Sustainable Finance and the Financial Sector
By adopting the Paris Agreement on climate change and the UN 2030 Agenda for Sustainable Development in 2015, governments from around the world chose a more sustainable path for our planet and our economy.
The Paris Agreement, signed in December 2015 by 195 countries, is the first-ever universal, global climate deal to adapt and build resilience to climate change and to limit global warming to well below 2°C. The Paris climate agreement, in particular, includes the commitment to align financial flows with a pathway towards low-carbon and climate-resilient development. To honour the International commitments, a specific policy framework is needed to incentivise the private sector which will have a key role.
At EU level, sustainable finance is a work stream aimed at supporting the European Green Deal by channelling private investment to the transition to a carbon neutral economy alongside public funding.
In the EU’s policy context, sustainable finance is understood as finance to support economic growth while reducing pressures on the environment and taking into account social and governance aspects. Sustainable finance also encompasses transparency with regard to ESG risk factors that may have an impact on the financial system, and the mitigation of such risks through the appropriate governance of financial and corporate actors. Any form of financial service that integrates environmental, social and governance (ESG) criteria into the business or investment decisions for the lasting benefit of both clients and society at large falls under the heading of Sustainable Finance.
In line with its Sustainable Finance Agenda the European Commission has been implementing a range of initiatives to meet its international environmental commitments and targets. Its Action Plan on sustainable finance and the EU Green Deal include substantial regulatory initiatives to help the EU reach its goal of net-zero carbon emissions by 2050 and maintain a stable and sustainable financial system.
The financial system has a key role to play as an intermediary between savings and investment, specifically, by reorienting private capital to more sustainable investments, fostering more transparency and long-termism in the economy.
Reorienting private capital to more sustainable investment requires a comprehensive shift in how the financial system works. The aim is to develop more sustainable economic growth and ensure the long-term stability of the financial system. Such thinking is also at the core of the EU’s Capital Markets Union (CMU) project. Sustainable finance will also help to ensure that investments support a resilient economy and a sustainable recovery from the impacts of the COVID-19 pandemic.
Regulatory Structure and Resources
Sustainability poses both a direct and indirect risk to the financial sector. The Authority supports the development of a harmonised and efficient international framework. Acknowledging the European Commission’s agenda towards the attainment of a sustainable financial system as a long-term investment, the MFSA has identified sustainable finance as one of its key priorities in its 2019 Strategic Plan.
Without any doubt, the Commission roadmap presents the need for adjustments both in the supervisory framework as well as in the investment value chain.
The Authority remains committed to actively participate in the relevant fora conscious of the fact that only by ensuring the uniformity of rules at European and International level can the financial markets facilitate cross-border investment and contribute meaningfully towards the achievement of sustainable development goals
With this in Mind the MFSA has already been participating for some time in the work of the Coordination Network on Sustainability (CNS) within ESMA, as well as the sustainable finance project group within EIOPA. The CNS was created to foster the coordination of national competent authorities’ (NCAs) work on sustainability. The project group within EIOPA was set up to offer advice to embed sustainability in the delegated regulations under Solvency II and the Insurance Distribution Directive. The MFSA also participates in the Network for Greening the Financial System (NGFS), specifically, in relation to a Macro Financial workstream. Its membership is spread across the five continents.
As a supervisory Authority, we also wish to see that the principle of proportionality is addressed during the upcoming negotiations on EU legislative dossiers at EU level. This is an important factor for the Maltese financial services sector which we will delve carefully into.
The MFSA also aims to ensure consistency of outcomes across all market segments. We look at ‘sustainability’ with a cross-sectoral viewpoint underlining the need for consistency, coherence and setting the right founding elements for such an important, structural shift in the financial landscape. We will therefore work to avoid a fragmented approach by different sectors and entities as we aim to facilitate the transition in a way at that minimises any negative impact.
The Authority also aims to increase awareness on sustainable finance amongst the entities under its supervision as it is extremely important to build the necessary knowledge, not just to ensure compliance with the requirements being imposed to but more importantly to drive ambitious policies to the benefit of all stakeholders and society at large.
As we focus on the implementation of the EU Regulations that have been adopted so far, we are also working on upcoming EU initiatives in order to get ahead of the curve, be proactive and pave the way forward.
Regulatory Structure and Resources
As the European regulatory landscape continues to evolve, financial sector stakeholders need to understand the building blocks that are already in place and the interplay between them, the obligations and responsibilities they may already have in this context, and the direction of travel as the framework continues to be strengthened and brings new opportunities within reach.
Adopted on 22 June 2020 and entered into effect on 12 July 2020. The Regulation establishes the conditions and the framework to create a unified classification system (or taxonomy) on what can be considered environmentally sustainable economic activities. Financial sector actors will likely be motivated to develop their analyses of their investment and financing targets, and to aggregate them in order to define their organization’s risks and impacts, as well as to further develop them into a report. In simpler terms Taxonomy is a classification system, which typically takes the form of a list or table that classifies specific objectives or concepts as sustainable.
