to be recommended to a client - in line with client's investment objectives - in order to ensure that ESG risks are adequately taken into account in the assessment of the target market. Asset owners and investment intermediaries should ensure that they have a sound understanding of the broad range of long-term interests and preferences of their clients and/or beneficiaries. This understanding should lead to an investment policy that is compliant with prudent person and incorporates the possible preferences stated by beneficiaries on ESG.

This option would either amend current Level 2 measures on general organisational and operating conditions or, where such measures do not yet exist as is the case under IORP II, introduce them in a consistent way. The Delegated Acts will be based on advice by the ESAs. As regards the suitability assessment, ESMA guidelines would be modified pursuant to Level 2 amendments. All these amendments would require public consultations of market participants.

Table 4: Discarded option for duties towards investors/beneficiaries

5.4.2. Pros and cons

Table 5: Pros and Cons of options on duties towards investors/beneficiaries

5.4.3. Impact on stakeholders

The table below assesses the impact of the policy options described above on key stakeholders. The following scale is used to assess the magnitude of the impact as compared with the baseline scenario (the baseline being indicated as 0): ++ strongly positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable.

Table 6: Impact on stakeholders of options on duties towards investors/beneficiaries

The different options would only indirectly affect issuers as this initiative mainly adds clarification and coherence across sectors. Integrating ESG factors under investors’ duties means, with regard to asset managers and institutional investors, that they would assess the sustainability risks of their portfolios as a whole, mainly over the long term. If this first preliminary assessment leads them to conclude that there are no risks deemed to be relevant for the portfolio stemming from those factors, then no further analysis is required. If, on the contrary, sustainability risks are relevant, under the current rules, it is necessary to assess their impact on the performance of the portfolio and therefore collect the necessary information for this purpose from investee companies.

Assessing the relevance of these sustainability risks for the investment portfolio as a whole is a broader concept than the risk that individual investee companies that are part of the investment portfolio pose in terms of sustainability. The broader risk related to the portfolio is not necessarily linked to the activities of individual companies because ESG risks also affect companies that do not carry out sustainable activities.

Since interviewed asset managers indicated that the lack of good quality and comparable data from companies is a barrier to assess the risks related to ESG factors, they are expected to engage with the investee companies to increase the level and quality of the ESG information disclosed from issuers if they target investments in those companies.

5.4.4. Stakeholder’s views

The table below summarises the views of stakeholders based on the results of the public consultation on duties towards investors'/beneficiaries and on targeted interviews with financial institutions held in January 2018.

Table 7: Stakeholder's views on duties towards investors/beneficiaries*

*See Annex 2, Section 13 for a more detailed and differentiated overview of stakeholders’ views.

5.4.5. Comparison of policy options

Table 8 below summarises the extent to which the options are effective, efficient and coherent. Effectiveness is mapped against the specific objectives set out in section 4.2. The respective scores are attributed on the basis of the analysis of pros and cons above.

Table 8: Benchmarking policy options on clarity concerning ESG integration as part of duties towards investors/beneficiaries

Note: Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive (score 2); +/++ very positive (score 1.5); + positive (score 1); +/ ≈ marginal positive (score 0.5); – – strongly negative (score –2); –/– – very negative (score –1.5); – negative (score –1); ≈/– marginal negative (score – 0.5); ≈ neutral.

Effectiveness: Option 3 is the most effective in reaching policy objective 1, as it introduces harmonised requirements across all relevant sectors on how and where existing processes/procedures of relevant entities need to be adapted for the integration of ESG factors at EU level. Specifying the consideration of ESG factors in investment rules, governance requirements and risk management serves the purpose of avoiding different approaches across financial sectors and Member States in the implementation of the current duties towards clients and beneficiaries, thus increasing consumer protection, ensuring a level playing field among the financial market participants and enhancing competition. Option 2 also contributes to policy objective 1, but the level of harmonisation would be much lower compared to Option 3, given that implementation of the Commission’s communication or recommendation by relevant entities and Member States is voluntary. In terms of other objectives, Option 3 also provides the most tangible (albeit indirect) contribution to objective 2, as mandatory and harmonised ESG integration by all relevant entities enhances transparency by improving the comparability of the information that is disclosed to end-investors on ESG integration. Under Option 2, information on ESG integration would likely not be comparable due to the possibility for relevant entities to adopt diverging approaches on ESG integration.

Efficiency: Option 2 is the least costly option, as it involves very limited compliance costs. Entities that do not already integrate ESG factors may decide to do so according to their own approach. It is likely that relevant entities who already integrate ESG factors would continue doing so, with no or very low additional costs. Option 3 would also entail limited compliance costs. Feedback from the public consultation and targeted interviews indicates that these are part of the overall internal/organisational costs related to the risk management and monitoring of certain exposures.

In fact, the tasks foreseen for financial entities covered by this initiative would be incorporated within the existing organisational and operating procedures. More precisely, as indicated by stakeholders, there is no need to hire new staff. It is more a question of investing more systematically in ESG expertise (e.g. at employee and board level), data and tools. This could involve —depending on the current level of ESG integration — buying ESG data from third-party vendors, more systematic integration in the investment decision process and risk assessment, and possibly further task specialisation and more active engagement with companies on topics related to ESG.

ESG related information and data may not be directly available on the market or the available data may be of low quality and not comparable. As explained in the last paragraphs of section 5.4.3, relevant entities shall rely on non-financial information published by companies. Moreover, they can also engage with the investee companies to increase the level and quality of the ESG information disclosed by issuers when they target investments in those companies.

For example, an asset manager invests in a small company located in the Netherlands where there are risks of flooding due to climate change. As part of the duties towards its clients, the asset manager should take this risk of flooding into account. The information to analyse this risk will not come from the small company in this example, but will be related to the country.

Similarly, investing in companies in emerging markets which might be more vulnerable to negative effects of ESG risks such as extreme weather events, resource scarcity, social inequality, and poor governance, require relevant entities to understand the materiality of those risks for their portfolios’ performance. Finally, national regulation on ESG issues can also have specific impacts on companies operating in a given sector, for instance to offset carbon emission (see e.g. the Chinese government initiative to reduce carbon emission).

Follow up interviews with asset managers indicated that their financial analysts develop more expertise in geographic areas or sectors where less information is available exactly because they have to make more efforts to be able to analyse and measure both financial and non-financial (ESG risks) and their impact on financial returns.

Option 3 is only on procedures, not on methodologies, to grant financial entities the flexibility that they need, as they clearly stated in the targeted interviews: “not be boxed into precise and strict rules”. In details,

-Public consultation: we asked asset managers what the additional cost would be of integrating ESG considerations and offered the choice between several ranges. Respondents, with only one exception, chose the lowest range of costs.

-Targeted interviews: six out of 23 interviewed entities provided numbers on the perspective costs of ESG integration. For the small entities, the additional cost ranged from EUR 80 000 to EUR 200 000 per year (for buying external data, doing additional internal research, engagement with companies etc.), i.e maximum 0.0001 % of AuM (by way of comparison, the total cost for an equity fund is around 2 % per year 46 ). The highest relative additional cost we recorded was 0.0003 % of AuM per year (for a player with EUR 72 billion AuM). Since we cover small and large players, we have no reason to believe that it would be fundamentally different for other market participants.

The benefits under Option 3 are expected to be higher due to the adoption of harmonised criteria that would ensure more clarity and a coherent approach across sectors and Member States as regards the integration of ESG factors by the relevant entities. This would also end up in more reliable and comparable ESG information for end-investors.

Coherence: By introducing requirements on the integration of ESG factors in selected areas (e.g. governance, risk management and suitability assessment) across all relevant sectoral legislation, Option 3 would ensure overall coherence of the EU rules on duties towards investors/beneficiaries. Option 2 would likely only have a marginal positive effect on coherence, as integration of ESG factors remains voluntary. Option 3 is also in line with the HLEG final recommendation stating that the Commission clarifies that the fiduciary duties of institutional investors and asset managers explicitly integrate material ESG factors in their key investment activities, including investment strategy, risk management, asset allocation, governance. Regarding the first Draft of the ECON Report on Sustainable Finance, Option 3 is in line with the European Parliament's position that fiduciary duty must encompass ESG factors on a mandatory basis.

Option 3 is also more coherent than Option 2 with other EU recent initiatives that explicitly require the integration of ESG factors into the decision making process by institutional investors (IORP II, the revised Shareholders Rights Directive , and the recent Commission proposal on a Pan-European Personal Pension Product ).

Having established how the options score in terms of effectiveness, efficiency and coherence, table 9 also highlights how the options score in terms of the level of stakeholder support and overall level of regulatory ambition. The latter could be an indication of the political challenges associated with the options in question.

Table 9: Summary of pros/cons of options on duties towards investors/beneficiaries

Both Option 2 and 3 received broad support from industry with a preference for Option 3. Most stakeholders consider that it is part of the duties towards investors/beneficiaries to consider and analyse all risks that are material for an investment product/service and that clarification on this aspect would be welcome. The vast majority of stakeholders is against rigid and prescriptive rules, because the relevance of ESG risks depends on the characteristics of the investment strategy, the time horizon, etc. It is therefore important to allow some flexibility to take into account such diversity in business models among different types of relevant entities. The industry would welcome guidance on how to integrate ESG factors. In particular, entities already integrating ESG factors indicate that developing harmonised guidance would help ensure consistency across sectors and products/services. The choice of Level 2 measures to implement this policy option would be proportionate from this point of view.

Option 3 is the preferred option as it is the best way forward in view of the comparative analysis in terms of effectiveness, efficiency and coherence. At the same time, stakeholder support is medium/high for Option 3, because it strikes the right balance between harmonization and flexibility, while reaching the policy objectives of clarity on investors' duties and ESG factors' integration. The preferred option is considered as proportionate in terms of costs for relevant entities as it requires limited investment in ESG expertise, data and tools. Moreover, the criteria specifying how and where material ESG risks are to be integrated within the existing procedures will be developed taking into account the size, nature, scale and complexity of the activities of the relevant entity. This option therefore will achieve the intended objectives without imposing any unnecessary burden on the relevant entities. It also has limited indirect impact on issuers (including small issuers) as they are already largely required to disclose material non-financial information in their management report.

5.5. Increase transparency by disclosing how ESG factors are integrated in the investment and advisors' recommendation process and, for investments targeting sustainable objectives

5.5.1. Description of the policy options

Option 1: Do nothing. 

See baseline scenario in section 5.1.

Option 2: introducing mandatory disclosures at the level of the institutional investors, asset managers and investment advisors on ESG integration in the investment/advisory process (light regulatory approach)

This option would introduce specific disclosure requirements at the level of the relevant entities within the already existing transparency obligations, on how they consider ESG factors within their investment decision/advisory process. This option would be coherent with the current approach already taken under Article 30 of the IORPs II Directive.

This could be achieved through a legislative proposal that includes provisions to modify the current sectoral rules (i.e. AIFMD, UCITS, MiFID II, Solvency II, EuVECA, EuSEF, IDD and IORP II) and introduce new ones (pension providers other than IORPs) thus ensuring full across-sectoral consistency. The new disclosure requirements would be complemented by a transitional period.

Option 3: introducing mandatory disclosures both at the level of the institutional investors, investment advisors and asset managers and for the given financial product or service (comprehensive regulatory approach)

Sub-option 3.a): On top of the mandatory disclosure at entity level, as described in Option 2, this option would introduce specific disclosure requirements at the level of the financial product or service. For each financial product (e.g. collective investment funds, insurance-based investment products) or service they offer (e.g. investment portfolio management), relevant entities would be required to provide pre-contractual and contractual information (e.g. prospectuses) on how ESG risks are taken into account within the investment/advisory process they have in place and on the related impact on the risk-adjusted returns of the portfolio of the resulting investment decisions (e.g. in the funds' annual reports) or on product/investment recommendations.

Sub-option 3.b): This option foresees the same disclosure obligations described under sub-Option 3a concerning transparency on the integration of ESG factors, but in addition would require, for products/services pursuing sustainability objectives, specific disclosure on how the sustainability investment objectives are achieved and on the contribution of the investment decisions to sustainability objectives. More precisely, asset managers and institutional investors would need to disclose, in compliance with the investor’s mandate: (i) when they market their products/services as pursuing environmentally sustainable investment objectives, how and to what extent the criteria for environmentally sustainable economic activities in the EU taxonomy, once developed, have been used. How the environmental sustainability of the investments selected for the financial product/service is determined once the taxonomy is in place (once the delegated acts enter into application, see box 7 (section B) on the immediate use of the taxonomy); (ii) when they market their products/services as pursuing sustainability investment objectives, the calculation methodology used to assess, evaluate and monitor the adherence and the contribution of the investment decisions to the sustainability objectives.

In addition, in cases where an index has been designated as reference benchmark, asset managers and institutional investors would be required to inform end-investors, by means of pre-contractual and contractual information and websites, about whether an index has been designated as a reference benchmark, the appropriateness of the index, the alignment of the index with the sustainability objective and the degree of freedom to deviate from that index. Asset managers and institutional investors would also explain the reasons for different weighting and constituents of the reference benchmark compared to a broad market index.

In addition, the sustainability impact of the financial products consistent with its sustainability objective would be regularly reported through indicators relevant for the chosen sustainability objective together with the related calculation methodology. 47 For this purpose, in order to limit the indirect cost on issuers (including smaller issuers), financial market participants would have to use information that issuers are already obliged to provide in accordance with the Accounting Directive (Directive 2013/34/EU).

Where an appropriate index has been designated as reference benchmark, this information would also be provided in relation to the reference benchmark and also to a broad market index to allow for comparison.

Where asset managers and institutional investors market themselves as pursuing a low carbon emission objective and no index has been designated as reference benchmark, they would publish on their website an explanation of how they intend to ensure continued adherence to the low carbon emission objective.

Both sub-options encompass a legislative proposal that include provisions ensuring full across-sectoral consistency, in order to address in a coordinated manner shortcomings in investor protection measures and guarantee more legal certainty. The lack of transparency on the integration of sustainability risks and on the pursuance of sustainable investments would not be solved solely by amending existing Level 1 sectoral EU rules on pre-contractual information and on reporting (i.e. AIFMD 48 , UCITS, MiFID II, IDD, Solvency II, EuVECA, EuSEF, and IORP II), as this could give rise to an uneven implementation among sectors and Member States. New rules would be introduced for pension providers other than IORP II. A directly applicable regulation, providing full harmonisation, is necessary to achieve the policy objective of increasing transparency on the integration of sustainability risks and on sustainable investments. A regulation, therefore, should best deliver maximum harmonisation avoiding divergences and thus ensuring greater regulatory convergence. Targeted Level 2 measures further specifying the details of the presentation and content of information on sustainability investment objectives to be disclosed in pre-contractual documents, periodical report and websites of relevant entities are also envisaged.

5.5.2. Pros and Cons

Table 10: Pros and Cons of options on disclosure

5.5.3. Impact on stakeholders

The table below summarises the overall assessment of the options to increase transparency by introducing disclosure requirements. The following scale is used to assess the magnitude of the impact as compared with the baseline scenario (the baseline being indicated as 0): ++ strongly positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable.

Table 11: Impact on stakeholders of options on disclosure

Furthermore, these options will also indirectly impact the content of the information disclosed by issuers. Option 2 and 3 will further incentivize issuers to disclose relevant ESG information that could be used by asset managers and institutional investors to assess the adherence and contribution of the product/service to the sustainability objectives pursued.

5.5.4. Stakeholder’s views

The table below summarises the views of stakeholders based on the results of the public consultation on duties towards investors'/beneficiaries (EC2017b) and on the targeted interviews with select stakeholders.

Table 12: Stakeholder's views on options on disclosure*

*See Annex 2 Section 13 for a more detailed overview of stakeholders’ views. Please note that stakeholders were only asked about the disclosure on how they integrate ESG factors in their investment decision or advisory process (Option 3a).

5.5.5. Comparison of policy options

Table 13 summarises the extent to which the options on disclosure are effective, efficient and coherent. Effectiveness is mapped against the specific objectives set out in section 4.2. The respective scores are attributed on the basis of the analysis of pros and cons above.

Table 13: Benchmarking policy options on disclosure on ESG integration and sustainability objectives

Note: Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive (score 2); +/++ very positive (score 1.5); + positive (score 1); +/ ≈ marginal positive (score 0.5); – – strongly negative (score –2); –/– – very negative (score –1.5); – negative (score –1); ≈/– marginal negative (score – 0.5); ≈ neutral.

Effectiveness: While Option 2 introduces high-level disclosure at entity level on ESG integration, Option 3a and 3b also require more granular disclosure at the level of the product/service on how ESG factors are integrated in the investment decision/advisory process and on the impact on portfolios resulting from investment decisions. Hence, these options are more effective in achieving specific objective 2. Option 3a requires relevant entities to disclose how they integrate ESG factors in their investment decision-making process, as part of their duties, i.e. how they comply with the investors' duties requirements (independently of whether ESG risks are material or not for their product/service). Asset managers indicated during targeted interviews that, even if they have risk management processes in place to analyse ESG risks, as part of their duties, they are not very transparent on this towards their clients. Option 3a reduces asymmetric information between asset managers and end-investors on this, making the latter ones more aware of all risks deemed material for the product/service they invest in.

The transparency requirement on ESG integration under investors’ duties alone would not satisfy the end-investors’ need to identify “ethical investments”. It is the second disclosure requirements, under Option 3b, on products/services pursuing sustainability objectives that would satisfy this need. Option 3b foresees on top of the same disclosure requirements as under Option 3a, that asset managers and institutional investors disclose information on how the sustainability objective of the investment decision is achieved when they market their products/services as pursuing sustainability investment objectives. Option 3b also foresees disclosure on the contribution/impact of the fund/portfolio to this sustainability objective.

Hence, Option 3b is considered the most effective, as it will also provide end-investors with concrete tools to identify investments that are aligned with their sustainability preferences. In turn, this positively contributes to increasing transparency on what is the ESG impact of these investments, and will reduce the risk that relevant financial entities claim their products to be more sustainability-friendly than they are in reality. Given the heterogeneous methodologies existing for assessing ESG related risks and opportunities as well as for calculating the contribution to the sustainability objective pursued with the investment decision, it may remain difficult for end-investors to compare these methodologies. With regard to specific objective 1, all options are expected to have a positive impact on the integration of ESG factors in the investment and advisory process. Increased disclosure (and consequently comparability) will likely increase market discipline, incentivising relevant entities to raise their standards on ESG integration.

Efficiency: Concerning disclosure on ESG integration, compliance costs would be higher under Options 3a and 3b than under Option 2, because these options require modification of product/service pre-contractual and contractual information, such as the prospectus and funds' annual reports. Modifying pre-contractual and contractual information of a product is the most costly element.

