November ESG Outlook for the financial market

November ESG outlook for the Financial Market – What you need to know

In this article we will cover the main news and insights from the ESG space and what it all means for private debt market actors.

Regulatory updates for asset managers and asset owners

– ESMA launches a public consultation on guidelines for using ESG and sustainability terms in funds’ names

As part of its Sustainable Finance Roadmap, on the 18th of November ESMA launched a public consultation on guidelines for using ESG and sustainability terms in funds’ names. Through the establishment of quantitative thresholds, ESMA aims both at protecting investors against unsubstantiated or exaggerated sustainability claims while also providing National Competent Authorities with clear and measurable criteria for verification purposes. In particular, funds having any ESG-related words in their name should have at least 80% of investments meeting the environmental or social characteristics or objectives purposed in the investment strategy. Furthermore, funds with sustainability-related terms should have at least 50% of investments meeting the definition of sustainable investment following article 2(17) of Regulation (EU) 2019/2088 (SFDR). Such thresholds wouldn’t fall under the SFDR umbrella, but rather under the UCITS and the AIFM Directives, and are expected to come into force by Q3/Q4 2023. Stakeholders can provide feedback by 20 February 2023.

– The ESAs issue a new Q&A document clarifying the Regulatory Technical Standards on the SFDR

Earlier last week the ESAs (European Supervisory Authorities – ESMA, EBA, EIOPA) also issued a Q&A document providing clarification on Del.Reg. 2022/2188 (Regulatory Technical Standards on the SFDR). The most interesting raised points concern EU Taxonomy disclosure. In particular, the ESAs stress again that Taxonomy disclosure is mandated only for those financial products promoting environmental characteristics (article 8) or environmental objectives (article 9). Such products should provide within pre-contractual disclosure the minimum Taxonomy-aligned investments mandated by the investment strategy while providing actual figures only through periodic reporting. Stakeholders raised also concerns about the lack of data from non-financial undertakings, with the ESAs restating that estimates and complimentary assessments should be allowed only for those investee companies that do not have Taxonomy reporting obligations. What’s even more relevant, is that ESAs discourage the use of controversies as a suitable proxy for the Do Not Significant Harm test, stating that controversies would fail to account for metric-based thresholds and process-based requirements, which are required for some activities, but that is currently not required to be reported by any company. We have previously addressed the use of controversies in the EU Taxonomy assessment here.

Regulatory updates for banks

EBA accepts the European Commission’s proposed amendments to the draft implementing technical standards (ITS) on Pillar 3 ESG risk disclosure.

On October 2022, the European Banking Authority (EBA) has accepted the European Commission’s proposed amendments to the draft implementing technical standards (ITS) on Pillar 3 ESG risk disclosure. With the ITS, EBA is pushing mandatory disclosure of climate risks for large traded credit institutions and investment firms regulated under the Capital Requirements Regulation (CRR). Starting in 2023, these institutions will have to provide a set of quantitative disclosures, including exposure to carbon-intensive sectors and firms, loans collateralized by the immovable property by energy performance of the collateral, and exposure to climate physical risks. Credit institutions will have time until 2024 to disclose their financed GHG emissions and their green asset ratio (GAR), i.e. the share of the banking book aligned to the EU Taxonomy requirements for climate change mitigation and adaptation for exposures to undertakings having Taxonomy reporting requirements. A novelty that EBA tried to introduce with the ITS, was the mandatory reporting of Taxonomy alignment also for exposures to companies out of the scope of Taxonomy disclosure obligations (“BTAR”, banking book taxonomy alignment ratio), such as SMEs, so as to better reflect institutions’ vulnerability to climate risks. It is exactly this latter point that the EC has rejected, making the BTAR disclosure only voluntary.

Market updates: Sustainable finance & greenwashing

Market updates for asset managers and asset owners

– Goldman Sachs Asset Management agrees to pay a $4 million penalty following the US SEC’s investigation

On the 22nd of November, Goldman Sachs Asset Management agreed to pay a $ 4 million penalty following the US SEC’s investigation into some funds marketed as ESG investments. The SEC investigation has uncovered investment malpractices taking place between 2017 and 2020, mainly revolving around missed application of claimed ESG screening prior to security selection.

