The current enactment of the EU Action Plan for financing sustainable growth (the ‘Action Plan’) is a sign of the EU’s efforts to support the transition to a sustainable economic system, so complementing other existing EU environmental and climate policies, in a clear commitment to the goals set by the 2016 Paris Agreement on climate change and the UN 2030 Agenda for Sustainable Development.
Investor protection regulation is one of the first segments in which the EU authorities intervened under the Action Plan, as the duty to act in investors’ best interest necessary implies that Environmental, Social, and Governance (ESG) preferences are also duly taken into account.
Our recently published paper offers an overview of the EU initiatives to implement sustainable finance, highlighting the main issues at stake in relation to investor protection, as well as the factors which could hamper the effective implementation of the reforms.
The paper starts with a brief analysis of the recent developments in the regulation of sustainable finance at the global level, and then offers a more detailed view on the establishment of a common regime on sustainable finance in the EU. Subsequently, it analyzes the recent new regulatory proposals, as well as the recommended changes to existing regulation (MiFID II, IDD, AIFMD, UCITS, etc.), specifically considering the barriers to the integration of sustainability risks and factors in the four main dimensions of the EU investor protection regulation: (1) disclosure of product information, (2) conduct of business rules, (3) product governance and intervention, and (4) financial education.
Although the reforming process is still under development, we consider that a first analysis of existing challenges and criticism to such proposals could assist both regulators and market operators in evaluating proper solutions to future potential barriers to effective implementation.
A first main challenge is the lack of a common methodology, standards for classification, or labelling of the relevant financial products, which could impact on the demand for sustainable investments. Indeed, the delay in the definition of a taxonomy, which was intended as the first key action of the Action Plan, risks causing a delay or at least putting into danger the successful implementation of the entire financial reform.
Proper disclosure of reliable ESG data and data assessment, verification, and comparison is another issue that risks impairing investors’ trust in sustainable finance, negatively impacting on product governance obligations, and raising market confusion. A strengthening of the reporting verification system should be promoted in order to avoid greenwashing. Comparability could be improved by requiring a limited number of common indicators to be disclosed, thus avoiding data manipulation and information overload. Other non-regulatory measures, such as cross-referencing with external data sources, could further enhance data reliability.
Another regulatory challenge consists in ensuring a balanced level of flexibility and providing a gradual approach to ESG integration, avoiding the requirement that financial operators should adapt to a high level of granularity for any ESG products, when the market for financial products is not mature enough, especially in relation to suitability assessments and product governance.
High levels of financial education and culture are also vital for the success of the reforming processes. In this regard, better disclosure of financial information, surveys and other financial education initiatives could be insufficient if not complemented with other behaviorally informed approaches capable of changing investors’ choice architecture, thus avoiding a misalignment between investors’ declared preferences and actual behavior.
Will the EU Commission successfully integrate sustainability risks and factors in the investor protection regime? As already stated, the reforming process is still under development, and further research on the outcomes of each of the analyzed factors is going to be needed once finalized. The new regulatory proposals are clearly aimed at providing more clarity on financial operators’ duties in terms of ESG considerations but also at improving the quality of offered investment services and products by better aligning them with investors’ preferences. Moreover, such measures are expected to, on the one hand, reward more sustainable and innovative businesses, and, on the other, lead companies to adopt more responsible production and decision-making processes, as well as to disclose the ESG impact of their activities properly.
The open question, which should be addressed and answered once the first set of rules is finalized, is whether such integration of ESG factors will be sufficient to ensure the successful restructuring of the EU financial system towards a sustainable and responsible economy, or whether additional substantial changes will be required. In other words, the recent EU reform proposals, though admirable, risk oversimplifying a complex issue that cannot be easily solved without considering their practical implications on each category of financial services providers.
Michele Siri is Professor of Business Law and holds the Jean Monnet Chair on European Union Insurance and Financial Markets Regulation at the University of Genoa.
Shanshan Zhu is Research Fellow at the Department of Law, University of Genoa.