As regards pre-contractual information, according to one estimate provided by an asset manager, the cost of modifying and reissuing a prospectus is about EUR 40 000 per product. However, feedback received from stakeholders and targeted interviews also highlighted the fact that, because of regulatory changes or other reasons, they have to revise the prospectuses of their product at least every year anyway. If the prospectus has to be periodically revised in any event, the cost of adding ESG related information should be a fraction of it. Therefore, to avoid additional costs, Options 3a and 3b foresee a transitional period meant to reduce considerably compliance costs.

Even though no quantitative data have been provided by stakeholders, in the public consultation and targeted interviews, relevant entities mentioned the potential of attracting new investors when disclosing ESG integration and sustainability objectives. Moreover, for end-investors, the costs of searching for the investments that correspond to their sustainability preferences will be reduced.

Cost related to the disclosure of the impact of investments on sustainability objectives, as well as on the related calculation methodologies have not been directly assessed. However, these costs are not expected to be significantly high. For sustainability products, asset managers and institutional investors are expected to rely on their existing tools/methodologies to measure that impact. Follow-up calls with some industry representatives clearly indicated that it is very difficult to manage “what you don’t measure”, meaning that they already have methodologies to calculate the “sustainability-related” impact of the funds compared to those of the benchmark.

Coherence: Options 3a and 3b are the most coherent with other EU rules and recent initiatives having the objective of increasing transparency on ESG factors in the markets and to the benefit of end-investors, such as the revised Shareholders Rights Directive , the Commission Proposal on a Pan-European Personal Pension Product (PEPP), the Directive on disclosure of non-financial information. Where institutional investors and asset managers make available packaged retail and insurance-based investment products, coherence with the procedural requirements foreseen by the PRIIPs Regulation for products targeting environmental and social objectives is ensured.

Having established how the options score in terms of effectiveness, efficiency and coherence, table 14 also highlights how the options score in terms of the level of stakeholder support and overall level of regulatory ambition. The latter could be an indication of the political challenges associated with the options in question.

Table 14: Summary of pros/cons of options

All options received support from stakeholders with a preference for Option 2. All stakeholders consider it important to increase disclosure at the level of the entity on the integration of ESG factors. Those entities already integrating ESG factors, mostly disclose information on this on their websites. The majority of respondents from industry support disclosure on ESG integration at product level, while a few oppose. 51 However, the overall feedback is that more harmonised disclosure on ESG integration would be very useful for end-investors, in particular for retail investors. Option 3b was mostly supported by entities that already have Socially Responsible Products (SRI). They underlined that there is currently a very heterogeneous level of disclosure on impact indicators for sustainability issues and only for a limited part of the ESG portfolio. These respondents also suggested to start gradually, for example with climate issues, where methodologies and efforts to build the effects of climate change related risks into business models are more developed.

In terms of level of ambition, Option 3b is rated as the most ambitious, as disclosure would also cover information on how the sustainability objective of the product/service is achieved and on the contribution/impact of investment decisions on that objective, but at the same time corresponds the most with the political urgency to take action on sustainability issues.

Option 3b is preferred given that it is the best way forward in view of the analysis of the comparison of options in terms of effectiveness, efficiency and coherence in Table 14. It reaches the policy objectives of higher transparency and reduced search costs for end-investors on both the integration of ESG risks in their investments and on how sustainable their investments are (where the investment product is marketed as such). The preferred option is considered as proportionate as regards the cost for relevant entities and the indirect cost for issuers. As regards the cost for relevant entities, it is not expected to be high as they can rely on their existing tools/methodologies. As regards the indirect cost for issuers, relevant entities would have to use the information provided by issuers in accordance with the Accounting Directive (Directive 2013/34/EU). This would limit the indirect cost for issuers (including smaller issuers) to disclose additional information.

5.6 Clarity on what are considered sustainable economic activities

5.6.1. Description of the policy options

See Annex 8 section I for a tree schematising the policy options and the key questions for retaining/discarding them.

Option 1: do nothing

See baseline scenario in section 5.1.

Option 2: EU environmental taxonomy with medium granularity (light regulatory approach)

Option 2 envisages the creation of an EU taxonomy on what can be considered an environmentally sustainable economic activity, for the purposes of establishing the environmental sustainability of an investment. This approach would identify and classify economic activities grouped by macro-sectors, sectors and sub-sectors 52 that have a clear positive impact on one or several of six environmental objectives aligned with the EU's public policy goals:

1.Climate change mitigation;

2.Climate change adaptation;

3.Water resource management and conservation (water efficiency and sustainable management and withdrawals);

4.Circular economy and waste management;

5.Pollution prevention and control (pollutants to and in air, land, water and sea) and reduction of noise impacts;

6.Healthy natural habitats (protecting and enhancing land & marine habitats and biodiversity).

Within each macro-sector, the taxonomy would identify the economic activities (per sector and sub-sector) that contribute unambiguously to at least one of these six environmental objectives. 53 An additional condition for an economic activity to be included in the taxonomy would be that it does not significantly harm any of the other EU environmental objectives ("do no harm" principle). In addition, the economic activity would have to be carried out in compliance with minimum international standards. 54 This would ensure that investments in economic activities which infringe on other environmental objectives and/or minimum international and national standards, are excluded. 55  

The list of eligible economic activities would not contain economic activities whose contribution to at least one of the six environmental objectives (i) is not unambiguous and/or (ii) depends on additional criteria. For example, the building sector would be excluded from the taxonomy developed under Option 2 as its' possible contribution to EU environmental objectives depends on the definition of further criteria such as, for example, energy efficiency performance.

See Annex 8 section IV for an illustration of the taxonomy under Option 2.

The legal instrument envisaged in Option 2 would be a directive. This directive would provide (i) the six EU environmental objectives and (ii) the list of eligible economic activities. The directive would achieve minimum harmonization at EU level. It would grant sufficient discretion and flexibility to Member States to (i) identify at national level more economic activities contributing to the six environmental objectives, and/or (ii) provide for more granularity in the additional criteria necessary for an activity to be considered environmentally sustainable for this taxonomy.

The directive would be subject to a review clause every three years with the objective of (i) taking into account possible technological developments or improvements in the knowledge and expertise on environmental issues and (ii) integrating social objectives and sectors contributing to those objectives, as knowledge gradually increases on these aspects.

Option 3: EU environmental taxonomy with high granularity (comprehensive regulatory approach).

Option 3 would lay down a framework for creating an EU environmental taxonomy on what can be considered an environmentally sustainable economic activity, for the purposes of establishing the environmental sustainability of an investment. As will be explained throughout this and the next section, the precise criteria and each and every use of the taxonomy will be subject to impact assessments before being implemented.

Option 3 would be more comprehensive and granular than option 2 thanks to the introduction of technical screening criteria to determine whether an economic activity substantially contributes to one or more environmental objectives.

The framework developed under Option 3 would thus identify:

·the same six environmental objectives as under Option 2;

·economic activities (grouped by macro-sector, sector and sub-sector) that can contribute to any of the six environmental objectives;

·technical screening criteria which would identify economic activities that are considered to contribute to the environmental objectives set out under the framework. The technical screening criteria would include:

o"screening issues" highlighting in general terms the most important potential impacts; 56

owhere possible and relevant, "quantitative screening criteria" i.e. metrics 57  and thresholds;

o"qualitative screening criteria;" 58  

oadditional requirements to be put in place in order to ensure the coherence of the development and use of the taxonomy; this will ensure that policy uses are properly impact assessed, and that the taxonomy (i) would not inadvertently lead to an undesirable diversion of investment activity, (ii) would not give rise to stranded assets, (iii) would not significantly hamper liquidity in financial markets, (iv) would not be disproportionately costly, (v) would not give rise to greenwashing, and (vi) is sufficiently clear so as to not create a litigious environment.

To understand the need for technical screening criteria, consider the example of a green bond issued by a construction company for a building that is energy efficient and thus, contributes to climate change mitigation – meaning that the environmental objective and the activity are clearly defined. Under Option 2, this bond would not qualify as it is not from an economic sector that in general can be considered green. On the contrary under Option 3, this activity would qualify. The technical screening criteria allow for the inclusion of green activities from brown sectors. Furthermore, the technical criteria would also provide for quantitative criteria against which the energy savings can be assessed, to ensure the extent to which the bond proceeds finance a project that truly contributes to climate change mitigation. In short, technical screening criteria could provide more flexibility and ensure a more level playing field within and between sectors, as they allow for more activities to be considered as environmentally sustainable, for the purposes of investments.

Under Option 3, similarly to Option 2, for economic activities to be included in the taxonomy, there has to be no serious conflict 59 with other EU environmental objectives ("do no harm" principle). In practice, according to this principle, an activity positively contributing to climate change mitigation can be considered environmentally sustainable if it complies with minimum requirements for the other 5 environmental objectives, as well as minimum social 60 and governance safeguards. This principle would help prevent situations whereby a mono-activity company, e.g. the producer of solar panels, would be considered green or sustainable even when - in an extreme situation - poor labour standards (i.e. use of child labour) are applied. This principle should be carefully calibrated for each activity so as to avoid cases of harmful trade-offs without unduly restricting the list of recognisable environmentally sustainable activities.

See Annex 8 section IV for an illustration of the taxonomy under Option 3.

The legal instrument envisaged under Option 3 would be a regulation which would notably set out a framework for the subsequent creation of an EU environmental taxonomy, laying down:

(I)the six EU environmental objectives to which activities must substantially contribute and to which they may not do significant harm;

(II)empowerment of the Commission to operationalize these objectives (both in terms of substantial contribution and ‘do-no-harm’) through the development of technical screening criteria, through a series of delegated acts. These technical screening criteria would be specific to macro sectors/sectors/sub-sectors and would lead to the identification of environmentally sustainable economic activities;

(III)the requirements for determining the technical screening criteria at Level 2, such as being based on scientific evidence and ensuring that all relevant economic activities (within an economic sector) are treated equally if they contribute equally to one or more of the environmental objectives (see also section 5.6.2).

In particular, the framing of this empowerment would ensure that technical screening criteria, to be developed in delegated acts, were calibrated in a way that ensures that eligible activities:

·provide a substantial contribution to one or more of the environmental objectives

·fulfil minimum requirements in order to ‘do no harm’ to any of the other environmental objectives

·are assessed in a way that avoids, inter alia: (i) distorting competition, (ii) providing inconsistent incentives, (iii) hampering financial market liquidity, and (iv) increasing the risk of stranded assets.

Additional information on how the taxonomy would be gradually developed, including the provisions of these minimum requirements and the management of risks, is provided in section 5.6.2.

There are four main reasons for this phased approach (i.e. starting with a regulation, followed by a series of delegated acts - covering gradually the six environmental objectives). First, the gradual development of the taxonomy allows for the careful selection of economic activities that would qualify under the taxonomy, which ensures that all relevant economic activities within a specific sector can qualify and are treated equally if they contribute equally towards one or more of the environmental objectives laid out in the proposed framework. Second, the gradual and phased approach would ensure the taxonomy is sufficiently stable and mature, having been tested with and reviewed by relevant stakeholders before being applied and used for the purposes of relevant financial services legislation (e.g. for disclosure requirements by asset managers and institutional investors offering products pursuing environmental objectives – see Box 7). This also means that each extension and each use of the taxonomy would be subject to the relevant impact assessments. Third, the phased approach would allow for the timely adoption of delegated acts on environmental objectives that require more urgent action and for which knowledge is more advanced (climate change), enabling the EU to reach some of its sustainability goals more swiftly. Fourth, this phased approach ensures sufficient flexibility for revisions to reflect future scientific, technological and market developments.

Same as in Option 2, the regulation would include a review clause after three years of entry into force. This 3-yearly review 61 would evaluate the Regulation as a whole, including whether there is a need to enlarge the scope of the taxonomy to also cover EU social objectives and hence the definition of socially sustainable economic activities (see also Box 5).

Box 5: A social taxonomy as a second step to get to a complete sustainable taxonomy

Table 15: Discarded options for an EU environmental taxonomy

5.6.2 How will the taxonomy be developed and updated (Policy Option 3)

Under Option 3, the taxonomy would be developed gradually through a phased approach. The proposed regulation would lay down the environmental objectives to which economic activities must substantially contribute and to which they may not do significant harm. The regulation would empower the Commission to operationalize these objectives through the development of technical screening criteria. These technical screening criteria would determine which economic activities would qualify as environmentally sustainable. The regulation would also frame this empowerment of the Commission, including setting out several requirements and important safeguards in developing the taxonomy through delegated acts. The regulation would lay down a review clause, which requires the Commission to publish a report evaluating whether the existing taxonomy remains fit for purpose and evaluating whether expansion to other sustainability objectives, such as social objectives, is appropriate.

The technical screening criteria for each environmental objective, covering both the criteria for what can be considered a 'substantial contribution' and for the notion of ‘do no harm’, would be developed through delegated acts, ensuring that a holistic approach is taken. Given the urgency to act and address climate change concerns, and the knowledge that has already been developed on this issue, there is a strong case for developing the technical criteria for the climate change mitigation and adaptation objectives first.

The expected timeline as well as the way the taxonomy would be developed, updated, and used is explained below.

Development and governance structure

Under Option 3, the proposal for a regulation would be adopted by the Commission in May 2018, and could be approved by the Council and the Parliament before the summer of 2019. The regulation, as explained above, would define the environmental objectives to which the economic activities must contribute to and to which they may do no significant harm, as well as the minimum social safeguards to which these activities must adhere.

The technical criteria for the six environmental objectives would be developed through delegated acts. Given the urgent need for climate change mitigation and adaptation, and given that most knowledge exists on these issues, the idea would be to first develop the technical criteria for these two objectives.

The goal would be to adopt the technical screening criteria for climate change mitigation and adaptation as soon as possible, and ideally by Q4 2019. 62 This would allow the EU to, among other things, clarify better by year-end 2019 how private capital can contribute to the achievement of EU's 2030 targets agreed in Paris. In order to move swiftly, the Commission would commence work on developing the technical criteria immediately, building on the input of a technical expert group, which is to be set up.

After the adoption of the technical criteria for the first two environmental objectives, this short-term governance structure would be replaced by a longer term governance structure, which would allow for the development of technical criteria for the other four environmental objectives, as well as for updating the existing technical criteria for the original two objectives, should there be a need for that based on technical or other developments. Starting from 2020, the technical expert group (the short-term structure) would be replaced by a Platform bringing together experts from both the public and private sectors. More details on this approach are provided below and in Annex 8 (where alternative options were considered and budgetary implications to develop and maintain a granular taxonomy were estimated).

Short-term governance structure and political oversight for developing the first taxonomy-elements by 2019:

·The Commission sets up a technical expert group by Q2 2018 through an open process (public call already published), which would be tasked to elaborate a taxonomy of eligible climate change mitigation activities by Q1 2019. The work of the technical group will expand further to climate change adaptation and other environmental areas later by Q2 2019. The European Environment Agency (EEA), the European Supervisory Authorities (ESAs) and the European Investment Bank (EIB) are expected to be part of this group.

·The Commission launches by Q3 2018 a public consultation on a draft framework for an environmental taxonomy, the responses of which will feed into the technical expert group's work.

·In order to keep the co-legislators fully informed on the progress and the direction of travel taken by the technical expert group in the development of the environmental taxonomy, the Commission will report at least twice a year to:

oEU Member States via a configuration of existing Member State expert groups or through a new expert group comprising representatives from national finance and environment ministries;

oThe ECON and ENVI Committees of the European Parliament.

The feedback gathered in these meetings will be channelled to and inform the work of the technical expert group. 63

·Relevant parts of the climate and environmental taxonomies will be presented to the Commission in the form of reports prepared by the technical expert group, with the support of a Commission secretariat.

Setting up of a new public-private platform steered by the Commission as of 2020

While the first taxonomy (i.e. the first list of environmentally sustainable activities with the relevant screening criteria) on climate change adaptation and mitigation 64 (the first two environmental objectives on the taxonomy) is expected by 2019 with the adoption of the first delegated act, and would coincide with the end of the initial mandate for the Commission technical expert group, there is a need to put in place a more robust long-term governance structure to update the EU taxonomy and further develop it for other environmental areas and possibly even social areas. This also caters to the need of providing for adequate political involvement in the further development and/or adjustments needed for such a taxonomy.

To this end, the Commission would create a new dedicated public-private platform on sustainable finance. This Platform would be set up as a Commission Expert Group similar to the format used for the set-up of a multi-stakeholder platform on the implementation of the Sustainable Development Goals and supervised by a Commission Inter-Service Steering Group.

Its core function would be to develop technical criteria for the other environmental objectives, and update the criteria for the two original environmental objectives. In addition, if the review of the Regulation on taxonomy concludes that the EU taxonomy should be extended to social aspects, this Platform would be tasked to develop the missing parts in the EU sustainability taxonomy (to be presented to the Commission in the form of reports).

The Platform’s additional tasks would include the promotion and monitoring of capital flows towards environmental and sustainable investments, providing advice to the Commission and EU Member States on their sustainable finance strategies, and fostering long-termism and transparency. It is expected that the core task of the Platform will gradually shift from developing and completing the EU taxonomy (including updates) to the role of an advisory and observatory body on sustainable finance over time.

Consequently, the Platform would contain two separate work streams. One work stream would be dedicated to the EU taxonomy and would be composed of public/private representatives/experts. 65 The other work stream would be responsible for the other tasks foreseen and would also comprise public and private sector representatives.

The Platform would have a full-time Chairperson. The Chairperson would be in charge of coordinating the Platform's output and reporting to the Commission Inter-Service Steering Group. The Chairperson would also ensure involvement of EU Member States and the European Parliament through regular dialogue/reporting.

A Commission Secretariat would support the work of the Chairperson and the public and private experts of the Platform. It would also ensure delivery of and consistency with the Platform's mandate.

Timeline for delegated acts

Assuming that the short-term governance structure delivers at least a list of activities (together with specific technical screening criteria) contributing to the first two of the six environmental objectives in 2019, it can be assumed that the Platform will be able to deliver every 18 months a report expanding the taxonomy by economic activities contributing to two additional environmental objectives, while updating the existing content (if need be). The provisional timeline foreseen for the adoption of the delegated acts would then be as follows:

·1st delegated act by year-end 2019 on at least economic activities contributing to environmental objectives #1 climate change mitigation and #2 climate adaptation;

·2nd delegated act by mid-2021 on environmental objectives #4 circular economy and waste management and #5 pollution prevention and control together with a revision/update of 1st delegated act;

·3rd delegated act by mid-2022 on environmental objective #3 protection of water and marine resources and #6 healthy eco-systems together with a revision of the second delegated act – this would complete the EU environmental taxonomy;

·4th delegated act by year-end 2026 on social objectives if review clause is successful – this would complete the EU sustainable (environment and social) taxonomy.

