In the fall 2015, in the run up to COP21, France became the first country to pass a law introducing mandatory extensive climate change-related reporting for asset owners and asset managers, the Energy Transition Law and its now famous Article 173.
The reporting obligations set out under Article 173 and its implementing decree have potentially far-reaching implications, requiring institutional investors to report on the integration of both physical risks and ‘transition’ risks caused by climate change on their activities and assets.
Whom Does Article 173 Apply To?
Article 173 addresses publicly traded companies, banks and credit providers, asset managers and institutional investors, the latter being listed as insurers, pension or mutual funds and sovereign wealth funds, with differentiated reporting obligations depending on their size and nature.
The law applies to French companies, meaning that French subsidiaries of large financial groups are potentially subject to requirements that do not apply to their parent companies.
What Must the Climate Change-Related Reporting Include?
A comply or explain approach
The law provides investors with broad flexibility in choosing the best way to fulfil the objectives, based on a comply or explain approach. It does not impose any specific method, giving leeway to find the reporting methodology suiting best the investment portfolio, for example reflecting specific asset classes or subsidiaries. However, investors must provide information and justification on the methodology used. They are encouraged to draw from current best practices. An assessment of the implementation will be carried out after two years, at the end of 2018, and the best-in-class approaches will be promoted.
Banks and credit providers will be subject to regular stress tests including a climate change component.
Publicly traded companies’ annual reports must disclose the financial risks related to the effects of climate change, the measures adopted by the company to reduce them and the environmental impact of the company’s activities and of the use of goods and services it produces.
Asset managers managing funds below 500 M€ and institutional investors with balance sheets below 500 M€ must report on the implementation of their ESG policies.
Asset managers managing funds above 500 M€ and institutional investors with balance sheets above 500 M€ are subject to extended climate change-related reporting obligations (besides their ESG policies). Those obligations are two-fold:
- Assessment of the portfolio’s exposure to climate change-related risks, including both physical risks (physical impact of climate change) and transition risks (impact of the transition to a low-carbon economy).
- Assessment of the investor’s contribution to meeting the international and national low-carbon goals, including the low-carbon targets set by the the investor itself and the actions taken to achieve these targets.
While Asset management companies have to report separately on each of the above 500 M€ funds they manage, institutional investors must provide a consolidated reporting on their assets.
Note that institutional investors may have a commercial relationship with asset management companies via dedicated funds and/or management mandates. Therefore, asset management companies may be directly or indirectly affected by Article 173, via their institutional investor clients. The terms and conditions of access to ESG information required by institutional clients to meet their own Article 173 reporting obligations are to be defined in the contractual relations between them and the asset management companies involved.
Though investors are free to choose which exact data to report, the implementing decree suggests including the following information:
- The consequences of climate change and extreme weather events on the assets
- Changes in the availability and price of natural resources
- Policy risks related to the implementation of national and international climate targets
- Measures of past, current or future emissions of GHG (both direct and indirect)
As mentioned above, all assessments must come with an explanation and justification of the methodology used.
As of now, 60 institutional investors are subject to the latter reporting requirements.
The Assessment of Climate Change-Related Physical Risks
What really makes Article 173 groundbreaking is the reporting obligation on climate change-related physical risks. The inclusion of physical impacts of climate change in a financial risk analysis is in line with the industry-led Task Force on Climate-related Financial Disclosures (TCFD) recommendations report, released on December 2016 and discussed in a policy brief and a webinar.
While traditional climate-related reporting focuses mainly (if not exclusively) on the impact of the organization’s activities on climate change, the French Energy Transition Law is truly pioneering as it also emphasizes the impact of climate change on the organization’s activities and assets. This new focus meets the demand of investors for enhancing financial risks assessment through taking better account of climate-related risks.
A Ripple Effect
The French government is hoping for a ripple effect, both internationally and on a national level, across the investment value chain. The service providers of eligible investors are already considering how to enhance their ESG and climate reporting practices in order to meet their clients’ demands and comply with the law.
Moreover, climate-related regulatory efforts are gaining momentum. Article 173 is expected to be the first of a series of national equivalent regulatory frameworks among the G20 countries. The TCFD was established shortly after the Law passed, at the December 2015 G20 summit, and explicitly offers its guidance for compliance with Art. 173.
In March 2016, the Dutch central bank DNB announced it was taking steps to monitor and mitigate climate risk. Last November, the European Union has issued a directive requiring all EU-based pension funds to assess for climate change risk.
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A handbook on Article 173 published by the French SIF
By Delphine Ly, Climate Analyst at Four Twenty Seven