Escali Blog

EU’s sustainable finance

Sep 2, 2020 10:55:59 AM / by Marina Silitrari

Feedback on financial institutions’ obligation of advice on social & environmental aspects


Legal basis and background

The EU’s action plan on sustainable finance seeks to ensure people have clear information on the social and environmental risks and opportunities attached to their investments. The European Commission’s Action Plan aims to integrate sustainable finance within the financial system. The goal is to shift capital flows away from activities with negative social and environmental consequences and direct them towards socially responsible ones.

The regulation on sustainability-related disclosures in the financial services sector (SFDR) came into force on the 27 November 2019 having been agreed by the Council and European Parliament.

On 18 December 2019 the Council and European Parliament reached a political agreement on a new regulation for the establishment of a framework to facilitate sustainable investment (the Taxonomy Regulation).

The Taxonomy Regulation was subsequently adopted by the Council and approved by the European Parliament paving the way for its publication in the Official Journal on 22 June 2020. This regulation sets out additional empowerments in SFDR for the ESAs to develop technical standards on disclosure.

Feedback request

Feedback was requested by the EC (European Commission) in June 2020 on 6 draft acts that outline financial markets participants’ duties to properly inform their customers about environmental, social and governance risks involved in their investments. The drafts corresponded to 6 major stakeholder categories:

  1. Mutual funds
  2. Investment funds
  3. Insurance firms & brokers
  4. Reinsurance companies
  5. Investment firms
  6. Alternative investment funds

On 17 June 2020, the Financial Supervisory Authority of Norway (Finanstilsynet) published an article asking to be informed if any of the suggestions might have a considerable impact on Norwegian participants’ interests. Finanstilsynet noted that the rules will be implemented in the EEA agreement, but how it will be implemented in Norwegian legislation is yet to be decided. The feedback window lasted from 8th of June to 6th of July.

The widespread feedback reflects common concerns and raises a colourful spectrum of issues:

  1. Quantification of the ESG risks – probably the most important issue raised

International Capital Market Association, Switzerland (ICMA) points out that “there is currently no standardized and audited data {…} to perform the quantitative assessment required under SFRD. This is mainly because under NFRD each company can ultimately determine which disclosures are most relevant to its own stakeholders and rely on a “comply or explain” provision. As raw data disclosed by issuers are still very limited in scope and quality, asset managers rely significantly on ESG data providers. But ESG scorings are still mainly focusing on the impact of issuers on their environment rather than on “sustainability risks” and can differ significantly from one provider to another.” The integration of some ESG factors when assessing the creditworthiness of issuers is not done systematically and the credit agencies also each have their own methodology.

They also note that another related issue is the disparity between the different degrees of quantification among the ESG risks. Even climate risk is challenging, where the CO2 ton price may be used as proxy. The other S and G risks are even less quantifiable.

ICMA point out that the ECB had recently acknowledged some of these problems in its May 2020 draft Guide on climate-related and environmental risks:

“The ECB expects institutions to assign quantitative metrics to climate-related and environmental risks, particularly for physical and transition risks. However, it also acknowledges that common definitions and taxonomies in these risk areas are still under development, and that qualitative statements can be used as intermediate steps while the institution is developing appropriate quantitative metrics.”

ICMA suggest that “in the absence of a common standard, certified and audited from issuers” {…} “sustainability risks may be assessed by management companies, or where relevant by investment companies, on a qualitative basis.

  1. Implementation timeline

Fédération Bancaire Française emphasizes that investment firms will have very limited time to adapt their processes and a longer implementation period would be necessary to let firms upgrade their IT systems, integrate clients’ sustainability preferences, and redesign their suitability and product governance processes.

  1. “Expertise” or “Skills and knowledge”?

The wording that has captured Association of the Luxembourg Fund Industry’s attention is one is “Member States shall ensure that {..} management companies retain the necessary resources and expertise, skills and knowledge for the effective integration of sustainability risks.” (ALFI) believes that “expertise” should be replaced by “skills and knowledge”. Indeed, given the recent emergence of focus on sustainability matters across the financial sector, ALFI believes expert resources are actually limited, and it may take some time to up-skill knowledge profiles to the expert level. Still under-development metrics make it difficult. Invest Europe (Belgium) agrees that “real”, established expertise is very difficult to achieve, and this concept does not correspond to the reality of what will be put in place by AIFMs to ensure sufficient knowledge of the subject matter.