The timeline above is subject to many variables, including the speed of political negotiations (for both the regulation proposal in May 2018 and the review clause that could expand the scope to include social) and of course the time needed by the Platform to elaborate the technical elements. As such, it should be considered provisional. For example, on a more optimistic stance, it is possible that the scope of the first delegated act could also include environmental objectives other than climate change mitigation and adaptation and that already with the 2nd delegated act, the Commission (based on the work of the Platform) would be in a position to put forward a complete EU environmental taxonomy.

How the taxonomy will be expanded and updated.

As explained, under Option 3, the taxonomy would be gradually expanded, first developing the technical criteria for climate change mitigation and adaptation, and later for the other environmental objectives. In addition, the taxonomy (where technical criteria have already been established) would also be updated (as opposed to expanded) on a regular basis (whenever needed) in order to incorporate relevant technological or other developments.  66 Note that updating the existing taxonomy is different from the three-yearly review, which is meant to re-examine the content of the regulation as a whole (and not the technical screening criteria) as well as the potential need to expand the scope to other sustainability objectives.

The expansion is not likely to cause significant issues as a holistic approach would be taken. Moreover, the use of the taxonomy would not be mandated until it has reached sufficient stability and maturity (i.e. the application would be deferred by 6 months, after the delegated act has entered into force, providing for sufficient time to test the approach with stakeholders and ensure relevant financial market participants have a good understanding of the concept). As mentioned, the future first list of economic activities contributing to climate change mitigation and adaptation (which would be developed at Level 2 with the first delegated act) would also already take into consideration the other environmental objectives when employing the "do no harm" principle, which foresees the exclusion of activities causing substantial harm to any of the other environmental objectives. As such, the expansion to other environmental objectives (from #3 to #6) would not entail revisiting the previous version of the taxonomy, instead it would add further economic activities to it; or clarify to which extent economic activities already included in the list, e.g. for contributing to climate change mitigation (#1) would also qualify as environmentally sustainable because they positively contribute to e.g. natural habitats (#6). A regular update of the taxonomy (meaning the technical screening criteria) is however needed to reflect possible technological and scientific developments and is not linked to the expansion to additional economic activities contributing to further environmental objectives.

How much would it cost to develop and update the taxonomy?

The costs for developing and updating the taxonomy are reflected in the budgetary implications for running the Platform. There is no cost difference between developing the taxonomy in one single step versus doing so gradually through a phased approach: in both cases, the technical criteria would need to be developed.

Costs for progressively developing and maintaining an EU taxonomy over the longer-term, through the Platform on Sustainable Finance, concern two cost categories: administrative expenditure and operating costs.

The vast majority of costs concern administrative expenditure. European Commission services (DG FISMA, ENV, CLIMA) responsible for managing the Platform will have to provide permanent human resources to this task. In addition, European Supervisory Authorities (ESMA, EIOPA and EBA) which will play an important role in ensuring applicability of an EU taxonomy to financial products and coherence with EU financial legislation will need to be reinforced with qualified staff. EEA, which will assume a crucial role in respect to providing technical expertise across various environmental fields in the context of the Platform, will need to be equipped with qualified staff for this purpose.

In total, administrative expenditure of European Commission services and European bodies to carry out work on an EU taxonomy are estimated to be around EUR 9.7 million for a 4-year period starting from 2020. Additional operational costs of around EUR 0.8 million for a 4-year period will need to be budgeted, notably for the organisation of meetings of private and public experts, studies and IT infrastructure.

Once the operational set-up of the Platform has been elaborated in greater detail, more precise costs estimates would be available.

Currently, after having carefully considered the pros and cons, verification of compliance with an EU taxonomy is not foreseen and thus, potential verification costs are not reflected in the cost estimates. However, the Commission's legislative proposal will include a review clause as regards verification requirements at a later stage.

Moreover, it could be argued that not acting now on climate change implies an opportunity cost. There is a strong economic case for a rapid low-carbon transition: the incremental capital cost of shifting investments for the IEA 66% 2°C scenario could be entirely offset as an integral part of a new growth model for low-carbon growth (OECD 2017a, OECD 2017b). There are clear negative macroeconomic implications of delayed action, and the cost of inaction has been assessed to be colossal, 67 including for financial institutions, such as banks and insurers who will be exposed to greater losses as a result of dwindling natural resources and weather-related disasters: between 2007 and 2016, economic losses from extreme weather worldwide have risen by 86% (EUR 117 billion in 2016) (IMF 2014) and it is estimated that close to 50% of the exposure of Euro area banks to risk is directly or indirectly linked to risks stemming from climate change. 68  

Framing of the empowerment: managing the challenges of building a taxonomy

As explained above, Option 3 lays down the framework for a process to develop the taxonomy over time. The proposed regulation on taxonomy would therefore foresee an empowerment to the Commission to specify the technical criteria and hence the determination of environmentally sustainable economic activities through a series of delegated acts. This empowerment is framed in terms of the requirements that need to be fulfilled when determining the environmental sustainability of an economic activity. First and foremost, these requirements mean that environmentally sustainable economic activities must:

1.contribute substantively to at least one of the six environmental objectives laid out in the proposal;

2.not harm any of the other environmental objectives extensively;

3.be carried out in compliance with a number of minimum social safeguards.

The technical screening criteria that would be developed are specific to the sub-sectors, so the proposal envisages that the Commission would specify qualitative technical criteria and quantitative technical criteria/thresholds (where applicable) through delegated acts. The proposal also defines certain requirements for how these technical screening criteria should be set at level 2: for example they would need to be based on available and conclusive scientific evidence, be proportionate to the nature and the scale of the economic activity, build on existing labelling and certification schemes, identify the most relevant potential contributions as well as the most relevant potential harms of the economic activity, and so on.

This approach is both selective, when ensuring that only activities with a substantive positive contribution to environmental objectives are considered, while remaining flexible as it does not limit the type of company or industry that can engage in such an activity. This means concretely that an economic activity that provides a significant positive contribution would be considered environmentally sustainable, even if it is carried out by a company from a traditionally 'brown' sector. Indeed, many of the economic activities with a large negative impact on the environment can also provide a substantial contribution to environmental objectives, by reducing this impact. The proposed taxonomy caters for this possibility. For such economic activities, it is appropriate to set out technical screening criteria that require a substantial improvement in environmental performance compared, for example, to the industry average. On the other hand, for those economic activities that are in "green" sectors where the environmental performance is already quite high, such a principle would not apply as they all provide a positive contribution to a given environmental objective and therefore would be considered environmentally sustainable.

As explained also further down, the notions of "contributing substantially to sustainability" and "do no harm" would be made operational through secondary legislation when the technical screening criteria will be developed through a series of delegated acts. See below "Operationalizing ‘substantial contribution’ and ‘do-no-harm’: how it works" for an example.

There are a number of potential risks that could arise in the development of the taxonomy, which will also need to be appropriately addressed and acknowledged in the proposed framework. These include:

·the potential of unfairly disadvantaging certain sub-sectors over others (as the technical screening criteria would be specific to each sub-sector);

·difficulties in operationalising the key requirements eligible economic activities will have to fulfil (in particular with regards to the interaction between the criteria and existing Union legislation as well as the interaction between the notions of 'do no harm' and 'substantial contribution'). Such challenges, if they are not acknowledged from the outset, could lead to institutionalised greenwashing, undesirable diversions of investment activity, stranded assets, and illiquid markets;

·raising disproportionate costs when not giving market participants sufficient time to prepare for the entry into application of the taxonomy, thus increasing litigation risks.

For these reasons, the empowerment will need to be appropriately framed and demarcated. In order to address potential burdens, including the creation of litigation risks, on financial market participants, the proposed framework would not foresee any immediate uses of the taxonomy (see also box 7). The operational provisions of the framework would only be applicable 6 months after the entry into force of the first delegated act, and at the same time as its entry into application. This would ensure that the taxonomy has been sufficiently consulted with stakeholders, to create buy-in and a good understanding of its nature, before being applied.

The delegated acts setting out the content of the taxonomy would be impact assessed to ensure the criteria are reasonably easy to apply and verifiable within reasonable cost-of-compliance boundaries. Subjecting each expansion of the taxonomy to rigorous impact assessments will also tackle dangers of greenwashing, when ensuring that only truly environmentally sustainable activities are considered under the taxonomy. Moreover, any potential future uses of the taxonomy would be subject to their own impact assessments. The date of entry into application of any future uses of the taxonomy would be calibrated in such a way, so as to allow financial market participants to prepare for its application.

The framing will also lay out a number of requirements that the delegated acts will need to fulfil with regards to avoiding undesirable diversions of investment activity and not giving rise to stranded assets when properly assessing transition risk that may arise when developing the taxonomy in stages. In order to appropriately address this risk, the framing will require the simultaneous development of the criteria laying out what can be considered a 'substantial contribution' to an environmental objective while at the same time clearly demarcating what would be considered to 'harm' any of the other objectives. The aim is that no activities are captured that will further down the line be no longer considered eligible.

Such assessments would also take account of existing EU legislation and policies: with regards to the notion of 'substantial contribution', the technical screening criteria would build on existing policies where possible, but go beyond what is required in existing legislation if necessary. Similarly, for the notion of 'do no harm', the minimum requirement, for instance in the area of protection of natural habitats, would be EU policies but technical screening criteria can be more stringent in areas, where there is no existing EU legislation.

In order to avoid distorting competition when raising financing for environmentally sustainable economic activities, the technical screening criteria will also be required to ensure that all relevant economic activities within a specific sector can qualify and are treated equally if they contribute equally towards one or more of the environmental objectives laid out in the proposal (a fair assessment of investments). It is recognised that the potential capacity to contribute towards these environmental objectives varies across sectors, which should be reflected in the criteria. However, within each sector, such criteria should not unfairly disadvantage certain economic activities over others if the former contribute towards the environmental objectives to the same extent as the latter.

For instance in the energy sector, assuming the objective is climate change mitigation through the stabilisation of greenhouse gas concentrations, this would mean that sub-sectors such as solar and wind energy would be treated equally. In order to achieve the objective of stabilising greenhouse gas concentrations, renewable energy sources like solar and wind energy, whose carbon emission should be low, would have to fulfil a number of criteria such as for example (without pre-empting the technical work preceding the adoption of the delegated act):, having in place the dedicated transmission infrastructure and support facilities and relying on no or minimal fossil fuel back-up. A sub-sector such as geothermal energy would have to comply with different criteria, as it is not by definition carbon-neutral but has the potential to substantially contribute to climate change mitigation, if developed further. So the criteria may entail requiring the direct operational carbon intensity of the geothermal power plant to be lower than a certain threshold, measured in gCO2 per kilowatt-hour, which is a criterion that would not make much sense in the renewables space, but ultimately achieves the same goal of stabilising greenhouse gas emissions. These and similar considerations will have to be taken into account in the establishment of technical screening criteria by the experts and will be part of secondary legislation put forward by the Commission and overseen by the co-legislators.

The framing will also emphasise the importance of ensuring market liquidity, even with the entry of green securities, so as to safeguard financial stability.

In monitoring and evaluating the actual impacts of the regulation, future evaluations will also analyse to what extent the specific safeguards proposed to mitigate possible risks on e.g. competition aspects, fairness, excessive costs, consistency of incentives, risk of stranded assets, impact on liquidity in financial market, and greenwashing have worked in practice, and determine whether any adjustments are needed in some areas (see also Section 7).

Finally, in terms of geographical scope, while climate change as well as many other environmental challenges have a global or at least transboundary dimension, impacts arising from climate change and environmental degradation as well as their solutions are often very local and context-specific. These issues will have to be taken into account when developing the taxonomy by either i) defining the environmental sustainability of an activity with reference to a national, regional, local or sectoral average (as applicable, depending on the nature of the activity) or ii) if these aspects are too pronounced, restricting the list of environmentally sustainable activities to those where location-/site-specific aspects are less pronounced. This choice will have to be subject to an impact assessment when adopting the various delegated acts.

Operationalizing ‘substantial contribution’ and ‘do-no-harm’: a practical example

Under Option 3, the Regulation would outline the environmental objectives, while empowering the Commission to develop the technical screening criteria. These technical screening criteria would operationalize these environmental objectives, both in terms of substantial contribution and do-no-harm. By way of example, for the objective of climate change mitigation this could work as follows:

1.An activity must contribute substantially to the stabilization of greenhouse gases (as required by the Regulation). Which economic activities would qualify would depend per sector. Thresholds would need to be determined per sector, and this would be established through the technical screening criteria. For example, for a hydropower plant, one screening criteria could be a required ‘% of GHG emissions saved’ by avoiding substantial methane emissions from the anaerobic decomposition of biomass in reservoirs.  

2.In addition, such an activity should not extensively harm the other five objectives and the specific requirements laid out therein. For example with regards to environmental objective #6 "Healthy eco-systems", the hydropower plant must not lead to significant habitat fragmentation, which could be determined by a technical screening criteria on ‘maximum hectares of land use change’ allowed. This criteria would take into account relevant legislative and non-legislative instruments of the Union such as in this case the Council Directive 92/43/EEC of 21 May 1992 on the conservation of natural habitats and of wild fauna and flora.

Furthermore, a number of minimum safeguards as laid out in the proposal would need to be met, in order to ensure that environmentally sustainable economic activities also comply with minimum international social and environmental standards and guidelines, such as the ILO Core Labour standards.

Box 6: How does the taxonomy reflect EU standards and legal commitments in the area of environment and climate change?

Box 7: An EU taxonomy: what it defines and how it will be used

5.6.3. Pros and cons

Table 16: Pros and cons for options on EU sustainability taxonomy

5.6.4. Impact on stakeholders

As explained in section 5.6.2, the proposed approach would identify requirements with which an economic activity must comply in order to be deemed environmentally sustainable, namely: contribute to one or more of the EU environmental objectives; not do harm to other EU environmental objectives; adhere to minimum social and governance safeguards; and comply with technical screening criteria. As previously described, this 4th condition will be developed through delegated acts, and will determine the list of environmentally sustainable activities with the desired level of granularity and will operationalize the notions of "substantially contributing" and "do no harm".

The taxonomy would apply to (i) Member States when setting out requirements for financial market participants with regard to the labelling of financial products pursuing environmentally sustainable objectives, and to (ii) financial market participants offering financial products as environmentally sustainable, as they shall disclose how and to what extent the criteria for environmentally sustainable economic activities are used to determine the environmental sustainability of the investments selected for the financial product.

However

-until the technical criteria are developed by the Commission, these uses do not yet apply. The development of the technical criteria through delegated acts, is subject to impact assessments.

-the details for how financial market participants are to disclose their information, will be developed through its own delegated act, also subject to an impact assessment.

In short, when the technical criteria are developed through subsequent delegated acts, and the taxonomy becomes more granular, thorough impact assessments would be carried out. Nevertheless, some preliminary minor qualitative impacts are presented in this section 79 with the use of a scale assessing the magnitude of the impact as compared with the baseline scenario (the baseline being indicated as 0): ++ strongly positive; + positive; -- strongly negative; - negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable. 

Table 17: Impact on stakeholders of options on taxonomy

Options 2 and 3 would also indirectly affect issuers. Option 2 would incentivise issuers to disclose information as regards their environmentally sustainable economic activities. Option 3 would further incentivise issuers to disclose information as regards screening criteria. Investors would have to use such information to determine if an activity can be considered as environmentally sustainable. Nevertheless, it is not expected that issuers would face important additional burdens, as those who carry out eligible economic activities are expected to have this information already available. This information will be part of their business model and would be used to market their products or services. In any case, it will be up to the issuer to decide whether the benefits of demonstrating that their activities are sustainable (in terms of, for example, attracting new and cheaper capital) outweigh the cost of providing a limited number of data points.

5.6.5. Stakeholders’ views

The table below summarises the views of stakeholders based on the results of the public consultation on the Interim Report of the High Level Expert Group on sustainable finance and targeted interviews conducted by the Commission with financial institutions (see Annex 2 "Stakeholder consultation" for more details). Stakeholders were asked what an EU taxonomy should cover, whether they saw a need for regulatory intervention and what the initial scope of an EU taxonomy should be.

Table 18: Stakeholders views on an EU taxonomy

See Annex 8 Section VII for a more detailed overview of stakeholders’ views.

5.6.6. Comparison of the policy options

This section assesses the policy options in terms of their (i) effectiveness in addressing the three specific objectives set out in section 3, (ii) their efficiency, and (iii) their coherence. Lastly, this section calculates a score for each of the three policy options, adding up the results from the assessment of the impact on the various stakeholders in section 5.3.5.

Table 19: Benchmarking policy options on taxonomy

Note: Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive (score 2); +/++ very positive (score 1.5); + positive (score 1); +/ ≈ marginal positive (score 0.5); – – strongly negative (score –2); –/– – very negative (score –1.5); – negative (score –1); ≈/– marginal negative (score – 0.5); ≈ neutral.

Effectiveness: Option 3 is the most effective in reaching the three specific policy objectives as:

Policy Objective 1: Reorienting capital flows

-it’s more granular than Option 2, allowing for more sectors and activities to qualify under the taxonomy than Option 2, thus being able to have a bigger impact on reorienting capital flows.

Policy Objective 2: managing financial risks

-it supports the integration environmental objectives by institutional investors and asset managers in their investment/advisory process by providing a common language (EU environmental objectives, screening criteria and metrics);

- in addition, it is likely to indirectly reduce the lack of information from issuers, as companies will be incentivised to report which of their activities according to the taxonomy can be defined as green or sustainable, which will also facilitate the integration of ESG factors by institutional investors;

Policy Objective 3: fostering transparency

-it increases transparency for end-investors by introducing a common language on what is green or sustainable and by incentivising relevant entities to disclose sustainable-related information in accordance with this language, allowing for easier comparison by end-investors of the disclosed information.

-it provides full clarity on which activities are green (and eventually sustainable).

Option 2 is less effective in terms of reaching the specific policy objectives as it provides less clarity on what are sustainable activities compared to option 3 and has no clear or only a marginal 81 effect on the other objectives.

Efficiency: Option 3 is more costly than option 2 as the taxonomy needs to be (further) developed with the input of experts and various stakeholders, making this a resource and time intensive exercise for the Commission. Furthermore, the taxonomy under option 3 will need more maintenance in order to keep up with technological and other relevant developments. To fulfil these tasks, there is a need to set up governance arrangements, which will require budgetary resources. See Annex 8, section IV for more details on the governance.

Coherence: Both Option 2 and 3 are in line with the HLEG final report recommendation stating that the taxonomy should be developed as a matrix having EU objectives as columns and eligible sectors as rows (HLEG, 2018). However, option 3 goes a step further by going into more detail (i.e. eligibility criteria at the level of the activities), as also recommended in the HLEG final report. Option 3 is also more in line with the position of the ECON – as reflected in the first Draft of the ECON Report on Sustainable Finance. 82 Lastly, while there are no EU policies specifically covering the subject matter with which coherence could be assessed, both options are in line with the EU commitment to sustainable development by ultimately channelling more investments into sustainable economic activities. However, as explained above, option 3 is expected to be more effective than option 2 in achieving this commitment.