In December 2019 the Regulation entered into force and applicable as of 10 March 2021. The Regulation introduces obligations on institutional investors and asset managers to disclose how they integrate Environmental, Social and Governance (ESG) factors in their risk processes. The Disclosure Regulation seeks to harmonise existing provisions on disclosures to investors in relation to sustainability-related disclosures by imposing requirements on so-called financial market participants and financial advisers in relation to financial products.
Benchmark administrators, providing new climate benchmarks, will have to comply with the Regulation by 30 April 2020. The aim of the legislation is to ensure the reliability of benchmarks and minimize conflicts of interest in benchmark-setting processes. EU BMR will affect all published indices ‘used’ in the EU in financial instruments and contracts or by fund managers. These benchmarks will allow a significant level of comparability of climate benchmarks methodologies while leaving benchmarks’ administrators with an important level of flexibility in designing their methodologies. The establishment of EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks, underpinned by a methodology linked to the commitments laid down in the Paris Agreement regarding carbon emissions, would contribute to increasing transparency and would help prevent greenwashing.
12 October 2022
The Report on Data and usability of the EU Taxonomy outlines recommendations on the usage of data to support upcoming and implemented Sustainable Finance reporting obligations. The recommendations outlined in the Report are valuable in the usability and application of the Taxonomy Regulation. The Report is based on data collected from companies currently reporting under the Taxonomy Regulation. The Platform has leveraged publicly available disclosures as well as its market insight to deliver a valuable snapshot of the first round of Taxonomy reporting. The expert group identified a number of challenges and misalignments in non-financial and financial reporting alike and highlighted emerging best practices and subsequent recommendations.
The Report advises on the application of minimum safeguards in relation to the Taxonomy Regulation. It does so by a) embedding minimum safeguards in existing EU regulation, b) identifying substantive topics relating to the standards and norms referenced in Article 18 of the Taxonomy regulation and c) presenting advice on compliance with minimum safeguards. The Report explores the links between minimum safeguards and the existing Sustainable Finance Disclosure Regulation (SFDR), the Corporate Sustainability Reporting Directive (CSRD), and the upcoming Corporate Sustainability Due Diligence Directive (CSDDD).
6 July 2022
The Network for Greening the Financial System (NGFS) report on bridging data gaps provides policy recommendations that policymakers and stakeholders can adopt to address climate-related data challenges. This report builds on previous work conducted by the NFGS on the assessment of the needs, availability and gaps of climate-related data, which resulted in the identification of three building blocks providing for the availability of reliable and comparable data. Namely; i) the development of global disclosure standards, ii) shared principles for sustainable finance classifications, as well as iii) metrics, certification labels, and methodological standards. The policy recommendations put forward in this report seek to further improve the availability, quality, and comparability of climate-related data.
The Basel Committee on Banking Supervision of the Bank for International Settlements (BIS) published principles for the effective management and supervision of climate-related financial risks, aiming to improve banks’ risk management and supervisors’ practices on this matter. The document sets out 18 principles that cover areas such as corporate governance, internal controls, risk assessment, management and reporting. The Committee expects jurisdictions to implement the principles as soon as possible and will monitor the achieved progress.
23 May 2022
The European Securities and Markets Authority (ESMA) published a study assessing the potential reasons behind the lower costs and better performance of environmental, social and governance (ESG) funds compared to other funds. In its report, ESMA found that ESG funds are more oriented towards large cap stocks, as well as towards developed economies. Moreover, ESMA notes that ESG and non-ESG funds also have different sectoral exposures.
27 April 2022
The NGFS report “Enhancing Market Transparency in Green and Transition Finance”, leverages the experiences of NGFS members and observers to shed light on the state of play and key challenges surrounding market transparency issues. The report sets out some key considerations relevant to policymakers and aims to feed into international discussions on improving compatibility of approaches to identify, verify and align investments to sustainability goals.
MFSA Report on Operational and Compliance Readiness by Financial Market Participants and Financial Advisers
12 April 2022
The MFSA report presents the Authority’s findings of its first supervision exercise into the state of readiness and compliance by financial market participants and financial advisors that fall within the scope of application of the Sustainable Finance Disclosure Regulation (SFDR). The report intends to increase awareness on sustainable finance among the entities under the Authority’s supervision. It also guides entities in scope to make any necessary improvements to the information they provide in relation to sustainability.
ESAs Issue Updated Supervisory Statement on the Application of the Sustainable Finance Disclosure Regulation
25 March 2022
The three European Supervisory Authorities (EBA, EIOPA and ESMA – ESAs) have updated their joint supervisory statement on the application of the Sustainable Finance Disclosure Regulation (SFDR). This includes a new timeline, expectations about the explicit quantification of the product disclosures under Article 5 and 6 of the Taxonomy Regulation, and the use of estimates.
23 November 2021
The market for ESG ratings and data has grown over the past few years, in part due to a lack of consistent information disclosures at the entity level. In its report, IOSCO suggests that Regulators could consider focusing greater attention on the use of ESG ratings and data products and the activities of ESG rating and data products providers in their jurisdictions. This could help to increase trust in ESG ratings and data going forward.
