What is ESG disclosure regulation?

Environment Sustainability and Governance (ESG) regulations

Environmental, social, and governance issues are becoming more important to financial organizations as a compliance issue.

As a result, on 27 November 2019, Regulation (EU) 2019/2088 (“ESG Disclosures Regulation”) came into force. This regulation on sustainability-related disclosures in the financial services sector will apply 15 months later.

By imposing requirements on so-called financial market participants and financial advisers in relation to financial products, the Disclosure Regulation aims to harmonize existing provisions on sustainability-related disclosures to investors. It will also demand that sustainability risks be factored into financial market participants’ investment decision-making processes or, where appropriate, advisory processes, as well as transparency for financial products that aim to make sustainable investments. Pre-contractual disclosures, disclosures on websites, and disclosures in periodic reports in connection to financial products are all specific obligations.

The ESG Disclosures Regulation intends to level the playing field with a cross-sectoral approach. The rule aims to reduce “greenwashing,” a type of marketing in which green values are falsely exploited to persuade investors that a financial market participant’s or adviser’s financial products are environmentally friendly.

What will ESG disclosure regulation mean?

Entity-level disclosure of adverse sustainability impacts

Firms with more than 500 workers must post a statement about negative environmental consequences on their website. The recitals define principal adverse impacts as negative effects of investment decisions and recommendations on sustainability aspects (e.g., environmental, social, and employee issues, respect for human rights, anti-corruption and anti-bribery issues).

Firms that have chosen to evaluate the main negative consequences of investment choices on sustainability issues must have methods for assessing these impacts in their due diligence processes. Details on how major negative sustainability effects are prioritized, concise descriptions of engagement policies, and references to any adherence to responsible corporate behavior rules and globally recognized standards for due diligence and reporting will be included in this material. Firms that have chosen not to consider the negative effect of investment choices must explain why.

Investor disclosures on the website

Relevant financial market players, such as asset managers, will be obliged to provide information on their websites regarding their policies for incorporating sustainability risks into investment decision-making processes. If they do not examine the negative effects of investment decisions on sustainability considerations, they must provide explicit reasons why.

All investors will get pre-contractual information

In precontractual disclosures, relevant financial market players must additionally give descriptions of the following:

  • the way sustainability risks are included into their investing decisions (i.e., how would an ESG event/condition have a substantial negative influence on an investment’s value, and how such risks are managed).
  • the findings of their analysis of the anticipated effects of sustainability risks on the profitability on the financial products they offer.

If it is determined that sustainability risks are not relevant, an explanation must be supplied.

Transparency of negative sustainability impacts at the level of financial products

The Disclosure Regulation establishes further particular disclosure obligations for two categories of goods.

  • items that promote environmental or social qualities, or a combination of these characteristics.
  • financial products with the goal of promoting long-term investment.

For these sorts of products, the Taxonomy Regulation specifies extra information that must be provided in pre-contractual disclosures and periodic reports. Following the product’s categorization, the appropriate disclosures, which are summarized below, may be needed.

Remuneration policies

The Disclosure Regulation will compel AIFMs and other financial market players to disclose information on how their pay plans are compatible with the incorporation of sustainability risks in their remuneration policies. This data will have to be made public on their websites.

Transparency in periodic reporting on the promotion of environmental or social aspects, as well as sustainable investments

Periodic reports for financial instruments that promote environmental or social characteristics, or a mix of those qualities, will need to contain a description of how well environmental or social criteria are satisfied. A description for financial products with a goal of sustainable investment must contain the “total sustainability-related effect of the financial product using appropriate sustainability indicators.” A comparison of the overall sustainability related effect of the financial product with the impacts of the designated index and a wide market index through sustainability indicators will be required if an index has been designated as a reference benchmark.

Financial products with environmental or social features should include pre-contractual disclosures

The following will be required in respect to financial products that promote environmental or social characteristics:

  • details on how certain qualities are satisfied (provided sound governance processes are followed by the investee firms).
  • information on whether and how an index is compatible with certain qualities when it has been recognized as a reference benchmark.
  • information about where to look for that index.

Pre-contractual declarations for certain financial instruments with a goal of long-term investment

When a financial product’s goal is sustainable investing and an index is used as a reference benchmark, the following information must be included:

  • details on how the selected index corresponds to the goal.
  • an explanation of why and how the selected index for that goal varies from a wide market index.

Pre-contractual disclosures shall include an explanation of how the sustainable investing aim will be met if no index has been chosen.

If no EU Climate Transition Benchmark or EU Paris-aligned Benchmark is available, the material must contain a thorough explanation of “how the continuous effort of decreasing carbon emissions is assured in view of reaching the long-term global warming targets of the Paris Agreement.”

On-site promotion of environmental or social features, as well as sustainable investments, is transparent

With regard to goods that promote environmental or social qualities, or a mix of these features, or financial products that have sustainable investment as their goal, the following information will need to be displayed on websites:

  • a description of the environmental or social features, as well as the goal of long-term investment.
  • information on the techniques used to analyze, measure, and monitor the environmental or social features or effect of the financial product’s sustainable investments, including data sources and underlying asset screening criteria.
  • the appropriate sustainability metrics for measuring the financial product’s environmental or social features, as well as its overall long-term effect. According to the Disclosure Regulation, this information must be clear, concise, and intelligible to investors, as well as provided in an accurate, fair, clear, non-misleading, simple, and brief manner in a prominent and easily accessible section of the website.

How can BRYTER help?

Corporations and financial institutions may quickly analyze the status quo of their ESG risks against industry standards and regulatory requirements with BRYTER ESG reporting software. Our interactive risk management ESG software walks users through a sector-specific questionnaire and produces a risk score for each examined category automatically. As a consequence, with our ESG Disclosure Regulation Guide the user receives a 360-degree evaluation of their ESG risks and possibilities, as well as actionable next actions for improving their rating.

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