Having established how the options score in terms of effectiveness, efficiency and coherence, table 20 also highlights how the two options score in terms of the level of stakeholder support and overall level of regulatory ambition

Table 20: Summary of pros/cons of options on taxonomy

Option 3 is the preferred option given that it is the best way forward in view of the analysis of the comparison of options in terms of effectiveness, efficiency and coherence in Table 20. It scores higher on effectiveness and coherence. It is also generally supported by stakeholders. It also entails the highest level of ambition. The latter is necessary in order to maximise the contribution of the EU taxonomy towards achieving the EU sustainability objectives.

The benefits of the phased approach are inter alia that the gradual development of the taxonomy (i) allows for the careful calibration of economic activities that would qualify under the taxonomy, which ensures that all relevant economic activities within a specific sector can qualify and are treated equally if they contribute equally towards one or more of the environmental objectives laid out in the proposed framework; (ii) ensures the taxonomy would be sufficiently stable and understood by relevant market participants before being applied; (iii) allows for the adoption of delegated acts on environmental objectives that require more urgent action and for which knowledge is more advanced, enabling the EU to reach its sustainability goals more swiftly; (iv) provides sufficient flexibility to allow for the necessity of being updated to reflect future scientific, technological and market developments.

This proposal complies with the principle of proportionality as set out in Article 5 TEU. The proposed measure is necessary to achieve the objective of providing clarity to investors by harmonising at Union level the criteria used to determine the degree of environmental sustainability of an investment. Providing common criteria will enable investors to more clearly identify the degree to which an investment is environmentally sustainable, and compare such investments, including across Member States. The measure is furthermore proportionate, as the taxonomy will not be applicable immediately, and as the final impact of the taxonomy and of its uses is subject to impact assessments.

The option is positively evaluated based on the analysis of ‘Pros’ and ‘Cons’ in Table 16.

A number of requirements for framing the empowerment to develop technical screening criteria are foreseen in view of the risks associated with the option: ensuring the taxonomy is sufficiently tested and mature before being applied, ensuring the taxonomy would not inadvertently lead to an undesirable diversion of investment activity, would not give rise to stranded assets, would not significantly hamper liquidity in financial markets, would not be disproportionately costly, would not give rise to greenwashing, and is sufficiently clear so as to not create a litigious environment.

5.7. A methodology for low carbon benchmarks

5.7.1. Description of the policy options

The proposal to create a harmonised methodology for environmental benchmarks aims to improve the quality of market tools available to asset managers and institutional investors to comply with their fiduciary duties and to better measure the performance of their low carbon strategies. In effect, asset managers and institutional investors are meant to select, as part of their duties, a reference index (where appropriate) taking into account the fund/portfolio investment strategy and in compliance with the investor's mandate. The lack of appropriate and objective low carbon benchmarks for passive investment strategies or as a performance benchmark for active investment strategies were identified during targeted consultations.

Different categories of low carbon indices have emerged in the marketplace. While some benchmarks deal with the objective to lower the carbon footprint of a standard investment portfolio, others target only components that specifically contribute to the 2° degree objective set out in the Paris Agreement. Despite the different strategies, these benchmarks are commonly classified as 'low carbon' benchmarks. This increases 'greenwashing' risks, as current disclosure of methodologies is heterogeneous and does not allow for effective comparison for investment purposes. 

As a consequence, the Commission proposes to evaluate possible regulatory interventions to introduce a clear distinction between the low-carbon benchmarks or 'decarbonised' benchmarks and 'positive carbon impact' benchmarks. In this regard, where asset managers and institutional investors use these benchmarks to comply with their duties, they need to (i) ensure consistency of exposures to sustainability between portfolios/funds (both active and passive) and their referenced low carbon indices, and (ii) disclose information to end-investors on such consistency (see Option 3b on disclosure, section 5.5). As, by definition, passive strategies aim at replicating a referenced index, the exposure between the two would normally be consistent. For active strategies, consistency of the exposure across portfolios and their associated low-carbon benchmarks would be assessed by measuring the tracking error or the ratio between the market value of the securities that are in the low carbon benchmark and the market value of the securities in the parent index.

A harmonised methodology to select constituents of low carbon indexes (see annex 9 on the methodologies of low carbon benchmarks) would achieve the following objectives:

·to provide investors with a more effective tool to achieve the 2° Paris objective.

·to foster a generally accepted market standard to measure a company’s carbon footprint and, in turn, an investment portfolio’s carbon footprint;

·to ensure that this standard methodology provides forward-looking metrics with respect to firm’s current exposure to expected climate risk, and,

·to improve transparency of the methodologies. Index providers would be asked to provide details of the amount invested in the components of the index and on their weights, in order to help asset managers and investors to better understand the characteristics of the low carbon index. This could also provide an incentive for corporates to improve their disclosure.

Option 1: do nothing. See baseline scenario in section 5.1.

Option 2: Minimum standards and greater disclosure of the methodology used for 'decarbonised' indices

The basic construction principle of existing decarbonised benchmarks is to take a standard benchmark, such as the S&P 500 or NASDAQ 100, and remove or underweight the companies with relatively high carbon footprints.

"Decarbonisation" of a parent index involves both minimizing exposure to carbon risk, by completely divesting from a company with a carbon footprint exceeding a given threshold, but also reweighting the remaining index components to minimize the tracking error between the decarbonized index and the benchmark index. As long as carbon risk remains unpriced by the market, the two indices may generate similar returns, thus achieving no or minimal tracking error. But once carbon risk is priced or is expected to be priced by the market, the decarbonized index could start outperforming the benchmark. Therefore, these indices are suitable for long-term passive investors who seek long-term returns investing in a broad universe of companies.

In terms of environmental impact, decarbonisation of investment portfolios is still expected to be aligned with a temperature rise of 4-6° C (in contrast to the 2° C objective) as they mainly reproduce the universe of the parent benchmark.

This Option would harmonise the key elements of the methodology of 'decarbonised' indices at EU level ensuring compliance with minimum standards. The enhanced transparency would increase the comparability of the methodology and, thus, reduce the possibilities for greenwashing.

This Option would both:

(i) improve the transparency of the benchmark's administrator methodology, and,

(ii) set up minimum key elements of the methodology used to determine a decarbonised benchmark by providing details on:

·the integration of climate-related parameters;

·the description of the constituents of the benchmark; and,

·the criteria used for selecting and weighing them.

This Option could leverage on existing European methodologies approved by the Commission and largely used by corporate companies to calculate their environmental performance such as the Product Environmental Footprint (PEF) and the Organisation Environmental Footprint (OEF). 83 Moreover, this Option would be enshrined into law by amending the EU Benchmark Regulation with the addition of a new chapter establishing a new category of benchmarks. The amendment would include an empowerment for the Commission to define the minimum key elements of the methodology.

Option 3: Harmonised EU rules for 'positive carbon impact' indices

Under this Option, the Commission would create a harmonised set of rules covering 'positive carbon impact' indices (also called, 'pure-play' low carbon indices) at EU level.

Pursuant to the EU methodology, these indices would have to screen the entire investible (listed) universe of companies selecting those companies whose emissions savings ("avoided emissions") exceed the emissions they are responsible for ("induced emissions").

For avoided emissions and induced emissions, the EU methodology would require calculation of scope 1, 2 and 3 emissions as defined in the figure below.

Figure 5: carbon emissions

Source: Forum pour l'investissement responsible

* See Annex 9 for a detailed explanation of Scope 1, 2, 3 induced emissions

Such an index would most likely comprise only companies that, despite a residual carbon footprint, are engaged in the development of technologies that contribute to a significant reduction of carbon footprint. Companies that are likely to emerge as having the most favourable savings versus footprint ratios (Carbon Impact Ratio or "CIR"- avoided emissions divided by induced emissions, see Annex 9) are renewable energy producers or manufacturers that sell equipment whose use contributes to a reduction in the carbon footprint that stems from the production of energy. 

Companies within this category would be net-emission savers (thus their CIR value would exceed a ratio of 1). It is likely that only investment in companies with such carbon emission profiles could be considered aligned with efforts to cap global warming at 2°C 84 .   

This Option would be achieved by amending the EU Benchmark Regulation, through the insertion of a chapter establishing a new category of benchmarks. The Benchmark Regulation would also include an empowerment for the Commission to further specify minimum standards for harmonising the methodology on how to apply the selection criteria. In order to define the above standards, the Commission would use the advice of the technical expert group on sustainable finance set up by the Commission in April 2018.

Option 4: Harmonised EU methodology for low-carbon and positive carbon impact indices

This Option envisages the introduction of harmonised rules for (1) low-carbon indices ('decarbonised' standard indices) and (2) ‘'positive carbon impact’ indices (or 'pure-play' low carbon indices). Hence, compared to Options 2 or 3, this Option would provide investors with a wider choice of indices based on harmonised standards for their methodology. Furthermore, it would enhance transparency and comparability at the same time, as it would require administrators of low-carbon and positive carbon impact benchmarks to disclose the total carbon-footprint exposure of their underlying assets or the estimated impacts on climate-change mitigation according to common standards.

This Option has been split in two sub-Options.

Sub-option 4a: according to the approach set forth in this sub-Option, the new framework would introduce minimum standards for methodologies applicable to low-carbon indices and ‘positive carbon impact’ indices. This Option would set up minimum key elements of the methodology used to determine decarbonised benchmarks and 'positive carbon impact' benchmarks, providing standards for the criteria and methods used to select and weigh the underlying assets of the benchmark. It would also allow for the calculation of the carbon footprint and carbon savings associated with the underlying assets, leveraging on existing European methodologies approved by the Commission and largely used by corporate companies to calculate their environmental performance such as the Product Environmental Footprint (PEF) and the Organisation Environmental Footprint (OEF) 85 .

Under sub-Option 4a, significant flexibility would be left to benchmark administrators in designing the formula for the calculation of their methodology and allow room for market players to develop new strategies for addressing environmental concerns. Furthermore, benchmark administrators would incur minor costs in adapting their own established methodologies to the minimum standards provided by the EU legislation.

Sub-option 4b: This Option envisages the introduction of a maximum harmonisation regime. The methodology of the two newly introduced categories of benchmarks would be fully harmonised on the basis of a comprehensive set of rules provided at Level 1 and further specified with detailed requirements in Level 2. Those rules would set up requirements for the selection and weighting of the underlying assets of the low carbon and positive carbon impact benchmarks.

This approach would allow a high degree of comparability of the (fully harmonised) methodologies of the two new categories of benchmarks. However, benchmark administrators would incur significant costs through compliance to the new requirements set by EU legislation. Furthermore there would be little flexibility available for developing new strategies or methodologies, meaning that this approach could prohibit the market from developing new innovative solutions to environmental issues.

Option 4a and 4b would be achieved by amending the EU Benchmark Regulation through insertion of a new chapter and a new annex introducing the new categories of low-carbon and 'positive carbon impact' benchmarks and the key requirements for their methodologies (respective to the chosen level of harmonisation – minimum standards or maximum harmonisation). The Benchmark Regulation would also, according to the chosen level of harmonisation, include an empowerment for the Commission to further specify the standards for methodologies applied to the two types of benchmarks, in particular in relation to the selection criteria of the underlying assets, the method for the calculation of carbon emissions and carbon savings associated with the underlying assets, as well as the criteria and method for the weighting of assets within a benchmark. In order to define the standards, the Commission would rely on the advice of the technical expert group on sustainable finance set up by the Commission in April 2018.

5.7.2. Pros and Cons

Table 21: Pros and cons of the options on low carbon benchmarks

5.7.3. Impact on stakeholders

In the table below, the following scale is used to assess the magnitude of the impact as compared with the baseline scenario (the baseline being indicated as 0): ++ strongly positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable.

Error! No sequence specified.Table 22: impact on stakeholders of the options on low carbon benchmarks

Those options will also have indirect impact on the quality of information related to climate factors provided by issuers and reduce the risk of greenwashing. The more the methodologies for low-carbon benchmarks are transparent and harmonised, the more it will incentivize issuers to disclose specific information enabling them to be selected by the low-carbon benchmarks' administrators. However, it will still be up to the issuer to decide whether the benefits of demonstrating that they are low-carbon (and thus potentially being selected as an underlying asset of an EU low-carbon benchmark, which will ultimately enhance the quantity and availability of less expensive capital) outweigh the cost of providing additional data points.

5.7.4. Stakeholders’ view

In the course of February – March 2018, DG FISMA conducted a series of interviews with asset managers and index providers. Participants were also invited to fill in a questionnaire on the current availability of low carbon indices that reflect their own low carbon investment strategies. The table below summarises the views of stakeholders.

Table 23: Stakeholder's views on low carbon benchmarks

See Annex 2 Section 13 for a more detailed overview of stakeholders’ views.

5.7.5. Comparison of the policy options

This section assesses the policy options in terms of their (i) effectiveness in addressing the three specific objectives set out in section 3, (ii) their efficiency, and (iii) their coherence. Lastly, this section calculates a score for each of the three policy options, adding up the results from the assessment of the impact on the various stakeholders in section 5.6.3.

Table 24 below summarises the extent to which the options on the creation of low-carbon indices are effective, efficient and coherent. Effectiveness is mapped against the specific objectives set out in section 4. The respective scores are attributed on the basis of the analysis of pros and cons above.

Table 24: Benchmarking the options on low-carbon benchmarks

Note: Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive (score 2); +/++ very positive (score 1.5); + positive (score 1); +/ ≈ marginal positive (score 0.5); – – strongly negative (score –2); –/– – very negative (score –1.5); – negative (score –1); ≈/– marginal negative (score – 0.5); ≈ neutral.

Effectiveness: By introducing relevant methodological standards for low carbon benchmarks in Europe, Options 2, 3 and 4 will provide investors and asset managers who want to develop a low-carbon strategy with relevant tools to compare/track the performance of their portfolios/funds.

Option 2 would create standards for the methodology of "decarbonised" indices, which would be easier for benchmark administrators to adopt but will not allow to fully reach the objectives. However, this harmonised methodology would only apply to a segment of low carbon indices that do not aim to align with the objective of limiting global warming to 2o C, and hence would only partially contribute to providing clarity at EU level on what are sustainable economic activities.

Option 3, would introduce a methodology, which would address the alignment with 2o C investment strategy and enable the potential inclusion of highly carbon intensive sectors provided that they contribute significantly to the reduction of emissions in assets tied to low carbon indices. However, this Option would be applicable to a relatively narrow range of low carbon investment strategies and hence may not deliver the benefit of greater clarity concerning low carbon investment strategies to many end investors.

Option 4a and Option 4b would apply to both decarbonised indices and positive carbon impact indices. Hence they would address the third objective of providing greater clarity over low-carbon investment strategies, while offering relevant investment entities the choice between the two types of benchmarks. While all options would involve disclosure by benchmark administrators, Options 4a and 4b would address a larger part of the low carbon investment universe, and indirectly contribute to improved quality of information provided by asset/investment managers to end-investors with regards to climate risks and opportunities. 88 Options 2, 4a and 4b may also help relevant investment entities with achieving a more coherent approach regarding the integration of ESG factors (cf. objective 1) by facilitating a more systematic assessment of climate risks.

Efficiency: From a cost-efficiency perspective, all options would mean that relevant entities would incur some costs. Options 3 and 4b in particular would be the most costly due to their high prescriptiveness and little flexibility for market participants. This would entail high compliance costs for the relevant entities that would outweigh the benefits in terms of transparency. Under Options 3 and 4b, the Commission would also incur relatively higher costs for the development of more granular methodologies. Indeed such development would require more detailed specification of the methodologies and tools, which would imply the preparation of more detailed guidelines for market participants. In contrast, Options 2 and 4a would cater more for market-led innovation and provide greater choice to market participants in terms of setting a different degree of ambition with respect to meeting climate related objectives (e.g. alignment to 2, 3 or 4°C scenario) and these options are therefore more efficient.

Coherence: All options broadly follow the policy recommendations regarding benchmarks, as set out by the High Level Expert Group on Sustainable Finance (HLEG, 2018), the Commission's Sustainable Finance Action Plan, as well as other EU sustainability objectives (i.e. SDGs). However, option 2 is not aligned with the achievement of EU sustainability goals. Option 3 would be more closely linked with EU sustainability goals by aiming to provide a benchmark aligned with a 2oC objective, whilst option 2 would only support a 4-6oC objective. Options 4a and 4b offer tools to align indices with the 2oC trajectory. Between the two sub-options, option 4a achieves this while providing enough flexibility to benchmark administrators to achieve compliance with limited costs.

Table 25 below summarises the overall scores for the policy options considered and highlights how they compare in terms of stakeholder support and overall level of regulatory ambition. As can be seen, Option 3 has received minimal support through the targeted consultations, as it would be relevant only for niche index providers that are already aligned with a 2oC strategy. The majority of index providers as well as asset managers are accustomed to the use of simple, mainstream indexes. They would thus have a preference for option 2, which would have the smallest disruptive impact on their businesses, whilst allowing them to use a commonly recognised tool. Option 4 is a mixture between the other two options, and it would cater for all stakeholders and also further the EUs sustainability goals. The sub-option 4a would provide for a greater flexibility and would therefore find the consensus of most stakeholders (as compared to the more prescriptive option 4b).

Table 25: Summary of pros/cons of the options on low-carbon benchmarks

Overall, Option 4a was identified as the preferred option given that it provides the most balanced approach in view of the analysis of the comparison of options in terms of effectiveness, efficiency and coherence (see Table 24). This option, jointly with option 4b, scores high on effectiveness and coherence. However, option 4a achieves this while providing greater flexibility to the market participants and while aiming to limit costs and thus achieving greater efficiency in comparison to option 4b.

The option is considered to be proportionate given that it will reach the objectives, whilst also allowing benchmark administrators a certain level of flexibility as regards the development of methodologies which go beyond the minimum requirements. This would allow room for market players to develop innovative strategies for addressing environmental concerns. Furthermore, the costs incurred by benchmark administrators in adapting their own established methodologies to the minimum standards provided by the EU legislation can be considered proportionate to reaching these objectives. The choice of a Regulation as legal instrument is the most appropriate to harmonise, given the cross-border nature of most benchmarks: the direct applicability of a Regulation would restrict the possibility of divergent measures being taken by competent authorities at national level, and will ensure a consistent approach and greater legal certainty throughout the EU.

VI. Preferred options and overall impact

This section first summarises (i) the description of the preferred options for each initiative covered by this impact assessment, (ii) the scope of each initiative in terms of financial entities covered, financial products, economic sectors and sustainability issues covered, (iii) the sequencing of the measures envisaged (Section 6.1). It then describes the existing links among the four different initiatives (Section 6.2). Lastly, it provides an assessment of the expected economic, social and environmental impacts of the preferred option for each of the four initiatives (Sections 6.3 to 6.5).

