EU Moves Towards Regulation for Climate Risk Disclosure

From Recommendations to Action 

March 15, 2018 – 427 ANALYSIS. The EU laid out a clear plan to move towards mandatory climate risk disclosure as part of a new set of regulations to finance sustainable growth and support the transition to a low-carbon economy. The European Commission’s Action Plan lays out a two year timeline for implementation, with a goal to create a taxonomy for climate adaptation finance by the end of 2019. These regulations from the EU will drive change into financial markets globally and set standards on reporting, disclosures and infrastructure resilience that will likely set the bar for the rest of the world.

The European Commission recently released its Action Plan: Financing Sustainable Growth to establish a regulatory framework that supports the goals of the Paris agreement. The Action Plan calls for transformation of the whole financial system to enable the financing of a sustainable, resource-efficient economy.

The Action Plan builds on the recommendation from a high profile expert group, the High-Level Expert Group on Sustainable Finance (HLEG), which was created by the European Commission in December 2016.   The group included experts from banking, insurance, asset management and stock exchanges. Its final recommendations to the Commission, released in January  acknowledged the responsibility of the financial system to drive change towards “enduring and inclusive economic prosperity”. HLEG recommendations aimed to both promote sustainable investments, so that capital reaches sustainable projects and also to ensure that the financial system itself addresses risk and builds resilience.

Incorporating many of the  recommendations of the HLEG, the Commission’s Action Plan lays out ten specific actions, setting deadlines within the next two years, with a number of thematic sub-actions that will be pursued simultaneously.  Action 1  lays the groundwork for many of the following actions as it will establish a Technical Expert Group on Sustainable Finance, with the responsibility of drafting a standardized EU sustainability taxonomy , including climate mitigation by Q1 2019 and adaptation by Q3. This effort will be supported by legislation this year that mandates the creation of the taxonomy.

The 10 actions are summarized in this infographic from the European Commission:

Mandating Disclosure

Of most immediate importance to investors is Action 7, which calls for the proposal by Q2 2018 of legislation mandating investors to explicitly consider sustainability factors in their investment decisions and disclose their methodology of doing so. This effort is particularly focused on improving the consistency and transparency of climate risk considerations by investors.

Likewise, Action 9 is focused on improving the methodologies and practice of corporate risk disclosure. The Commission will publish a report on current reporting legislation by Q2 this year, which will inform a revision of corporate reporting guidelines to help them align with the TCFD recommendations, by Q2 2019. Later this year the Commission will develop a European Corporate Reporting Lab, under the European Financial Reporting Advisory Group, to help develop best practices for corporate reporting. The goals of Action 10 will support these actions by supporting a shift in corporate governance. It aims to improve transparency and combat long-termism, by engaging with stakeholders around corporate governance starting by Q2 next year.

Revamping Credit Ratings

The Commission also commits to revamping the ways in which credit ratings incorporate sustainability metrics into their scoring. Through Action 6, the European Securities Markets Authority (ESMA) will examine the credit ratings’ current practices around this topic by Q2 2019 and the Commission will pursue comprehensive research on reporting standards, exploring the potential of mandating agencies to integrate specific sustainability metrics into their standards.

Client Clarity

To improve consumers ability to identify sustainable investments, Action 2 calls for the technical expert group to publish a report exploring green bond standards by Q2 2019 and the Commission will consider expanding the EU Ecolabel to include financial products, initially focusing on retail investments. Likewise, Action 4 says that by Q2 2018, the MiFID II and IDD rules will be updated to ensure that sustainability preferences are considered when banks, investment firms and insurers offer accounts to clients and by the end of the year the ESMA will include these provisions in their guidelines. Through Action 5 the Commission will adopt acts that improve the transparency of sustainability benchmarks by Q2 2018.

 Comprehensive Sustainability Support

The Commission identifies a lack of technical expertise as a challenge to pursuing sustainable infrastructure projects and aims to confront this by to increasing the technical support available to investors.  It will run a pilot project offering tools for sustainable infrastructure projects, from 2019-2023 through Action 3.

Action 8 states that the Commission will consider including sustainability frameworks in prudential requirements, looping in the European Insurance and Occupational Pensions Authority (EIOPA).

“A Blueprint” for Change

While the HLEG emphasized that its report is only the beginning of an enduring effort to create a resilient financial system that supports a sustainable society, the Commission’s resulting Action Plan clearly defines the next steps. And as HLEG also emphasized its report’s relevance for financial sectors worldwide, the Commission’s Action Plan states that a “coordinated, global effort is crucial.”  As “the HLEG hopes to stimulate a wide public debate that helps shift Europe’s financial system from post-crisis stabilization to supporting long-term growth,” that same widespread conversation is essential to driving global change. These regulations from the EU, as is often the case, will drive change into financial markets globally by setting new standards global financial institutions must meet.

Download the HLEG Recommendations.

Download the EC Action Plan

For more resources on building a sustainable financial sector, read about Four Twenty Seven’s work providing the technical secretariat for an EBRD and GCECA initiative to build a resilient financial sector and download the GARI Investor Guide to Physical Climate Risk and Resilience.