  1. Customer’s choice vs financial advisor’s duty to inform

The Polish Financial Supervision Authority perceives the mentioning of “choice” in the definition of “sustainability preferences” as fairly problematic: They see “an inconsistency with the notion of the “choice of the customer” and the role of the suitability assessment. Under the suitability assessment, the burden lies on the insurance intermediary/insurance undertaking to gather the necessary information about the customer to enable the insurance intermediary/insurance undertaking to recommend suitable products for that customer. By using the language of the customer’s “choice” as to whether to integrate a product into their investment strategy, this seems to effectively pass the burden of responsibility back onto the customer to legitimise the suitability assessment done by the insurance intermediary/insurance undertaking. It would seem to make more sense to talk of the customer’s “preferences” so the burden remains on the insurance intermediary/insurance undertaking’s side, to guide the customer in making a decision based on his/her preferences.”

  1. Singling out sustainable risks

Alternative Investment Management Association UK states there should not be disproportionate emphasis placed on sustainability risks compared to other risk factors: Our members understand and support the addition of “sustainability risks” in the list of specific risks to be considered in general risk management policies but consider that such addition is broadly sufficient to ensure that sustainability risks are taken into account throughout the decision-making process. However, singling out this type of risk in the context of the management of conflict of interests, the general requirements, and the supervisory functions, might result in a potential disconnect between the assessment of this type of risk and the general investment or risk management approach” The idea is mentioned by most of the participants. Among others Invesco, Luxembourg expresses its concern that the current drafting could give the impression that sustainability risks should be considered above other risks, also stating   that this might have unwanted consequences.


  1. Investor’s choice of participation degree: Alternative Investment Management Association UK also recommends that investors should be offered a diversified choice with regard to their sustainability preferences: Opting for a “sustainable financial product” entails a choice by investors, for example, some may choose screening of controversial underlying investments while others may want exposure to impact funds.
  2. Terminology: “financial instruments” and not “financial products”

The Swedish Securities Markets Association (SSMA) points out that the MiFID II definition of sustainability preferences refers to “financial instruments” and not “financial products”, which is the term used in SFDR. As a result, the MiFID II rules will include instruments for which financial market participants do not have obligation to publish data under SFDR, such as bonds and shares, or the obligation to categorise these. They also note that other sectorial legislation proposed by the Commission as part of the same ESG-package have been drafted differently. In fact, in IDD, UCITS, AIFMD and Solvency II, the definition of “sustainability preferences” refer to “financial products” and not “financial instruments”.

  1. Derivatives (OTC/ETD)

The Swedish Securities Markets Association (SSMA) comments that “amendments will also have to be made to recital 6 of the MiFID II Delegated Regulation 2017/565 in order to ensure that it is in alignment with the adjusted Article 2. Moreover, if the term “financial instrument” is kept in the definition of “sustainability preferences”, it should be clarified in a recital that the intention is to include instrument used for investment purposes and that derivatives used for hedging is outside scope. Otherwise we see a risk that the terminology used will lead to implementation difficulties and unintended consequences “.

  1. Internal role assignment

The Investment Company Institute Global (ICI, UK) points out that “Asset managers’ compliance or internal audit control programs do not cover management of security level investment risks. Rather they address business risks such as anti-money laundering, fraud, business continuity, valuation/pricing procedures, client information security, trading errors, insider trading, and due diligence processes for the organization. The incorporation of ESG integration into the investment process is the responsibility of the portfolio management teams.”


Updates in Escali to accommodate the upcoming change

Escali Financial Systems AS has already started to update its system to accommodate the upcoming ESG regulations. We have begun introducing fields that can capture information from different ESG rating agencies. We allow ratings ranging from 0 to 100 (Sustainalytics, Bloomberg ESG Data Science, DowJones Sustainability Index) as well as CCC to AAA (MSCI ESG Research) and D- to A+ (Thomson Reuters).

We have also created a Power BI report that can analyse a fund or portfolio average ESG rating, as well as other ESG indicators.


We look forward to these changes and are ready to provide any assistance and/or expertise our customers might need.

Tags: ESG, EU

Marina Silitrari

Written by Marina Silitrari