6.1. Description of the preferred options for each of the four initiatives

The table below recalls the preferred option for each problem driver.

Table 26: Summary of the preferred options

6.1.1. Duties toward investors/beneficiaries with regards to ESG factors

(I)Description

This initiative requires integrating ESG factors in the investment and advisory process of relevant financial entities as part of their duties towards investors/beneficiaries. More specifically, for asset managers and institutional investors, this option would detail how and where material ESG risks are to be integrated within the procedures in the areas of investment strategy, risk management, asset allocation and governance taking into account the size, nature, scale and complexity of the activities of the entity. In addition, for investment advisors, individual portfolio managers and insurance distributors, this option would detail how and where ESG factors are to be integrated within the procedures in the areas of the suitability assessment and the product selection.

(II)Scope

This measure covers all financial entities that receive a mandate from their clients and beneficiaries to take investment decisions on their behalf or to receive recommendations and have therefore the duty, under the current legislative framework, to take these decisions according to the best interests and to the expectations of their clients and beneficiaries. The following entities are therefore covered by this action: collective investment managers (regulated by UCITS, AIFMD, EuVECA, EuSEF), insurance undertakings and insurance distributors (Solvency II, IDD), occupational pension funds (IORP II), investment advisors and individual portfolio managers (MiFID II). As regards pensions funds and insurance companies, the legislative proposal covers: (i) all pension funds offered to EU retail investors (occupational pension funds and individual and personal pension products); and (ii) all life insurance products with investment complements - so called insurance based investment products (IBIPs) - offered to both retail and professional investors.

In terms of financial products/services impacted, the requirement for the relevant entities to integrate ESG factors in their investment decision and advisory process would apply to all financial products offered and to the relevant services (individual portfolio management and advice) provided by the financial entities covered by this measure - whether or not they pursue sustainability investment objectives. This means that all economic sectors could be impacted. While the universe of investments potentially affected by this initiative is therefore very large, its impact is likely to vary across entities and products/services depending on different characteristics such as the entity's business model (e.g. the type of products offered or services provided) and the product's features (e.g. short-term horizon vs long-term horizon). Indeed, for some investments, ESG factors will not be material enough to be integrated in the investment decision-making process.

(III)Sequencing

First, a proposal will be adopted in late May 2018 amending IORP II to provide the Commission with an empowerment to adopt delegated acts ensuring that occupational pension funds would be required to integrate ESG factors in their investment decision process.

Shortly thereafter, the Commission will launch a joint call for advice to the European Supervisory Authorities with the objective of adopting Delegated Acts requiring other financial institutions mentioned above to integrate ESG factors in their investment decision and advisory process.

By mid-2018, the Commission will amend the delegated acts for IDD and MiFID in order to include ESG preferences in the investment advice and portfolio management service.

6.1.2. Disclosure on ESG integration and sustainability products

(I)Description

The preferred option on disclosure is composed of two mandatory requirements:

üFirst, it requires all the entities covered by the previous initiative on investors' duties to be transparent towards their clients on (i) the procedures and processes they have in place to take into account ESG factors in their investment and advisory process and (ii) on the extent to which these risks are expected to have an impact on the returns of the product/service offered/provided, irrespective of whether or not sustainable investment objectives are pursued.

üThe second mandatory requirement concerns a subset of financial products/services. Asset managers and institutional investors - when they market their products/services as targeting sustainable investments - would have to disclose how they adhere to these targets with their investment decisions, in particular by providing information on methodologies used to assess, evaluate and monitor the adherence and the contribution of the investment decisions to their sustainability objectives. 89 Information would also have to be provided on whether an index has been designated as a reference benchmark and the appropriateness of the index for the sustainable investment objective pursued. For financial products that pursue a low carbon emission objective, where no index has been designated as reference benchmark or where asset managers and institutional investors choose to significantly deviate from this benchmark, additional information would have to be provided to explain in detail how they intend to ensure continued adherence to the low carbon emission objective. The current disclosure requirements set out by EU legislations with regard to these products do not provide all the necessary information to properly inform end-investors about the sustainability-related impact of their investments. Therefore, it is appropriate to set out more specific disclosure requirements. This will limit greenwashing of financial products and provide end-investors with the information necessary to identify investment opportunities that reflect their sustainability preferences. To meet the disclosure requirements, financial market participants are required to use information that issuers are already obliged to provide in accordance with the Accounting Directive (Directive 2013/34/EU). This aims at reducing the indirect cost for issuers (including smaller issuers).

These two disclosure requirements are mandatory in regular reports (for instance, annual reports), websites and pre-contractual and contractual information (for instance, prospectus).

(II)Scope

The first requirement to disclose information on the integration of ESG risks would apply to the same financial entities as those covered by the initiative on duties towards inves-tors/beneficiaries: asset managers (regulated by UCITS, AIFMD, EuVECA, EuSEF), insurance undertakings and insurance distributors (Solvency II, IDD), occupational and other pension providers, investment firms providing investment advice and individual portfolio managers (MiFID II). In terms of financial products/services impacted, the re-quirement to disclose how ESG factors are taken into account and which impact ESG risks are expected to have on the value of the portfolio would apply to all financial prod-ucts offered by these entities, individual portfolio management and investment advisory services, irrespective of whether or not they pursue sustainable investment objectives. Therefore, all economic sectors would be impacted.

The second mandatory disclosure applies to the following financial entities: managers of UCITS, AIFs, EuVECA and EuSEF, individual portfolio managers, insurance undertakings (offering insurance based-investment products), IORPs and other pension providers. But it applies only to financial products/services that pursue sustainable investments.

Sequencing

Both requirements would apply at the date foreseen by the proposed regulation, when adopted – a date which would be deferred in order to provide financial market participants with sufficient time to comply with those requirements.

As regards the second mandatory requirement, the Commission would adopt Level 2 measures further specifying the details of the presentation and content of information on sustainability investment objectives to be disclosed.

6.1.3. Taxonomy

(I)Description

The preferred option would lay down the conditions to subsequently create an EU environmental taxonomy on what can be considered an environmentally sustainable economic activity, for the purposes of establishing the environmental sustainability of an investment. The proposed taxonomy would, at first, be strictly environmental as it would only include six environmental objectives. However, a review clause three years after entry into force would foresee the possibility of extending the taxonomy to also cover social objectives.

(II)Scope

The proposed EU taxonomy would apply to (i) Member States when setting out requirements for financial market participants with regard to the labelling of financial products pursuing environmentally sustainable objectives, and to (ii) financial market participants offering financial products as environmentally sustainable, as they shall disclose how and to what extent the criteria for environmentally sustainable economic activities are used to determine the environmental sustainability of the investments selected for the financial product

The taxonomy would however have no immediate impact as the application is deferred until 6 months after the entry in applicability of the first delegated act (foreseen in 2020 on the first two environmental objectives namely climate change mitigation and adaptation).

All relevant financial entities that are providing green financial products, could (overtime) be incentivized to use the proposed taxonomy.

As regards economic sectors, the economic activities which are identified as significantly contributing to at least of the six environmental objectives (or thereafter possibly social objectives) would be impacted.

As regards firms, they may be incentives voluntarily to provide information to what extent their activities would fall under the proposed taxonomy.

Overall, compared to the first two initiatives on investors' duties and disclosures, the scope of the proposed taxonomy is narrower.

(III)Sequencing

The environmental taxonomy would be established in two stages.

First, a regulation would identify: (i) the six environmental objectives to which economic activities should substantially contribute to be covered by the taxonomy; (ii) the high level principles for determining (at level 2) the technical screening criteria for identifying environmentally sustainable economic activities; and (iii) the minimum safeguards with which economic activities would have to comply to be eligible. In addition, it would empower the Commission, under additional requirements, to establish the technical screening criteria for determining a) whether an economy activity substantially contributes to one or more environmental objectives, and b) whether it significantly harms one or more environmental objectives.

Then, the Commission would establish through delegated acts, subject to their own impact assessments, the technical screening criteria for specific activities, on the basis of the advice from the technical expert group established for that purpose, while managing any risks in the development of the taxonomy. These technical criteria would notably (i) determine under which conditions a specific economic activity is substantially contributing to one – or several – of the six environmental objectives, and (ii) specify the minimum requirements with which economic activities would have to comply to avoid significant harm to any of the other environmental objectives. It is foreseen that the first delegated act covering economic activities contributing to the climate change adaptation and mitigation objectives would be adopted by year-end 2019. The objective would be to adopt the second and third delegated acts by year-end 2021 and year-end 2023 respectively. The EU environmental taxonomy would then be completed. (see section 5.6.2 for more details)

Subject to the outcome of the review of the regulation, which would happen at the earliest three years after entry into force, the scope of the taxonomy could also be expanded to also cover social objectives. Then a fourth delegated act with the technical screening criteria for identifying economic activities contributing to these social objectives could be adopted by year-end 2026.

6.1.4. Low carbon and positive carbon impact benchmarks

(I)Description

The preferred option will introduce EU minimum standards for methodologies to develop ‘low carbon' and 'positive carbon impact' benchmarks. This will foster generally accepted market standards to measure a company's carbon footprint and, in consequence, an investment portfolio's carbon footprint. Doing so, it will provide investors who want to invest in low carbon strategies with a reliable tool.

(II)Scope

The financial entities impacted by the initiative will be (i) the low carbon benchmark administrators which will have to adapt their methodologies to the minimum standards defined by the amended Benchmark Regulation EU, and indirectly (through disclosure requirements) (ii) asset managers using low carbon benchmarks. The financial products impacted will be those claiming to follow low carbon investment strategies. The economic sectors impacted would be those which, because they contribute to lowering greenhouse gas emissions, could be components of low carbon benchmarks.

(III) Sequencing

There will be two steps. First, the Benchmark Regulation will be amended to (i) create the new categories of low carbon benchmarks’ and ‘positive carbon impact benchmarks’ providing for key requirements for harmonising their methodologies, and (ii) to empower the Commission to adopt a delegated act further specifying the minimum standards for these new categories of benchmarks.

In the second step, the Commission will, on the basis of the advice provided by the expert group set up for that purpose (which will also provide advice for delegated acts on taxonomy), adopt a delegated act to provide further key minimum standards necessary to define, for low carbon and positive carbon benchmarks: (i) the criteria for the choice of the eligible underlying assets, including, where applicable, the exclusion criteria for assets; (ii) the criteria and method for weighting of assets in a benchmark; and (iii) the method for the calculation of carbon emissions and carbon savings associated with the underlying assets.

6.2. Links between the four initiatives and scope of requirements on asset managers depending on their investment style

While each of the initiatives is self-standing and is meant to tackle different problem drivers (or their combination), they interact in various ways, while contributing jointly to meeting the wider objectives as set out in the Commission's Action Plan.

The following examples can illustrate some of the most prominent links and interactions of the four initiatives:

üThe initiatives on investors' duties and disclosure are linked, in the sense that investors' duties would make it mandatory for asset managers and institutional investors to integrate ESG factors in their investment decision process, and disclosure requirements would make it mandatory to disclose how this is done.

üThe initiatives on investors' duties, benchmarks and disclosure are linked: where asset managers market themselves as pursuing a low-carbon emission objective, they would be required to designate an appropriate benchmark, such as the EU low-carbon index or the positive carbon impact index as a reference benchmark. Where no index reflecting the asset managers' low-carbon strategy is available on the market, the asset managers would need to provide a detailed explanation of how they intend to ensure continued adherence to the low-carbon emission objective. 

üThe initiatives on taxonomy and disclosures are linked, in the sense that financial market participants offering financial products/services as environmentally sustainable, shall disclose (once developed) how and to what extent the criteria developed in the taxonomy to define environmentally sustainable economic activities are used to determine the environmental sustainability of the investments selected for the financial product.

All initiatives announced in the Commission Action Plan on sustainable finance adopted in March would have an impact on various stakeholders throughout the different stages of the investment value chain, as illustrated by Figure 2 in Section 1.3.

When it comes to asset managers and institutional investors, they would be subject to different requirements depending on their investment style. The investment style can range from very general to very specific approaches, as demonstrated in Figure 6:

Figure 6: the scope of requirements on asset managers depending on their investment style

1)As part of their investors' duties, all asset managers and institutional investors would have to integrate ESG factors in their investment decision making process and disclose how this is done (i.e. how they comply with the investors' duties requirements). These requirements are crucial in particular where investors express their preference to consider ESG factors in their investments. 90  

2)Where the asset manager markets a product/service claiming that such product/service targets sustainable investments, this asset manager would have to disclose information demonstrating that the sustainability impact of the product/service in question is indeed consistent with its sustainability objectives (e.g. through indicators relevant for the chosen sustainability objective together with the related calculation methodology used to assess, evaluate and monitor the adherence and the contribution of the investment decisions to the sustainability objectives). 91

3)Where the asset manager markets a product/service claiming that such product/service pursues a low carbon emission objective, this asset manager would have to designate an appropriate benchmark, such as the EU low-carbon index or the positive carbon impact index as a reference benchmark. Where no index reflecting the asset manager's low-carbon strategy is available on the market, the asset manager in question would have to publish on their website an explanation of how they intend to ensure continued adherence to the low carbon emission objective. 

6.3. Economic impact

This section first describes the expected overall economic impact of the four initiatives, then presenting in more details the expected impact of each of them.

6.3.1. Overall economic impact of the four initiatives

By increasing the overall transparency, the different initiatives will reduce the asymmetry of information between end-investors, financial intermediaries and index provider. First of all, end-investors will have more information on how those intermediaries integrate ESG factors in their investment decision-making process and whether an appropriate benchmark is used. Second, intermediaries will be better informed about the ESG preferences of their clients and will know which activities can be considered as environmentally sustainable. Indirectly, this will incentivise issuers to disclose more ESG information and provide information on their environmentally sustainable activities. Lastly, financial intermediaries will have more information on the methodology used by index providers and thus will be able to select more appropriate benchmarks.

This enhanced transparency from the whole investment value chain will increase the reliability and attractiveness of ESG financial products and foster innovation in investment strategies and the design of these financial products.

The proposed initiatives would also reduce the current market fragmentation in terms of methodologies for identifying environmentally sustainable activities/investments and developing low carbon benchmarks, as currently no common approach exist on the market.

By fostering the development of more ESG products, the initiative would increase competition between financial intermediaries and therefore reinforce the efficiency of the market of ESG products. It would incentivise financial entities to be more innovative and to adopt higher ESG standards. This would ultimately increase the competitiveness of the European sustainable finance market. The combination of a more competitive and efficient market of ESG products and the growing demand from end-investors for such products, helped by the reduction in search costs, should ultimately result in the growth of this market.

By explicitly requiring financial intermediaries to integrate ESG factors in their investment decision process, it would contribute to the Commission objective to mainstream sustainability into risk management. 

By providing more clarity on the market on which activities can be considered as environmentally sustainable, fostering the sustainable investment market and mainstreaming sustainability into risk management, the Commission initiative is expected to contribute to the reorientation of capital flows towards sustainable investments and hence to the objective foster a sustainable economy. The magnitude of the reoriented capital flows will depend on (i) the actual interest for sustainable products among investors operating in this more favourable environment, and (ii) on the implementation of several elements of the various initiatives, which will be impact-assessed at a later stage.

6.3.2. Economic impact of preferred options on integration of ESG factors and disclosure

A clear and coherent approach on integration of ESG factors would have the following economic impacts: (i) ESG risks would be more systematically taken into account in financial modelling, leading to an optimal risk-return trade-off at least in the long-term and fostering market efficiency; (ii) it would encourage innovation in investment strategies due to the consideration of a wider range of factors, both financial and non-financial, creating the conditions to attract new investors; (iii) by providing (retail) investors with an opportunity to clearly express their non-financial investment objectives during the advisory process, it would increase the aggregate demand for ESG financial products and services; and (iv) it could increase competition, incentivising entities to adopt high ESG standards.

In terms of costs, feedback from stakeholders indicates that these are part of the overall internal/organisational costs related to the risk management and monitoring of certain exposures. In fact, the additional tasks imposed on relevant entities covered by this initiative would be incorporated within the existing organisational and operating procedures without creating any new area of obligations. Duties towards investors/beneficiaries mean that relevant entities have to take investment decisions in the best interest of their investors or beneficiaries, and in accordance with the mandate received from them. In order to comply with these duties, relevant entities have already in place processes and procedures to identify, assess, manage and monitor all risks that are deemed to be material for the value of assets underlying the service/product they offer.

The foreseen Level 2 measures do not add a completely new requirement and are proportionate. For entities already integrating ESG factors in their investment decision-making process, there would be no additional costs. For entities that do not currently already integrate ESG factors, the additional tasks would imply some compliance costs. However these tasks would be carried out in a proportionate manner according to the features of the existing organisational and operating conditions. Those costs are part of the overall internal/organisational costs related to the risk management and monitoring of certain exposures. In fact, the tasks foreseen for financial entities covered by this initiative would be incorporated within the existing organisational and operating.. More precisely, as indicated by stakeholders, there is no need to hire new staff. It is more a question of investing more systematically in ESG expertise (e.g. at employee and board level), data and tools. This could involve —depending on the current level of ESG integration — buying ESG data from third-party vendors, more systematic integration in the investment decision process and risk assessment, and possibly further task specialisation and more active engagement with companies on topics related to ESG. The cost of ESG integration. for the small entities ranges from EUR 80 000 to EUR 200 000 per year (for buying external data, doing additional internal research, engagement with companies etc.), i.e maximum 0.0001 % of AuM (by way of comparison, the total cost for an equity fund is around 2% per year 92 ). The highest relative additional cost for medium-size entities is around 0.0003 % of AuM per year (for a player with EUR 72 billion of AuM).

Mandatory disclosures on ESG would ensure that all relevant entities do it in a comparable way. This, together with requiring disclosure both at entity and financial product or service level will increase the granularity of available information to end-investors. While higher granularity may increase the amount of available information, comparability would be increased and the cost of processing this information would be kept within acceptable limits, if provided in a standardised way. Transparency will increase as the information will be effective in reaching the market, and better serve the general objective of reducing search costs for end-investors. Some stakeholders indicated that the most significant costs would come from reviewing the pre-contractual and contractual documents (e.g. about EUR 40 000 per prospectus). However, these costs are expected to be limited if a transitional period is foreseen as suggested under the preferred option. Moreover, if the prospectus has to be periodically revised in any event, as explained by stakeholders, the cost of adding ESG related information should be a fraction of it. Asset managers and institutional investors offering products and providing services pursuing a sustainability investment objective will also incur the costs linked to the disclosure of the contribution/impact of the fund/portfolio to this sustainability objective pursued. However, no specific methodology is imposed. Therefore, the relevant entities offering financial products pursuing sustainability objectives, can rely on the methodology in place to calculate the sustainability-related impacts that the policy option requires to disclose. As a consequence, compliance costs are not expected be significantly high. Moreover, there are reputational benefits for relevant entities from disclosure, as well as reduced costs for end-investors to find financial products and take investment decisions that correspond to their sustainability preferences.

