Background
The Disclosure Regulation will apply from the 10th of March 2021. It compels professional investors and financial advisors to disclose, in quite some detail, how the risks of negative environmental, social and governance (ESG) impacts may affect the value of an investment. Investment fund and asset managers are also required to disclose how exactly they take long term ESG impacts into account.
The Disclosure Regulation is part of the European Commission’s Action Plan on Sustainable Finance, a strategy to integrate sustainability and ESG considerations into its financial policy framework. The purpose of the strategy is to increase transparency and ensure that sustainability claims in investment products are substantiated.
Scope
The regulation applies to a wide range of entities. Its scope encompasses all professional investors but does not apply to banks. This means the law applies to managers of pension and hedge funds, investment managers, and insurance companies. Advisory enterprises with more than three employees must also comply with the Regulation.
The disclosure requirements will apply to investment products which promote environmental or social objectives or have ‘sustainable investment’ as their objective.
Requirements
The Disclosure Regulation imposes four transparency requirements on entities within its scope, each of which are set out in more detail below. The requirements are:
- Pre-contractural disclosures
- Disclosures in periodical reports
- Website disclosures
- Marketing communications
- New taxonomy regulation
Pre-contractual disclosures
Before entering into a contract with a client, financial market participants will have to disclose:
- The procedure for integrating sustainability risks into investment decisions
- The impact sustainability risks are likely to have on investment returns
- How remuneration policies align with the integration of sustainability risk
Further, where a financial product has sustainability as a target:
- An explanation of how the target will be measured. The designated benchmarking index and weighting of factors must be explained
- If there is no reference benchmark in place, alternative methodologies for measuring sustainability targets must be explained
Disclosures in periodical reports
For financial products that promote socially or environmentally sustainable features, periodic reports will need to include:
- A description of the extent to which social or environmental sustainability criteria have been met.
- If sustainability is the objective of a financial product, the report must include the overall sustainability impact of the investment. Sustainability indicators and comparisons to any designated index used as a benchmark will be included.
Website disclosures
Website disclosures will be required from investment professionals, making:
- An outline of policies around the integration of sustainability risks in investment decisions.
- Principle adverse sustainability impacts of investments and a statement on due diligence policies relating to those impacts
- justifications for any instances where adverse sustainability impacts are not considered in the investment decision-making process.
- describing sustainable investment targets and the methodology used to assess impacts.
- Information on how remuneration policies are consistent with the integration of sustainability risks
- The information required under Articles 8 and 9 (on pre-contractual disclosures) and Article 11 (periodic reports)
Marketing Communications
Article 13 of the Disclosure Regulation states that financial market participants have a responsibility to ensure that their marketing communications do not contradict the regulation in any way.
The Taxonomy Regulation
The Taxonomy Regulation establishes an EU-wide classification framework for identifying environmentally sustainable economic activities. This is also due to apply by the end of 2021. The Taxonomy Regulation will work in tandem with the Disclosure Regulation to prevent financial market participants from ‘greenwashing’ financial products for a competitive advantage. Using the new criteria, investors are expected to favour sustainable economic activities in order to attain better ESG credentials than their competitors.
What does this mean for business?
Whilst the purpose of the legislation is to regulate the financial services sector and will immediately impact investors the most, it could also have far-reaching effects on the business community. More and more institutional investors are looking for businesses capable of articulating a sustainable strategy that outlines not just growth opportunities, but also the related risks. ESG criteria are used by socially-conscious investors and shareholders to screen investments and can help companies gather and retain funding. The importance of ESG factors will increase with the new Disclosure Regulation, making it imperative for businesses to implement and be able to demonstrate good ESG performance.
For more information on the services Ardea International offer to businesses looking to improve ESG performance, see our ESG Toolkit page.
Ardea International is also hosting two webinars on the 19th November 2020. The two free webinars will cover social risk and resilience, as well as carbon performance measurement. The sessions will give participants insights from acknowledged experts on practical steps they can take to enhance ESG performance.
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