In its report, IOSCO has also set out specific recommendations on what Regulators could consider when developing their framework. These recommendations are underpinned by more specific guidance to assist members when navigating this new market. The recommendations include promoting more transparency regarding the methodologies that ESG ratings and data product providers use in developing their products; ensuring their procedures for managing conflicts of interest are appropriate and improving communication channels between two providers and the entities covered by their ESG ratings or data products without undermining their impartiality.
IOSCO Report on Recommendations on Sustainability-Related Practices, Policies, Procedures and Disclosure in Asset Management
2 November 2021
The IOSCO report aims to improve sustainability-related practices, policies, procedures and disclosures in the asset management industry through five recommendations for securities regulators and policymakers. The recommendations are designed to provide a list of potential areas for consideration as regulators and policymakers consider developing sustainability-related rules and regulations, consistent with their mandates and domestic regulatory frameworks. The report also outlines the need to address challenges associated with the lack of reliable data at the corporate level. In its report, IOSCO presents its view on setting regulatory and supervisory expectations to support asset managers in addressing the current challenges.
Scenarios in Action: A Progress Report on Global Supervisory and Central Bank Climate Scenario Exercises
19 October 2021
NGFS released the report “Scenarios in Action: a progress report on global supervisory and central bank climate scenario exercises”, which sets out how a growing number of NGFS members, across all continents, are using climate scenarios to identify, assess and understand climate risks in their economies and financial systems.
The report features 30 NGFS members’ climate scenario exercises. As climate scenario analysis is a new and growing field of activity, it also highlights a number of the challenges that need to be addressed in undertaking this work. By providing insight into how central banks and supervisors have sought to address these challenges, the report serves as a practical reference work for those seeking to do climate scenario exercises in the future. Objectives of climate scenario exercises range from assessing macroprudential, macroprudential and economic risks, to developing capabilities both internally and within the broader financial sector. As climate scenario exercises develop, insights into the financial impacts from transition and physical risks will become increasingly comprehensive, based on a converging set of methodological practices and a growing body of data.
6 July 2021
The new Sustainable Finance Strategy sets out several initiatives to tackle climate change and other environmental challenges while increasing investment in the EU’s transition towards a sustainable economy. More precisely, the Strategy aims to:
- extend the existing sustainable finance toolbox to facilitate access to transition finance,
- improve the inclusiveness of small and medium-sized enterprises (SMEs) and consumers, by giving them the right tools and incentives to access transition finance,
- enhance the resilience of the economic and financial system to sustainability risks,
- increase the contribution of the financial sector to sustainability,
- ensure the integrity of the EU financial system and monitor its orderly transition to sustainability, and
- develop international sustainable finance initiatives and standards.
6 July 2021
The Commission legislative proposal for a European Green Bond Standard (EUGBS) aims to set the standard for how companies and public authorities can use green bonds to raise funds on capital markets, to allow for investments while meeting sustainability requirements and protecting investors from greenwashing. The new EUGBS will be open to any issuer of green bonds, including issuers located outside of the EU under four requirements:
- the funds raised by the bond should be fully allocated to projects aligned with the EU Taxonomy;
- there must be full transparency on how bond proceeds are allocated through detailed reporting requirements;
- all EU green bonds must be checked by an external reviewer to ensure compliance with the Regulation and that funded projects are aligned with the Taxonomy;
- external reviewers providing services to issuers of EU green bonds must be registered with and supervised by the European Securities and Markets Authority (ESMA).
21 April 2021
The European Commission adopted an ambitious and comprehensive package of measures to help improve the flow of money towards sustainable activities across the European Union. The package is comprised of: The EU Taxonomy Climate Delegated Act; A legislative proposal for a Corporate Sustainability Reporting Directive (CSRD); and six amending Delegated Acts on fiduciary duties, investment and insurance advice.
1 March 2021
EBA Report to the EU Commission on KPIS and Methodology for Disclosures by Credit Institutions and Investments Firms under the NFRD on how and to what extent their activities qualify as environmentally sustainable according to the EU Taxonomy Regulation.
25 February 2021
The three European Supervisory Authorities (EBA, EIOPA and ESMA – ESAs) have published a joint supervisory statement on the effective and consistent application and national supervision of the Regulation on sustainability-related disclosures in the financial services sector (SFDR).
2 February 2021
The European Supervisory Authorities (ESAs) have developed draft Regulatory Technical Standards (RTS) with regard to the content, methodologies and presentation of sustainability-related disclosures under empowerments Articles 2a, 4(6) and (7), 8(3), 9(5), 10(2) and 11(4) of Regulation (EU) 2019/2088 (hereinafter Sustainable Finance Disclosure Regulation “SFDR”).
11 December 2019
The European Green Deal provides an action plan to boost the efficient use of resources by moving to a clean, circular economy, and restore biodiversity and cut pollution. The plan outlines investments needed and financing tools available. It explains how to ensure a just and inclusive transition.
8 March 2018
The Sustainable Finance Action Plan is a major policy objective by the European Union which aims to promote sustainable investment across the 27-nation bloc. The Plan is part of a wider Sustainable Finance Framework which is backed by a broad set of new and enhanced EU Regulations.