6.3.3. Economic impact of preferred option on taxonomy

An EU taxonomy is an important step towards providing clarity on what constitutes a sustainable economic activity. The impacts on stakeholders depend on its final uses and on the details of such taxonomy, which will be developed subsequently by the adoption of delegated acts. As explained also in section 5.6.2, a proper assessment of the impacts will take place before adoption of those delegated acts. In particular, the impact of technical screening criteria will have to be assessed in terms of impacts on existing green financial products and on competition within and between industries. In fact, the technical screening criteria should ensure that all relevant economic activities within a specific sector can qualify and are treated equally if they contribute equally towards one or more of the six environmental objectives. It is recognised that the potential capacity to contribute towards these environmental objectives varies across sectors, which should be reflected in the criteria. However, within each sector, such criteria should not unfairly disadvantage certain economic activities over others if the former contribute towards the environmental objectives to the same extent as the latter. When establishing technical screening criteria, the Commission should assess whether adoption of these criteria for sustainable activities would give rise to stranded assets or deliver inconsistent incentives, and whether it would have any negative impact on liquidity in financial markets.

In any event, a uniform classification at EU level would already help to determine which activities can be regarded as sustainable and send appropriate signals to economic actors, as it would "translate" EU policy objectives into tangible guidance to identify the relevant projects or investments. It could therefore help orient more capital flows towards sustainable investments.

6.3.4. Economic impact of preferred option on low-carbon indices

EU minimum standards for methodologies to develop low-carbon and positive carbon impact indices and better disclosure would have the following impacts: (i) it would reduce the asymmetry of information between investors and index providers, giving asset managers and portfolio managers all the necessary information to select a low carbon index which reflects their investment style; (ii) it would reduce market fragmentation as the methodologies for developing low carbon indices would be harmonised according to minimum standards; and (iii) it would indirectly impact the quality and comparability of climate-related information disclosed by corporate companies who want to be part of the index.

The preferred policy option would thus help reach the policy objectives set out in section 4, whilst also creating better market conditions for the relevant stakeholders. It would establish a common basis for low-carbon methodology that would increase credibility and uptake by market participants, whilst also leaving sufficient space and incentives for private companies to innovate and come forward with new solutions. By developing common minimum standards for which products can claim to follow a "low carbon" or "2 degree" investment strategy it would also help reduce greenwashing risks, thus ensuring a more effective allocation of funds towards sustainable assets and lower search costs for stakeholders.

6.3.5. Competitiveness and impact on third countries

This initiative is related to the EU commitments to choose a more sustainable path for our planet and our economy stemming from the 2016 Paris agreement on climate change and the United Nations (UN) 2030 Agenda for Sustainable Development (UN, 2015). Other initiatives currently ongoing at international level include, for instance, the Chinese Green Bond.

Third countries entities and persons making available financial products or services covered by this initiative within the territory of the Union are subject to the sectorial rules laying down the conditions under which they may carry out their activities within the Union.

6.3.6. Impact on issuers

The preferred options will indirectly impact issuers by incentivizing them to disclose the additional ESG information necessary for financial intermediaries. Nevertheless, under the requirements of the Accounting Directive (2013/34/EU), undertakings are largely required to provide in management reports non-financial information necessary for an understanding of the undertaking's development, performance or position. 93 In addition, as of 2018, large listed companies as well as non-listed banks and insurance companies are required to disclose such information in non-financial statements. This will provide additional valuable information to asset managers and institutional investors on the issuers business model, policies, principal risks and key performance indicators. For the purpose of the disclosure requirements on products/services targeting sustainable investments, financial market participants would have to use information that issuers are already required to provide in accordance with the Accounting Directive (Directive 2013/34/EU). This aims at reducing the indirect cost on issuers (including smaller issuers).

For issuers not covered by the reporting requirements of the Accounting Directive, the incentive to disclose additional information will come with a cost. The Commission has estimated the additional cost to disclose a non-financial statement between EUR 600 and EUR 4 300 per issuer 94 .Nevertheless, such disclosure will also enable those issuers to access additional investors and potentially reduce the cost of capital. It will be up to the issuer to decide whether the benefits of producing such information (in terms of, for example, attracting new and cheaper capital) outweigh the cost of providing additional information. 

6.4. Environmental impact

6.4.1. Overall environmental impact of the four initiatives

Taken together, the four initiatives, by mainstreaming sustainability in investment decision-making processes and supporting the development of a larger, more efficient and more competitive market of ESG products, are expected to facilitate investments in (more) sustainable projects and assets. The additional investments resulting from increased transparency and market harmonisation would support the far-reaching sustainable transformation envisaged by the environmental policies already in place at EU and Member State levels. Investments in green sectors (e.g. renewable energy, energy efficiency, waste management, environmental restoration) would thus translate into immediate and longer term environmental benefits such as reduced pollution levels (e.g. to air, water and soil) with related health benefits, reduced greenhouse gas emissions mitigating dangerous climate change and the preservation and enhancement of natural capital and eco-system services.

6.4.2. Impact of preferred options on integration of ESG factors and disclosure

In 2015, European households held EUR 34 trillion of financial assets, representing 40% of the total financial assets. About 25% of these assets were invested in equity and funds, another 40% in insurance and pensions, and the difference in deposits (2Dii 2017). Mobilising some of these assets would be a major contribution to financing a transition to a more sustainable economy. Greater clarity on ESG integration and increased transparency will raise ESG awareness among all stakeholders, possibly unlocking capital flows towards environmental investments. The preferred option on disclosure will notably contribute to achieving the EU environmental objectives by requiring disclosure on the impact of investments on climate and other environmental issues. In addition, financial market participants offering financial products or providing services targeting environmentally sustainable investments, will be required to disclose how and to what extent the criteria (once developed) to define environmentally sustainable economic activities are used to determine the environmental sustainability of the investments selected for the financial product. This will provide end-investors with the adequate information to identify investments that are aligned with their preferences as regards the environment, by increasing transparency on what is the environmental impact of products and services targeting environmental investments. This will reduce the risk that relevant financial entities claim their products to be more environmental-friendly than they are in reality and contribute to enhance investors’ confidence regarding "green" claims.

6.4.3. Impact of preferred option on taxonomy

The first impact of the taxonomy is that it will clarify what is green, which should directly benefit investors and financial market participants. It is then expected to have a series of positive secondary/indirect impacts, depending on the uses made of the taxonomy (see Box 7 in section 5.6.2.), including a positive environmental impact. By providing clarity on what is ‘green’, an EU taxonomy would facilitate investments in sustainable projects and assets across the EU. This would contribute to the achievement of the EU environmental goals e.g. lowering greenhouse gas emissions in line with the Paris Agreement, and moving to a resource-efficient and circular economy.

The use of the EU taxonomy for (financial) product standards and labels would improve environmental integrity of green investments within as well as outside the EU (as the taxonomy would also apply to EU investors investing globally). As such, it would help to minimise the risk of greenwashing and avoid the negative environmental impacts from investing in assets that are not in line with the EU sustainability goals.

Box 8: EU labelling for environmental policy

6.4.4. Impact of preferred option on low-carbon indices

It appears urgent to invest in assets and projects that have a positive impact in terms of GHG emissions and contribute to the Paris objectives. For this reason, the harmonisation of sound and transparent methodologies based on EU minimum standards for different types of low-carbon indices would provide all types of investors pursuing different types of low-carbon strategies with adequate tools to assess the coherence in terms of suitability between their fund/portfolios and the benchmark and track/measure the performance against a low-carbon benchmark. With a sound methodology to select its underlying assets, an index, can also help in aligning corporate strategies and the economy with climate goals.

6.5. Social impacts

The social impacts of the preferred policy options are currently difficult to assess. As noted on several occasions by different categories of stakeholders, the lack of relevant expertise on non-financial factors - and in particular social issues - hampers the integration of these aspects into investment decisions. However, the mandatory consideration of ESG factors by relevant entities is expected to result in the development of higher expertise on the analysis and modelling of non-financial factors, including social factors. In the long-term, this is expected to result in increased mainstreaming of social risks in investments. With regard to the taxonomy, as the scope is currently limited to environmental issues, no immediate social impacts are expected. This may change once the proposed initiative is reviewed – and possibly expanded to also cover social objectives.

VII. How will actual impacts be monitored and evaluated?

Ex-post evaluation of all new legislative measures is a top priority for the Commission. The Commission services will establish a programme for monitoring the outputs, results and impacts of this initiative one year after the legal instrument becomes effective. The monitoring programme will set out the means by which the data and other necessary evidence will be collected. An evaluation is envisaged five years after the implementation of the measures. The objective of an evaluation is to assess, among other things, how effective and efficient the measures have been in terms of achieving the objectives presented in this impact assessment and to decide whether new measures or amendments are needed.

The success of this initiative will be monitored and evaluated in terms of the positive contribution of each of the proposed actions to the overarching goals of the Commission Action Plan on "Financing Sustainable Growth" and in particular to the specific objectives of (i) ensuring a clear and coherent approach across sectors and Member States as regards the integration of ESG factors by relevant entities in their investment/advisory process; (ii) increasing transparency towards end-investors by improving ESG-related disclosure requirements, and (iii) providing clarity at EU level on what are sustainable economic activities.

Specifically, for the integration of ESG factors in the investment and advisory process, success can be defined based on three indicators: (i) the level of ESG integration is above the current level and the expected growth rate of ESG integration by relevant entities; (ii) an increase in the level of transparency regarding ESG integration as reported in surveys of end-investors; and (iii) an increase in the demand of sustainable investments (thanks to reduced search costs). As regards disclosure, improvements in the quantity and quality of the information disclosed will be considered indicators of better transparency and hence of the success of the proposed measures. The timely development of the taxonomy along the steps outlined in Section 5 as well the future different uses of the proposed classification will be measures of its success. Lastly, the introduction of new categories of benchmarks allowing the use of appropriate indices by funds with a specific low-carbon investment strategy would signal the success of this measure.

Where relevant and in particular for the proposed taxonomy, future evaluations will also analyse to what extent the specific safeguards proposed to mitigate possible risks on e.g. competition aspects, fairness, excessive costs, consistency of incentives, risk of stranded assets, impact on liquidity in financial markets, and greenwashing have worked in practice, and determine whether any adjustments are needed in some areas.

The Commission services will measure progress through general key performance indicators (KPIs). As announced in the Action Plan, the Commission will also set-up in late 2019 a dedicated public-private platform on sustainable finance, which will among other tasks monitor the flow of investment in sustainable assets and activities and could serve as a forum for information sharing. The Commission services will consider using the following to monitor and evaluate:

On integration of ESG factors in the investment and advisory processes

·Data on the performance of relevant entities' products/services before and after the implementation of the proposals;

·Baseline survey and follow up survey (5 years) to (i) monitor the market evolution of sustainability preferences by end-investors, (ii) how financial entities incorporate end-investor preferences in their procedures and (iii) the inclusion of questions on client's preferences as regards sustainability in the suitability test of investment advisors.

·Evolution of information used when integrating sustainability factors, i.e. number of sustainability ratings providers and the costs of producing sustainability ratings and the fees charged;

·A report, which could be undertaken by ESMA, on the experience gained by regulators in enforcing the initiative and how cooperation has worked.

On disclosure

·Impact on end-investors' portfolio choices when comparing financial products using available sustainability information by baseline survey and follow up survey to monitor market evolution and costs of disclosure;

·Mystery shopping to assess compliance / timing of disclosure of sustainability factors and the accuracy of the provided information;

·Supervisory / ESA monitoring to keep track of potential mis-selling.

·The share of households' financial assets invested in products targeting a low carbon strategy.

On taxonomy

·Baseline survey and follow-up survey (5 years after entry into force) to monitor the evolution of the use of taxonomy by public and private entities;

·A Commission report on the functioning and deliverables of the dedicated public-private platform on sustainable finance, with a specific focus on the taxonomy (3 years after the establishment of the platform).

·

On low-carbon benchmarks

·Evolution in the number and size of funds/portfolios using low carbon and positive carbon impact benchmarks;

·Number of entities disclosing to be using one of the EU low-carbon benchmarks;

·Number of complaints received by the Commission from relevant benchmark users;

·The costs of producing these benchmarks and the fees charged for the licensing;

·A Commission report under the Benchmark Regulation to review the functioning and effectiveness of the benchmarks and the appropriateness of their supervision (review clause Article 54).

·

Glossary

Annex 1: Procedural information

I. Lead DG, Decide Planning/CWP references

This Impact Assessment Report was prepared by Directorate C "Financial markets" of the Directorate-General for Financial Stability, Financial Services and Capital Markets Union" (DG FISMA).

The Decide Planning reference of the file titled "Sustainable Finance Initiative" is PLAN/2017/1954.

The EU has set itself ambitious climate, environmental and sustainability targets, through its 2030 Energy and Climate Framework, the Energy Union and its Circular Economy Action Plan.

The new legislations and amendments to existing legislations supported by this impact assessment have been announced in the "Action Plan: Financing Sustainable Growth" (7.03.2018).

II. Organisation and timing

Several services of the Commission with an interest in the assessment of the initiative have been associated in the development of this analysis.

Three Inter-Service Steering Group (ISSG) meetings, consisting of representatives from various Directorates-General of the Commission, were held in 2017 and 2018. They were chaired by the Secretariat General (SG).

The first meeting took place on 25 October 2017 and was attended by DG CLIMA, ECFIN, ENER, ENV, JUST, MOVE, SJ and the SG.

The second meeting was held on 17 January 2018. Representatives from DG CLIMA, ECFIN, ENER, ENV, JUST, MOVE, SJ and the SG were present.

The third meeting was held on 6 March 2018. Representatives from DG BUDG, CLIMA, ECFIN, ENER, ENV, JUST, MOVE, SJ and the SG participated. This was the last meeting of the ISSG before the submission to the Regulatory Scrutiny Board (RSB) on 16 March 2018. The hearing with the RSB took place on 18 April.

The fourth meeting was held on 23 April 2018. Main purpose was to consult on the legal texts and seek input from other DGs to strengthen the impact assessment following the negative opinion issued by the RSB on 20 April. Representatives from DG BUDG, CLIMA, ECFIN, ENER, ENV, JUST, MOVE, EPSC, SJ and the SG participated.

The fifth meeting was held on 3 May. Main purpose was to consult on the legal texts and the impact assessment after re-submission to the RSB on 26 April.

In addition, DG FISMA had numerous bilateral exchanges with other DGs (in particular CLIMA, ENV, ENER, JUST, SJ and the SG) throughout the preparation of the impact assessment and the legal texts.

DG FISMA updated the Impact Assessment by taking into account the comments made by other DGs. In particular, the following changes were made:

·At the request of DG CLIMA, more clarity was provided on the definition of green, ESG and sustainable, and the consistency when using these words in the impact assessment was improved.

·At the request of LS, the section on the legal basis was strengthened by explaining more precisely the legal basis for each of the several initiatives assessed in the impact assessment.

·On taxonomy, DG FISMA extensively consulted in particular with DG ENV, DG CLIMA, ENER, SJ, SG and BUDG on (i) policy options, (ii) the six environmental objectives to be addressed by the taxonomy, (iii) the most appropriate way to define the macro-sectors, sectors and sub-sectors as well as the technical screening criteria for identifying environmentally sustainable activities, (iv) the structure to be put in place to provide technical advice to the Commission on the development of the taxonomy, including its governance.

·At the request of DG BUDG, the budgetary implications of the various structures envisaged to provide technical advice to the Commission on the development of the taxonomy and the methodologies on low carbon benchmarks were provided.

·At the request of DG JUST, it was clarified that, to be considered environmentally sustainable under the taxonomy legislation, any activity would have to be carried out in compliance with minimum safeguards notably in the social and human rights' fields. 

·At the request of DG ENV, the methodologies for low-carbon benchmarks make a reference to the Product and Organisation Environmental Footprint (PEF/OEF) methods (at least the greenhouse gas emissions dimension) in the methodology for low-carbon benchmarks.

·At the request of DG MOVE and DG ENER, illustrative examples of the taxonomy in the transport and energy sectors were added.

·On investors' duties, the focus on governance was strengthened at the request of DG JUST.

·At the request of SG, the analysis of the different policy options, in particular those related to the low carbon benchmarks, was strengthened.

III. Consultation of the Regulatory Scrutiny Board (RSB)

The Impact Assessment was submitted to the RSB on 16 March 2018. The hearing took place on 18 April. The RSB issued a negative opinion on 20 April. The main recommendations focused on: (i) the scope of the various initiatives covered by the impact assessment; (ii) issues related to the taxonomy – including the sequencing in the development of this taxonomy; (iii) the specification on some options, in particular as regards, ; (iv) the costs and risk assessment; and (v) the need for a full description of the preferred option, and the monitoring and evaluation foreseen.

Before re-submitting the impact assessment on 26 April, DG FISMA addressed these comments as follows:

·The different scopes of the four different initiatives in terms of financial entities, financial products and economic sectors impacted were explained, as well as the scope of the associated requirements on asset managers depending on their investment style,

·The sequencing/steps/legislative acts for making the four initiatives operational were explained;

·A full description of the preferred option was included, and the links between the different initiatives explained;

·More information on the impact of the four initiatives in terms of costs was provided;

·On taxonomy: (i) the immediate and potential future uses were better described, as well as how the taxonomy would be "operationalised"; (ii) more information was provided on the minimum requirements and technical screening criteria for identifying "eligible" environmental economic activities in delegated acts and the framing of the empowerment requested by the Commission to adopt them; (iii) it was clarified that the nature and magnitude of the costs on stakeholders would be impact-assessed before the adoption of the delegated acts establishing the technical screening criteria; (iv) the consistency and complementarity with already existing EU legislation and policies in other areas (e.g. environment and climate, energy, transport) was explained; (v) the sequencing and then the interactions between "an environmental taxonomy" and a "social taxonomy" were explained; (vi) how the taxonomy would be expanded and updated over time was clarified and the associated costs estimated; and (vii) it was clarified how the co-legislators would be informed/involved throughout the development of the technical screening criteria for level 2.

·A description of existing labelling schemes at EU level in the area of energy and environment was incorporated;

·More information was provided on market-based practices that have developed recently, and current shortcomings in them, as well as issues relating to greenwashing;

·On investors duties, the additional tasks that would be required from asset managers and other relevant entities investors were better described, together with the associated of costs.

·It was clarified that ESG integration in terms of investors' duties is not a widespread practice;

·The main elements for constructing a low carbon benchmark were described.

·The baseline was strengthened;

·More information on the views on issuers and the impact of s (notably in terms of costs) on issuers (notably SMEs) was incorporated;

·The monitoring and evaluation foreseen was more targeted.

