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Exploring the New EU Sustainable Investment Roadmap

In reaction to greenwashing, European Commission introduces new roadmap of regulations aimed to improve the quality of financial products related to sustainability.
As societal and environmental issues take spotlight in global agenda, we see how investors turn to impact finance. According to the data from Morningstar, ESG funds in Europe have attracted net inflows of €151bn between January and October 2020 only, which is a staggering 78 % increase in comparison with 2019. Moreover, PwC analysts claim that ESG funds can increase their share of total European assets from 15 % to 57 % by 2025.
Brilliant numbers, but is there a catch? Well, yes. We all understand that the incredible growth is attributed, in part, to loose ESG definitions as well as greenwashing. Taking advantage of lack of strict definitions, some asset managers label their instruments as “ESG”, without a true basis for such claims.
In reaction to such negative trends, European Commission introduces new roadmap of regulations aimed to improve the quality of financial products related to sustainability. A new European regime on sustainability-related disclosures in the financial sector was firstly introduced in 2018 (during the so-called European Commission’s Action Plan on Sustainable Finance).
Starting from March 2021, EU imposes new ESG requirements for a wide range of “financial services participants”. This includes not only investment firms and fund managers in Europe, but also non-EU fund managers with market funds in the European Economic Area under the national private placement regime.
To make EU financial markets more sustainable the regulator introduces two key aspects of The Taxonomy Regulation and Disclosure Regulation – “SFDR”.

I. Taxonomy Regulation

The main idea behind the Taxonomy Regulation is to create an EU-wide classification intended to set a framework for identifying the clear environmental sustainability thresholds. This will harmonise standards and avoid labelling of instruments as more environmentally friendly than they really are. The majority of the provisions of the Taxonomy Regulation will apply from 31th December, 2021.

II. Disclosure Regulation – “SFDR”

The SFDR introduces obligations on investors and asset managers to disclose how they integrate ESG factors into their risk processes. The obligation applies to everyone, regardless of whether a fund claims to be ESG-focused. Additionally, asset managers will be required to review their whole portfolio and consider a range of metrics to ensure compliance. The disclosure requirements consist of 50 sustainability measures, of which 30 are mandatory.
Asset managers now need to implement a due diligence policy on the principal adverse impacts of their investments or disclose that “no consideration of sustainability adverse impacts” was given, – in a separate section of their web-pages.

* * *

In Q1 2021, the European Commission has presented a Non-Financial Reporting Directive governing corporate ESG disclosures. This obliges  companies to disclose data on their business models, policies, principal risks, and key performance indicators (KPIs) related to environmental and social issues relevant to their business. As the harmonization of standards takes place, it will help investors and other stakeholders make better decisions with regards to impact.
Now the financial market participants look forward to January 2022, the first deadline for asset managers to submit annual product-level ESG disclosures in line with SFDR. Asset managers are now required to report on climate change mitigation and adaptation in line with all previously mentioned regulations.
Now the financial market participants look forward to January 2022, the first deadline for asset managers to submit annual product-level ESG disclosures in line with SFDR. Asset managers are now required to report on climate change mitigation and adaptation in line with all previously mentioned regulations.

Concluding Remarks

Although the integration of sustainability in finance may now seem overwhelming, we should understand it as a transition, not an immediate outcome per se. Several asset managers have already started the implementation of new regulations, setting good precedence for other companies to keep up and create their strategies and visions, identify possible opportunities and risks, and adjust their investment principles accordingly. Let’s hope that the European Commission will now effectively guide the market participants, making this transformation smoother.

About the author:

Viacheslav Khobta is a regular contributor to Cyan Reef with passion towards disruptive technology themes. Viacheslav has a strong analytical background in asset pricing and fintech research. MSc in International Finance, University of Economics in Bratislava (SK), Kyiv-Mohyla Academy (UA), University of Bergen (NO).

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