– ESAs launches market consultation for collecting stakeholders’ views on greenwashing definition and practices, amidst increasing downgrades of article 9 funds by Blackrock, Invesco, and others

On the 15th of November, the ESAs launched a market consultation for collecting stakeholders’ views on greenwashing definitions and practices, amidst increasing downgrades of article 9 funds by Blackrock, Invesco, and others. As we explained here, article 9 products following the SFDR are those having a sustainable investment objective, i.e. they not only advance environmental or social characteristics but also do not significantly harm other E/S dimensions. The ESAs clarified back in June that article 9 products can make sustainable investments only. This clarification is still triggering article 9 funds downgrades, the most recent touching HSBC AM, Amundi, and DWS. According to the ex-DWS Sustainability Officer, many players knowingly labeled dark green products tracking broad market indices that would have never qualified as sustainable investments; at the same time, the ambiguous language of the SFDR has left too much room for interpretation.

According to Morningstar research, less than 5% of Article 9 funds target sustainable-investment exposure between 90% and 100%, which calls into question the feasibility of the new quantitative thresholds proposed by ESMA, without posing risk to fund diversification. The same holds for EU Taxonomy alignment, with almost 90% of article 8 and 70% of article 9 products reporting 0% alignment. However, article 9 has been the only one registering net positive inflows during Q3, with article 6 and article 8 funds registering net outflows of almost 90 bn, but with article 8 still accounting for 33,6% of EU registered funds (vs 4,3% for article 9 products). Article 8 and article 9 products are still dominated by equity and large-cap signaling the market challenges in designing sustainable products for other asset categories. Amid concerns of global recession and inflationary pressures, despite an evident down-warding trend started at the beginning of the year, sustainable funds in Europe seem to hold better than their conventional counterparts.

Market updates for banks

– The European Central Bank (ECB) publishes the results of its review of credit institutions’

The European Central Bank (ECB) has just published the results of its review on credit institutions’ (107 significant banks 79 less significant banks) preparedness in addressing climate and environmental (C&E) risks in line with supervisory expectations issued in November 2020. The ECB expects supervised institutions to:

  • adequately assess the impact of C&E risks on their activities by March 2023;
  • integrate C&E risks in their governance, strategy, and risk management by the end of 2023;
  • fully integrate C&E risks in the Internal Capital Adequacy Assessment Process (ICAAP) and stress testing.

The ECB’s review shows that while more than 80% of assessed institutions recognize the materiality of C&E risks and have some basic practices in place (e.g. preliminary risks mapping and KPI setting, a qualitative mitigation strategy), less than 10% use sufficiently granular counterparty and risk information, showing lack of adequate data infrastructure and governance. Furthermore, the majority of assessed institutions, while having policies and procedures in place, fail to reflect assessed material risks into portfolio allocations, consequential limits, tolerances, and thresholds. The ECB took proportional steps in its supervisory engagement, sending feedback letters and setting institution-specific remediation timelines with a view to ensuring full alignment with all expectations by the end of 2024.

– The European Commission calls for EBA’s advice an assessment on green loans

On the 22nd of November, the EBA also received from the EC a Call for advice on green loans and mortgages, with a focus on households and SMEs. The EBA is requested to assess the green loans market together with existing methods for qualifying green loans, with a particular emphasis on Taxonomy-aligned loans. Furthermore, the EBA is tasked with evaluating the legislative and non-legislative measures that could incentivize green loan origination and facilitate their uptake by borrowers. The EC requests the EBA to provide its advice by the end of December 2023.

How we enable our clients to solve their ESG challenges?

At CARDO AI we are leveraging our R&D efforts to help our clients get an enriched view on their exposure to small and mid-size companies, expanding their capabilities in sustainable portfolio building, Taxonomy-alignment evaluation, and granular climate and risk assessment.

Learn how by requesting a demo today!

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