A new version of the Impact Assessment was submitted to the RSB on 26 April 2018. The RSB issued a negative opinion on 4 May. The main recommendations focused on: (i) the uses of the taxonomy, and the risks of making them mandatory before the taxonomy has reached sufficient stability and maturity; (ii) the lack of explanation on how the six green dimensions of the taxonomy would be made operational; and (iii) the lack of information on the costs related to investors' duties and disclosure requirements.

Before re-submitting the impact assessment on 8 May, DG FISMA addressed these comments as follows:

·Acknowledging the risk of making the uses of the taxonomy mandatory before it has reached sufficient stability and maturity, the uses have been narrowed to two: (i) Member States or the Union must apply the taxonomy when setting out requirements for financial market participants with regard to the labelling of financial products pursuing environmentally sustainable objectives; and (ii) financial market participants offering financial products marketed as environmentally sustainable shall disclose how and to what extent the technical screening criteria defined in delegated acts to identify environmentally sustainable economic activities are used to determine the environmental sustainability of the investments selected for the financial product.

·Furthermore, to ensure that the taxonomy has reached sufficient maturity, having been tested with and understood by relevant stakeholders, before these uses become mandatory, two safeguards have been put in place: (i) these uses are deferred until six months after the entry into force of the first delegated act on climate change, and (ii) they will be subject to the impact assessment that will accompany each delegated act.

·In addition, to further limit the risks, two mandatory uses have been removed: (i) the requirement for administrators of low carbon and positive impact carbon benchmarks to use the concept of 'environmentally sustainable economic activity' defined by the taxonomy when designing parameters of the methodology for selecting the underlying assets of their products, and (ii) the mandatory disclosure by asset managers and institutional investors offering financial products pursuing environmental objectives of the proportion of investments in companies undertaking 'environmentally sustainable economic activities' as defined in the delegated acts.

·How the six green dimensions of the taxonomy will be made operational has been explained in further details.

·Additional information on costs associated with new requirements on investors' duties and disclosure for issuers (in particular smaller issuers) and financial firms has been provided.

·The challenges associated with the development of the taxonomy through delegated acts (notably undesirable diversions of investment activity, unclear ESG compliance requirements, disproportionate costs, a taxonomy developing in sequential stages that delivers flawed or inconsistent incentives and stranded assets, possible encouraged and institutionalised greenwashing, a possible need for third party verification, a litigious environment emerging from a lack of legal clarity and that liquidity in financial markets would suffer from introducing new classes of 'green' securities) have been described. Acknowledging these risks and challenges, a requirement was introduced in the preferred option (and thereafter in the draft taxonomy regulation) that the Commission, when developing delegated acts, would have to assess the impact on competition within and between industries (to ensure that all relevant economic activities within a specific sector can qualify and are treated equally if they contribute equally towards one or more of the six environmental objectives), on existing green financial products and markets, and on liquidity in financial markets – in particular evaluating the risk to give rise to stranded assets or to deliver inconsistent incentives

·The necessity to specify technically, for each economy activity, how it will be determined if it "does not harm" any other objective and if it "contributes substantially" to at least one of the six objectives is now acknowledged. The technical screening criteria for determining if an economic activity "contributes substantially" to at least one of the six objectives each environmental objective and if it "does not harm" to any other objective would be developed through delegated acts. These delegated acts will be impact assessed.

·Better consideration was given to costs associated with the development of methodologies for low carbon or positive impact carbon benchmarks. As a result, the preferred option now is to establish at EU level minimum standards in the development of these methodologies (instead of maximum harmonisation requirements leading to a fully harmonised methodology, which would be more costly).

On 14 May, the RSB issued a positive opinion with reservations, which DG FISMA addressed as follows:

·On taxonomy: (i) further clarification was provided on how the notions of "do no harm" and "contributing substantially to sustainability" will be made operational; and (ii) it was clarified that future evaluations would also analyse to what extent the specific safeguards proposed to mitigate possible risks on e.g. competition aspects, fairness, excessive costs, consistency of incentives, risk of stranded assets, impact on liquidity in financial markets, and greenwashing have worked in practice, and determine whether any adjustments are needed in some areas

·On investors' duties and disclosures: (i) it was clarified that it is the disclosure requirements on products/services pursuing sustainability objectives that would satisfy the end-investors’ need to identify “ethical investments” – and not the transparency requirement on ESG integration under investors’ duties; (ii) examples of situations where ESG related information and data may not be directly available on the market or the available data may be of low quality and not comparable were incorporated; and (iii) it was clarified that disclosure requirements on sustainable products also cover asset managers that are part of banking and insurance groups.

·Some tables on costs and benefits were improved to make the cost-benefit trade-off more transparent.

·Lastly, a full reviewing, editing and streamlining of the text was completed.

IV. Evidence, sources and quality

The impact assessment largely benefited from the work of the High Level Expert Group (the HLEG) on Sustainable Finance established in December 2016 by the European Commission to help it develop an overarching and comprehensive EU strategy on sustainable finance. The HLEG, which worked intensively for 14 months, comprised 20 senior experts from civil society, the finance sector and academia as well as a number of observers from European and international institutions. To further its analysis and gather feedback, it also reached out to non-HLEG stakeholders to obtain targeted feedback on their analysis and further specify their recommendations to the European Commission

In addition, the comprehensive qualitative and quantitative evidence from the following consultations has informed/supported this impact assessment:

·Public consultation on long-term and sustainable investment – 18 December 2015 - 31 March 2016

·Feedback on the Inception Impact Assessment on institutional investors' and asset managers' duties regarding sustainability – 13 November - 11 December 2017

·Public consultation on institutional investors' and asset managers' duties regarding sustainability – 13 November 2017 - 29 January 2018

·Targeted interviews with stakeholders and questionnaires on ESG integration and taxonomy

·Studies/projects on sustainable finance with European Commission participation

·Conference on the Interim Report of the High Level Expert Group on Sustainable Finance on 18 July 2017

·High-level conference on Sustainable Finance on 22 March 2018

·European Parliament draft report for a resolution on sustainable finance – 2 February 2018

·Consultation of Member States through Council meetings

See Annex 2 for more details on these consultations.

Other sources used included: EIB, UNEP, Eurosif, OECD, and other studies and papers referred to in the final annex on "References".

Annex 2: Stakeholder consultation

I. Overview of consultation activities

1.Public consultation on long-term and sustainable investment – 18 December 2015 - 31 March 2016

2.Public consultation on the Interim Report of the High Level Expert Group on Sustainable Finance – 18 July - 20 September 2017

3.Feedback on the Inception Impact Assessment on institutional investors' and asset managers' duties regarding sustainability – 13 November - 11 December 2017

4.Public consultation on institutional investors' and asset managers' duties regarding sustainability – 13 November 2017 - 29 January 2018

5.Targeted interviews with stakeholders and questionnaires on ESG integration and taxonomy

6.Targeted questionnaire on the usefulness of suitability tests

7.Targeted interviews with stakeholders and questionnaire on the usefulness of a harmonised methodology for a low carbon index

8.Studies/projects on sustainable finance with European Commission's participation

9.Conference on the Interim Report of the High Level Expert Group on Sustainable Finance – 18 July 2017

10.High-level conference on Sustainable Finance – 22 March 2018

11.European Parliament draft report for a resolution on sustainable finance – 2 February 2018

12.Consultation of Member States through Council meetings

13.Detailed overview of individual responses per policy area

II. Stakeholder consultations

1. Public consultation on long-term and sustainable investment

In December 2015 the European Commission (DG JUST) launched a public consultation on long-term and sustainable investment. The consultation document provided for 31 questions in total. The period of consultation ran from 18 December 2015 until 31 March 2016. The summary of the responses to the public consultation was published in October 2016 (EC, 2016b).

The objective of this public consultation was to gather information on how institutional investors, asset managers and other service providers in the investment chain factor in environmental, social and governance (ESG) information and performance of companies or assets into investment decisions, and what the possible obstacles to long-term, sustainable investment are. This consultation was launched in the context of aspects relevant for the Capital Markets Union project.

91 replies were received. These came from a broad variety of respondents, including institutional investors, asset managers and their respective associations, as well as NGOs, public authorities, business federations and other service providers. As to the geographical distribution, most responses came from the UK, France, Belgium, Germany and the Netherlands.

In the context of the present impact assessment, individual responses were analysed to identify any feedback on taxonomy, benchmarks, suitability and the role of investment advisors and consultants, as well as any element (e.g. quantification, problems, solutions, references to national legislation and private initiatives) that could further inform this impact assessment.

Recurring themes that are relevant for the present analysis include:

·The link between fiduciary duty and ESG: most respondents saw no contradiction between the two; however, views were split between those who would prefer a (regulatory) clarification and those who would not.

·EU legislation and ESG integration: some pieces of EU legislation were perceived by respondents as problematic for ESG integration; this applied in particular to accounting rules and capital requirements under Solvency II (according to some respondents).

·ESG information: a vast majority of respondents indicated that while there is a lot of information available, its comparability and reliability remains problematic. This is particularly the case for ESG information disclosed by investees.

Overall, the consultation appears to have shown that the markets do not sufficiently internalise ESG risks and respond to ESG opportunities. Many contributors underlined that the transition to "mainstream" sustainable investment needs to be appropriately supported and called for actions to resolve the mentioned problems. More detailed input from this consultation has been included in the relevant sections of this impact assessment.

2. Public consultation on the Interim Report of the High Level Expert Group on Sustainable Finance

The High-Level Expert Group (HLEG) on Sustainable Finance was set up at the end of December 2016 to help develop an overarching, comprehensive EU strategy on Sustainable Finance by giving operational, practical, and concrete recommendations. The HLEG published its interim report on "Financing a Sustainable European Economy" (HLEG 2017a) in mid-July 2017 and presented the report at a conference on 18 July 2017.

In order to gather targeted feedback on the analysis and reflections in the interim report, as well as to inform the preparation of the final report, the HLEG prepared and issued a consultation questionnaire. Each HLEG member and observer received responses to all questions relevant to their respective work streams within the HLEG, thus ensuring that responses from the consultation were considered in the context of defining the final recommendations.

An aggregated and anonymised feedback statement (HLEG 2017b) was published along with the HLEG final report (HLEG 2018) on 31 January 2018. This statement summarises the respondents’ answers and serves as a further contribution to the wider policy debate on Sustainable Finance in the European Union.

Certain strong trends transcending all the answers were noted, including the following ones – of which the first three are directly relevant for this impact assessment:

·More than 30% of respondents underlined the importance of a clear policy and regulatory framework setting out a long-term EU strategy on sustainability and providing a favourable environment for sustainable investment and subsequent finance.

·The necessity to develop a commonly agreed taxonomy of sustainability is another outstanding concern expressed by more than 20% of respondents. Among others, replies from the banking and the insurance sectors, but also from public authorities highlighted the need for a clear and generally accepted taxonomy.

·Another issue which was at the centre of respondents' attention is the definition of fiduciary duty, which generally could be extended to embed wider environmental, social and governance considerations. In particular replies from financial system participants and facilitators indicated the importance of clarifying the definition of fiduciary duty which should include the notion of sustainability.

More than 30% of participants also expressed their conviction about the importance of improved disclosure, including data quality, availability and comparability, harmonised metrics, and standardised reporting requirements. The issue of transparency was raised frequently with regard to credit rating agencies. Many respondents advocated for more incisive incorporation of ESG in credit ratings and a good share made clear references to the Task Force on Climate-related Financial Disclosures (TCFD).

3. Feedback on the Inception Impact Assessment on institutional investors' and asset managers' duties regarding sustainability

The inception impact assessment on institutional investors' and asset managers' duties regarding sustainability (EC, 2017b) was published on 13 November 2017 with a possibility to provide feedback until 11 December 2017.

The Commission received eight responses to the inception impact assessment (EC, 2017c). 101 All of them supported the Commission’s work to ensure that sustainability factors are assessed, consistently taken into account and disclosed by institutional investors and asset managers.

The respondents raised a variety of issues such as: definition, scope and materiality of sustainability factors; need for regulatory intervention at EU level (legislative action vs. guidance); transparency and disclosure; need for flexibility and proportionality; clarity of investors' duties in the existing EU legislation; supervision of ESG integration; comparability and reliability of available data; taxonomy; and risk management and governance arrangements.

4. Public consultation on institutional investors' and asset managers' duties regarding sustainability

On 13 November 2017 the Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA) of the European Commission launched a public consultation on institutional investors and asset managers' duties regarding sustainability (EC 2017b). The consultation closed on 29 January 2018. The feedback statement to this public consultation was published by the European Commission in May 2018 (EC 2018b) and answers have extensively informed this impact assessment.

The purpose of the consultation was to seek views on how institutional investors and asset managers (could) include ESG factors when taking investment decisions. This would help them allocate capital more efficiently by taking into account sustainability risks, rather than merely seeking to maximise short-term financial returns. Respondents were invited to provide concise and operational suggestions on measures that can be enhanced or on complementary actions to deliver the policy goals.

The consultation followed up on two of the eight early recommendations delivered by the HLEG in its interim report of mid-July 2017 (final HLEG report was published on 31 January 2018). One recommendation focused on establishing a "fiduciary duty" that encompasses sustainability. The HLEG suggested clarifying that the duties of institutional investors and asset managers explicitly integrate material ESG factors and long-term sustainability. Another recommendation focused on strengthening "disclosure" on all sustainability dimensions.

The consultation document provided for 37 questions in total. including sub-questions. The first section was addressed to all respondents and had questions on general overview, problem, policy options and impacts for stakeholders. The second section was specifically addressed to end-investors and the third section to relevant investment entities. The questions focussed on several issues such as inter alia the relevance of ESG factors in the investment decision-making process, the consideration and level of integration of sustainability factors, possible constraints and risks/opportunities related to sustainability factors, disclosure of information on sustainability factors and costs/benefits due to the integration of sustainability factors.

DG FISMA received 191 responses to the consultation. Contributions were made by a broad variety of stakeholder groups, including beneficiaries and end clients, banks, pension and insurance providers, asset managers, investment advisors, service providers, issuers, and law firms as well as national, EU and international regulatory and supervisory authorities. Replies originated in 17 European and five non-European countries.

5. Targeted interviews with stakeholders and questionnaires on ESG integration and taxonomy

In order to support the preparation of this impact assessment and in parallel to the public consultation on institutional investors' and asset managers' duties regarding sustainability, the Commission conducted targeted stakeholder interviews to gather more detailed information on the issues raised in the public consultation and obtain views on taxonomy. These interviews took place in January – February 2018, targeting medium-sized/large asset managers and institutional investors (insurance companies and pension funds) that have already integrated ESG factors in their investment decision process and/or have SRI products. In total, 23 entities were interviewed. Questionnaires on integration of ESG factors in the investment decision process and on taxonomy were sent out to the interviewees to obtain their input and data.

Need for clarity and disclosure: The vast majority of interviewed entities agreed about the need for clarification at EU level on the fact that duties towards investors imply assessing ESG-related risks and taking them into account if they are relevant/material. Only 3 entities did not agree: one insurer stated that Solvency II already contains sufficient language and two asset managers replied that the concept of investors' duties already means covering all relevant risks. There is also a need to develop ESG expertise/education among relevant entities and communicate in a transparent way via good disclosure.

Areas of ESG integration: The most common areas of ESG integration identified by interviewed entities were investment strategy, risk management, governance measures (i.e. ESG specific committee, ESG board member, ESG internal control processes), engagement with investees and voting policy. Some respondents also mentioned that they have in place separate ESG policies and reporting processes to an ESG committee and the board. In some cases, ESG integration is aligned with remuneration policies.

Benefits of ESG integration: Among the main reasons for integrating ESG factors in their investment process, asset managers mentioned the positive impact on financial performance (particularly over the long term), improved risk/return characteristics of the managed portfolio, reputational benefits of ESG integration, and ability to attract new clients. Insurers and pension providers mentioned an increased investor/customer demand due to the integration of ESG factors.

Barriers to ESG integration: All interviewed entities except one insurer indicated that the lack of good quality and comparable data from investees/companies is an important barrier to assessing risks related to ESG factors. An overwhelming majority mentioned that there is a lack of common metrics, tools and methodologies to analyse ESG factors. It is not easy to analyse these non-financial factors with standard tools and models used to assess financial risks. Almost all of the interviewed entities use ESG ratings, data and research from external providers, with the cost of acquiring these services/data varying between EUR 80 000 and EUR 150 000 on average per year. The majority of the interviewed entities combine external ratings with their own internal research, which consists of quantitative analysis and models developed internally, as well as qualitative analysis of companies’ business models. A small/medium asset manager indicated that the overall cost of ESG integration is about 1-1.5% of the total cost of the product/service, which includes the cost of collecting ESG data from external providers, and the additional internal/organisational costs linked to setting up documentation, preparing a prospectus, drafting contracts (legal), and monitoring the exposure (risk management). Other barriers mentioned by almost all respondents were the lack of expertise/education on ESG issues and compliance costs (consisting primarily of costs related to IT systems and processes, costs of conducting research, consultancy and legal costs). In particular, investment in ESG expertise was mentioned as the most needed element in order to assess and integrate ESG factors. Most respondents also emphasised that the lack of harmonisation of ESG concepts/EU taxonomy is a significant issue, which, if addressed, could lower the costs of analysing ESG factors. On proposed policies, answers from the interviewed entities indicated that some EU guidance or standardisation of risk factors’ assessment would be helpful – with some expressing a preference for setting minimum standards.

Disclosure on ESG integration: Most of the interviewed entities make ESG-related disclosure at entity level and in annual/periodic reports, while others have client-specific disclosure, which is not public. A few entities have started to make public ESG disclosure at product/fund level because the assessment of ESG risks is done at the same level; hence, disclosure at product level does not require significant additional costs. While some entities consider that there is a need of harmonisation at EU level of how to disclose integration of ESG factors, some indicate that it would be costly to do it at product level. In particular, the review of the prospectuses is the most costly part of disclosure, with a cost around EUR 40 000 per product according to several respondents). In contrast, one entity indicated that for legislative or other reasons they have to update their products' prospectuses annually. Therefore, adding ESG disclosure at the moment when the prospectus is updated would not require an additional cost.

On taxonomy, the majority of interviewees agreed that a taxonomy at EU level would be helpful to fulfil their investor duties and take into account ESG factors in their investment decision process. Some interviewees have developed an internal taxonomy while others are using existing taxonomies with some adjustment. Three stakeholders indicated that they plan to develop or are in the process of developing their own taxonomy. Several interviewees were aware of government-led and market-led initiatives on sustainable finance and taxonomy.

The majority of interviewees saw the need for regulatory intervention at EU level with the involvement of market participants. A minority of stakeholders expressed preference for principle-based guidance. A taxonomy would have a positive impact on end-investors as it would facilitate the creation of more opportunities for sustainable investments. The majority of interviewees called for coverage of all three dimensions, starting with the E and then continuing with the S and the G. Finally, one of the interviewees commented that any legislation on ESG should regard the whole investment portfolio as investors should know the impact of all their investments.

