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EU Commission Proposals Focus on Sustainable Finance

Comparing and contrasting approaches to ESG investing in the U.S. and Europe

Andy Pettit 


The difference between the European and U.S. approaches to sustainable investments is stark.

We recently told you about the guidance released by the U.S. Department of Labor regarding how retirement plan sponsors should consider environment, social and governance (ESG) factors when picking a plan’s investments. Meanwhile in Europe, regulators are reviewing feedback on proposals to put the European Union’s financial sector front and center in achieving the EU’s climate change and Paris Agreement obligations.

The European Commission proposals constitute the first legislative package following the action plan set out by the commission in March. The plan was the culmination of more than a year of work by the commission’s high-level expert group on sustainable finance. We expect the impact of the proposals to reach beyond the EU borders, with direct implications on firms that offer investment products in the EU and with a taxonomy having the most use if it’s adopted globally.

4 key features of the European Commission proposals

The commission’s sustainable finance proposals are far-reaching, with implications for investment advisers, investment managers, index or benchmark providers, and investors.

  1. Financial advice suitability tests. Under MIFID II and the Insurance Distribution Directive, European firms are already obligated to establish clients’ investment objectives prior to recommending suitable products. The commission’s proposals will extend these two sets of rules and require advisers to take additional steps when determining risk profile and assess their clients ESG preferences when advice is being offered.
  2. ESG in the investment process. Pre-contractual disclosures to European investors continue to evolve. Under the commission’s proposals, investment managers will need to include details of how ESG risks are included in their processes, the extent they are expected to impact their investment returns and how remuneration is tied to ESG goals.
  3. Carbon benchmarks. After the LIBOR scandal, and the manipulation of interest rates on which the LIBOR benchmark was built, a new Benchmark Regulation took effect in July. It imposes significant registration and disclosure requirements upon providers of any benchmarks being used within the EU. The new proposals will add a set of criteria for low and positive carbon benchmarks to that regulation.
  4. Defining what is environmentally sustainable. The fourth commission proposal is for a new regulation to determine which economic activities are environmentally sustainable and make it easier for investors to compare the aims of competing products.

Sustainability as a driver or a tie-breaker of investment decisions

The European Commission’s proposals are heading down a path of enabling ESG factors to be a primary driver of investment selection if an investor wishes. As such, these proposals go much further than the U.S. Department of Labor’s guidance, in which plan fiduciaries can use collateral considerations such as social or environmental benefits as tie-breakers for an investment choice. That means that a plan sponsor can select an investment with social or environmental benefits if it’s expected to perform the same as an investment without these benefits. Similar rules apply to other fiduciary advice in the U.S.

How investors and advisers can make investing decisions under the commission’s proposals

The sustainable investing landscape covers a rapidly growing number of products and a variety of individuals’ views, beliefs and levels of understanding. As this landscape continues to evolve, it’s vital that investors are not prejudiced, that their expectations are managed, and unintended consequences and client dissatisfaction are guarded against.

Under the European Commission’s proposals, advisers will increasingly be expected to have an expertise on ESG that’s at least equivalent to that which they provide to their clients across other areas of their personal finances. This is a big ask. And we believe that advisors would benefit from more guidance and examples of how best to tease out clients’ ESG preferences and their importance relative to other factors such as income stream, growth aspirations or retirement requirements. That’s some of what we said in our feedback about the  proposals. Ultimately, this will help maximise the chances of receiving good advice on sustainable investments.

Learn how Morningstar’s ESG data and research can help inform your investing decisions.

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