6. Targeted questionnaire on the usefulness of suitability tests 102

The replies to the questionnaire on the usefulness of suitability tests showed that during the suitability assessment process either a general question is asked in relation to ESG preferences in the questionnaire to collect clients’ information or several specific questions are posed in order to clearly understand clients' preferences as regards sustainable finance. One respondent noted that they present or make available to clients their ESG risk management policies as part of their presentation of a product as these polices can impact the process of investments' selection.

The level of interest of clients in considering ESG factors in their investment decision process and choice of asset managers depends on each client, but overall this interest is growing. This is evident from the increase in the request for information linked to ESG issues.

Asset managers integrate (a) question(s) related to ESG issues into the questionnaire to collect clients’ information due to the following reasons: i) this is an opportunity to ex-plain the investment strategy in place; ii) a prominent role of ESG factors in the advisory process could be used as an element of differentiation which can be communicated to their clients; iii) it raises the awareness of clients on ESG factors/products; and iv) they believe that it is their role to initiate the discussions on ESG factors/products.

However, one respondent stated that they have not integrated such questions as the majority of their clients delegate to them the risk management of their investments, including the ESG risk management. Therefore, the clients have to study the ESG risk management policies in place and decide if these policies satisfy them.

For most respondents, a minority of their clients raise proactively ESG issues during the advisory process. Some of the reasons for this are: i) the information on ESG products is not very transparent; ii) the risk of 'greenwashing' of existing documentation is high; and iii) there is a lack of education on the impact of sustainability factors on risk and performance. In the case of one respondent, a majority of their clients raise these issues during the advisory process.

Respondents had divergent views on the need for providing more information to clients (e.g. in the prospectus, key information documents under the Packaged Retail and Insurance-based Investment Products Regulation or on an asset manager's website) on ESG factors and sustainable finance. Some believed that investors have sufficient information to take informed investment decisions. These respondents were concerned that harmonising the type of ESG information in product documentation might bring large discrepancies in understanding the reality of an asset manager's ESG risk management policies. Some ESG information should be made available to clients, but asset managers should choose the presentation format as they know best the specificities and characteristics of their ESG risk management policies.

However, there was also support for the provision of further ESG information as it would be useful for investors, especially individual investors who are by nature mostly long-term driven and therefore have a great need for sustainable finance products. In addition, it was pointed out that the issue is a matter of educating the investment advisors and fund distributors, as well as of making ESG portfolios transparent.

Constraints that prevent asset managers, to one extent or another, from integrating ESG factors in the suitability assessment include: i) the high costs involved; ii) lack of time due to the complexity of the advisory process and/or the lack of education of their clients; iii) their methodologies for the calculation of risks are not tailored to adequately take into account ESG risks; iv) lack of expertise and experience of their staff on ESG products; and v) the belief that clients are not interested in ESG products. Again, the importance of ESG education and training of investment professionals and advisors working with clients was stressed.

Respondents consider ESG factors in their product selection, but with different periodicity (i.e. always or only when the product is specifically dedicated to ESG strategies).

As for requiring the integration of ESG considerations into the suitability assessment, views were split among the options of not doing it, using non-binding guidance or clearly requiring it in legislation.

7. Targeted interviews with stakeholders and questionnaire on the usefulness of a harmonised methodology for a low carbon index

The interviews revealed that views on low carbon indices and their usage are split broadly between two groups of respondents – mainstream asset managers and “pure play” index providers. Mainstream asset managers and index providers see low carbon indices as a tool to manage carbon exposures and the risk of future regulatory intervention (which might lead to "stranded" investment assets), and hence focus on “green beta” or "decarbonized" indices. The basic construction principle of these indices is to take a standard benchmark, such as the S&P 500 or NASDAQ 100, and remove or underweight the companies with relatively high carbon footprints. Mainstream asset managers and index providers strive to reduce the overall carbon footprint of their portfolios when compared to the standard market cap weighted portfolios by achieving e.g. a 40% reduction in carbon footprint when compared to the standard or "parent" indices without aiming to align portfolios to a 2°C investment strategy.  "Pure play" index providers argued that these mainstream “decarbonised” indices are not aligned with a 2°C investment strategy. This group therefore advocated for a more stringent methodology in selecting benchmark components such as a carbon impact ratio. 

The interviews also revealed significant differences in how index providers measure carbon footprint. Most mainstream index providers tend to look at carbon emissions directly caused by a company's production activities and indirect emissions generated by the supply of raw materials or other "inputs" procured by the company upstream in order to produce its products or deliver its services.  Representatives of ''pure play'' index providers believe that this approach is insufficient to reflect a company's carbon footprint as emissions caused by a company's customers are disregarded.

Respondents to the questionnaire currently do not use a low carbon index because they believe that: (i) the current methodologies do not reflect all sources of CO2 emissions; (ii) their clients (investors) have no confidence in the methodologies employed by available low carbon indices; and (iii) there is an absence of low carbon indices reflecting their investments' approach and style.

The majority of respondents observed that there is merit in developing a harmonised low carbon index methodology at EU level and stressed the importance of reliable data on indirect carbon emissions caused by users or suppliers of a company (scope 3 emissions). They expressed concerns about comparing different sectors and potential excessive focus on some sectors.

When asked what the main features of low carbon indices should be, the majority of respondents observed that scope 3 emissions should be included in assessing CO2 emissions. Half of the respondents noted that the methodology of a low carbon index should be aligned with a potential upcoming EU green taxonomy. Some respondents were sceptical about the development of a harmonised methodology at EU level, mentioning concerns about data, unclear link between carbon footprint and environmental risks with financial impact (e.g. transition risk), and backward-looking nature of most methods. In particular, data on scope 3 emissions are considered more problematic due to lower availability and data quality issues.

8. Studies/projects on sustainable finance with European Commission's participation

In 2015, DG Environment published a study on Resource Efficiency and Fiduciary Duties of Investors (EC 2015) with the objective to provide clarification and policy advice on the integration of environmental and resource efficiency issues into the fiduciary duties of institutional investors. The study did not find explicit legal barriers to integrating sustainability factors into investment decisions either at EU level, or in the Member States included in the sample 103 . However, it identified conflicting interpretations of the fiduciary duty, which may prevent some investors from considering these factors, and revealed that investors do not adequately recognise the importance of environmental and social risks. The report further identified that one of the barriers to integrating ESG factors in investment decision making is the complexity and quality of ESG information, which is not always financially material, consistent and reliable, and hence does not enable comparability.

The European Commission also funded two Horizon 2020 projects related to sustainable finance. The first project centred on Developing Sustainable Energy Investment (SEI) Metrics, Benchmarks, and Assessment Tools for the Financial Sector. 104 This project ran from March 2015 to March 2018 and focused on developing tools for private and public entities such as an energy investment roadmap for the financial sector, guidance for institutional investors on setting climate performance targets and launching benchmark indices, and portfolio optimization tools. The second project focused on Energy Transition Risks & Opportunities 105 , with the objective to help investors and policymakers understand the energy transition risk and assess its materiality for equity and bond portfolios.

9. Conference on the Interim Report of the High Level Expert Group on Sustainable Finance on 18 July 2017

The European Commission organised a conference "Sustainable Finance: Interim Report" on 18 July 2017 in Brussels to gather stakeholder reactions to the Interim Report of the High Level Expert Group on Sustainable Finance (HLEG 2017a). Approximately 450 participants representing public authorities, the civil society, the financial sector and other stakeholders discussed the analysis and recommendations contained in the report. The conference allowed stakeholders to provide feedback to the European Commission and the HLEG on barriers to and possible solutions for increasing sustainable finance, as well as ways to establish a more sustainable financial system.

10. High-level conference on Sustainable Finance on 22 March 2018

The European Commission held a high-level conference on Sustainable Finance on 22 March 2018 in Brussels. The overall objective of this high-level event was to keep up the momentum established at the One Planet Summit and continue to consolidate the support and commitment from EU leaders and key private players for the changes needed in the financial system to fund the transition towards a low-carbon economy.

This high-level event focused on the key role finance industry and market players should play alongside the EU effort to build the economy of tomorrow: a low carbon, circular and resource-efficient economy. In this context, the European Commission also presented the EU strategy on Sustainable Finance as described in the Action Plan on Financing Sustainable Growth. Besides the high-level keynote speeches, three very fruitful panel sessions with high-level panellists from various sectors took place on the following topics: (i) Financing sustainability: towards a more future-friendly capital allocation; (ii) Commission Action Plan on Sustainable Finance; and (iii) How to translate the EU Strategy in practice? Furthermore, there was a debate on "How fast can the EU deliver?".

There was a strong support for the EU Action Plan on Financing Sustainable Growth from a broad range of speakers, some of them even calling for it to be more ambitious. Many speakers and panellists stressed that: (i) there is an urgent need to take action, given the acceleration of global warming and the impact on the economy and our societies; (ii) the cost of not acting will be larger than the cost of acting; and (iii) the financial sector has a large role to play.

11. European Parliament draft report for a resolution on sustainable finance – 2 February 2018

The European Parliament – Committee on Economic and Monetary Affairs – has published a draft report (EP 2018) for a resolution on sustainable finance on 2 February 2018.

The overall objective of this Parliament initiative on sustainable finance is to enable and accelerate the stabilisation of the climate and the protection of the global ecosystem. The role of finance and investments can contribute to ensuring a rapid transition to a sustainable economy, and clear information about the sustainability impacts of financial products. The draft report responds to the final report of the HLEG on Sustainable Finance of 31 January 2018 and lends political support to the HLEG recommendations.

In order to enshrine ESG factors in the EU financial decision-making, the draft report mentions inter alia the issues of taxonomy, disclosure and fiduciary duty. On taxonomy, it calls on the Commission to lead a multi-stakeholder process to establish a robust and credible EU green taxonomy through a legislative initiative. As disclosure is a critical enabling condition for sustainable finance, it urges the Commission to ensure mandatory disclosure. Fiduciary duty should be extended to encompass a mandatory ‘two-way’ integration process whereby asset managers are obliged to consider ESG factors and clients are asked about their timeframe and sustainability preferences.

The European Parliament's draft report for a resolution on sustainable finance was negotiated among the political groups in the European Parliament and adopted by the Committee on Economic and Monetary Affairs on 24 April 2018. The plenary vote is expected to take place on 28 May 2018.

12. Consultation of Member States through Council meetings

Sustainable Finance was discussed at several Council meetings, including the Economic and Financial Affairs Council (ECOFIN) and the Financial Services Committee (FSC). Meetings held in 2017 focused on the work of the HLEG and its Interim Report.

At the January 2018 FSC meeting, the Commission presented a non-paper on Sustainable Finance to the Member States. The non-paper introduced the Commission’s work on the forthcoming Action Plan and highlighted potential policy actions such as on taxonomy, standards and labels for sustainable financial products. Most Member States that intervened were in favour of an EU regulatory intervention to establish an EU taxonomy of sustainable activities. Member States also emphasised a need for flexibility, which was considered in the assessment of policy options.

Before the February 2018 meetings, the Bulgarian Presidency issued notes to the ECOFIN and the FSC, asking the Member States which policy actions need to be taken at European level to promote sustainable finance. They also inquired into existing policy actions of Member States related to the HLEG recommendations.

The ECOFIN Council held on 20 February 2018 showed a wide support for HLEG recommendations and EU-level actions to support sustainable finance. Sustainable finance was also discussed at the FSC meeting on 21 February 2018, with a specific focus on the forthcoming Action Plan and proposal on taxonomy. Overall, there was a broad support for the Commission actions in the area of sustainable finance from 18 Member States. 11 Member States emphasised that a common taxonomy is a key starting point for further policy actions.

Member States expressed a general support for a taxonomy at EU level at the February 2018 meeting of the Expert Group on Banking, Payments and Insurance.

The project also received high-level political support including the European Council, which stated in its March 2018 Conclusions on jobs, growth and competitiveness that ''the EU needs to keep working towards a future-proof and fair single market that is fit for the digital age and an enabler for competitiveness, innovation and sustainability'' (European Council 2018).

At the April 2018 meeting of the Economic and Financial Committee (EFC) Member States expressed support for the Commission's sustainable finance programme.

13. Detailed overview of individual responses per policy area

a. Duties towards investors/beneficiaries

Table 27: Detailed overview of individual responses on duties towards investors/beneficiaries 

b. Disclosure

Table 28: Detailed overview of individual responses on disclosure

c. EU Taxonomy

See Annex 8 Section VII for a detailed overview of stakeholders’ views on EU taxonomy.

d. Low carbon benchmarks

Table 29: Detailed overview of individual responses on low carbon benchmarks

Annex 3: Who is affected and how?

Practical implications of the initiative

The preferred options described in section 5.4 to 5.7 will have the following practical implications:

The preferred policy option on investors' duties will have an impact on the relevant investment entities, as they are expected to integrate ESG factors in the areas of governance, risk management, investment strategy and asset allocation, suitability tests, and product selection. This will require investments in ESG expertise and tools, especially for those entities that never integrated these factors. The implication will be consistency and clarity about what relevant investment entities should do in terms of taking ESG considerations / risks / factors into account when they make investment decisions.

The areas just mentioned are the ESG elements that relevant investment entities will have to disclose on ESG integration (in reports and product information), together with the impact of ESG factors on the risk-adjusted returns of the related product/service. If asset managers / institutional investors claim that they pursue a strategy with a sustainability investment objective, they will have to demonstrate it (disclose the impact of their products/portfolios on climate/environment). End-investors will be therefore able to make informed investment decisions thanks to the higher transparency linked to the harmonisation of ESG integration processes and related disclosure at product level.

The preferred policy option on taxonomy will define the conditions for the subsequent creation of an EU environmental taxonomy for the purposes of establishing the environmental sustainability of investments. Such a common understanding will have an overall positive impact on the financial sector as indicated in the summary table below. Any measures adopted by Member States or by the EU for regulating financial market participants with regard to the labelling of financial products pursuing environmentally sustainable objectives would have to apply the uniform criteria. While Member States would be allowed to continue their national labelling schemes (that might possibly co-exist with the EU Eco-label framework to be extended later to financial products), they would be obliged to use the uniform EU taxonomy for those schemes. As the taxonomy will be gradually developed, public authorities would have to set up a governance framework. 106 This governance framework will guarantee that the taxonomy remains a living classification that can be changed/updated over time.

Meanwhile, administrators of low-carbon benchmarks will have to use harmonised minimum standards at EU level. This would drive the possibility for relevant investment entities to adopt these indices as a reference benchmarks and hence to credibly commit to a low carbon strategy. Investors who would like to invest in low carbon footprint issuers would have an appropriate index / tool to assess their investment. This would foster generally accepted market standards to measure a company's footprint and, in consequence, an investment portfolio's carbon footprint, while keeping sufficient flexibility for the private sector to innovate.

Summary of costs and benefits

The following tables present systematically the costs and benefits, which were identified and assessed during the impact assessment process for the preferred policy options outlined in Section 5.

Table 30: Overview of benefits

Table 31: Overview of costs

Annex 4: Sustainable finance trends in Europe

In the past 20 years, asset owners and asset managers have increasingly turned to sustainable investment 127 . In addition, the need to consider ESG factors in the general investment process of all investment as part of their duties towards clients and beneficiaries has grown albeit at a slow pace (See Box 2 in Section 2.1.2).

Despite the fact that sustainable investment practices are often described in the literature using different terms such as “socially responsible investments (SRI)” or “responsible investments”, there is a common understanding that each of those terms indicates the process of integrating investors’ concern about ESG factors in their investment decision process (Kreibohm 2016)  128 . At its heart is the concept of a long-term oriented investment approach, which integrates ESG factors in the research, analysis and selection process of securities within an investment portfolio. It combines fundamental analysis and engagement with an evaluation of ESG factors in order to better capture long term returns for investors, and to benefit society by influencing the behaviour of companies (Eurosif, 2016). In this respect, studies and surveys from various sources have provided evidence that a number of asset managers and asset owners consider those factors, but the development over time is slow. 129  

According to the Eurosif study (2016) 130 , sustainable investment strategies in Europe have developed slowly over the last years. In 2015, the amount of assets subject to sustainable investment strategies represented 51% of total European assets under management (AUM) compared to 56% in 2013 and 47.5% in 2011 (see Figure 2). Overall figures indicate that the total amount of assets based on sustainable investment strategies have increased to approximately EUR 11 trillion (see Figure 7). Institutional investors mainly drive these developments. As per the latest figures dated 2015 131 , institutional investors hold 77.93% of sustainable assets. It is interesting to note the relative increase of retail assets, which grew from 5.90% in 2011 to 22.07% in 2015 suggesting their interest towards sustainable investments (EuroSIF 2016). 

Figure 7: Sustainable investment strategies in Europe (in EUR trillion)

Source: European Commission analysis based on EuroSIF data

The European sustainable investment fund market has also continued to grow between 2010 and 2016 as shown in a study conducted by KPMG (2017). While in 2010 there were 1 503 funds managing EUR 251 billion, in 2016 the number of funds increased to 2 413 with EUR 476 billion of AUM. The amount of sustainable AUM have registered the largest growth between 2014 and 2016 with an increase of 26.6% (see Figure 9). Among the 2 413 funds registered in 2016, 70% were ESG cross-sectoral funds. Environmental funds amounted to 17% of total sustainable AUM and social funds to 8%. 132

According to Morningstar, which assigns sustainability ratings to funds, 155 funds have a sustainability rating above average (see Table 32). 133 Among those 13 falls under the category of low-carbon funds with a total AUM of EUR 2.44 billion.

Table 32: European sustainable investment funds by domicile

Source: European Commission analysis based on Morningstar (2018)

At global level, the initiative on the Principles for Responsible Investment (PRI) has registered a constant growth of signatories since its launch in 2006. The latest PRI annual report (2017) refers to 1 713 signatories globally. Of those signatories, 929 are in Europe (PRI, 2018a). In 2014, there were 814 signatories, 226 of whom were asset owners and 588 were asset managers (PRI, 2014). Committing to the PRI principles implies, among other things, to incorporate ESG issues into investment analysis and decision-making processes and to seek appropriate disclosure on ESG issues by the entities in which signatories invest.

Finally, according to a global survey of 461 asset owners and asset managers, 174 of which were European, 46% of asset owners indicated that they plan to have 50% or more of their investments in ESG funds. Moreover, 54% of asset managers plan to market 50% or more of their funds as ESG funds (BNP Paribas, 2017). 134  

Key figures

Figure 8: Sustainable investment strategies out of total AUM in Europe (in EUR trillion)

Source: European Commission analysis based on EUROSIF and EFAMA data

Figure 9: AUM on the European sustainable investment fund market (in EUR billion)

Source: KPMG (2017)

Annex 5: Implementation Timeline