Mediaboss Marketing

This briefing in our ESG series for Irish funds and fundmanagement companies focuses on the European Commission'sproposals to establish a classification system or"taxonomy" to identify whether and to what extent aneconomic activity can be considered to be sustainable.

With the aim of furthering sustainable finance and ESGintegration, the European Commission (the"Commission") introduced a package oflegislative measures in 2018 that includes three key Regulations:the Taxonomy Regulation, the Disclosures Regulation and the LowCarbon and Positive Impacts Benchmarks Regulation.

The aim of the Taxonomy Regulation is to establish an EU-wideclassification system or taxonomy for environmentally sustainableeconomic activities. This classification system is to be used toreduce fragmentation arising from market-based initiatives andnational practices and address practices of"greenwashing" so as to allow investors better compareESG products.

The Taxonomy Regulation was adopted by the Commission on 18 June2020 and entered into force on 12 July 2020 and builds on the workof the Technical Expert Group on Sustainable Finance(TEG) set up by the Commission to assist indeveloping the taxonomy and furthering other EU Action Planinitiatives. These EU-wide standards will form the basis foreconomic and regulatory measures and the eventual creation oflabels to enable capital markets to identify investmentopportunities that contribute to the EU's environmental policyobjectives.

The initial focus of the Taxonomy Regulation is on environmentalobjectives, with social objectives to be considered later.

At a high level, sustainable investment under the TaxonomyRegulation is an investment in an economic activity thatcontributes to an environmental objective as measured by keyresource efficiency indicators provided that such investments donot significantly harm any of those objectives and that theinvestee companies follow good governance practices.

For a product to be properly characterised as environmentallysustainable it should:

Contribute substantially to one of the defined environmentalobjectives;

The six environmental objectives are:

Each objective is explained further in the Taxonomy Regulationand linked to any existing EU law on that area. Further granularitywill be given in technical screening criteria, which will be builtup over time and are to be updated on a regular basis to reflectthe changing nature of the science and technology that underpinthem.

The Taxonomy Regulation also mandates the establishment of a"Platform on Sustainable Finance", which will includerepresentatives of various EU bodies (including the EuropeanEnvironment Agency and the European Supervisory Authorities),environmental experts, and accounting and reporting experts with abroad remit to advise the Commission on the technical screeningcriteria and on the need to update these based on a number ofcriteria, including developing trends and stakeholder requests.

The technical screening criteria, or "taxonomy", forthe first two environmental objectives climate changemitigation and climate change adaptation should beestablished by the end of 2020 in order to ensure its fullapplication by end of 2021. For the four other objectives, thetaxonomy should be established by the end of 2021 for applicationby the end of 2022.

The Taxonomy Regulation recognises that, while some activitiesmay bring a positive output toward the relevant objective, they maybe accompanied by a negative impact and so the taxonomy addressesthe need to measure the combined outcome and identify the minimumrequirements necessary to avoid a significant harm to otherobjectives.

The Taxonomy Regulation applies the principles while adopting aneutral stance in relation to different energy forms. The keyconsideration is whether they are low in greenhouse gas emissionsand the categorisation includes two sub-categories of"transitional" and "enabling" activities.

Transitional activities relate to activities for which there areno technologically and economically feasible low-carbonalternatives, but that support the transition to a climate-neutraleconomy in a manner that is consistent with a pathway to limit thetemperature increase to 1.5 degrees Celsius above pre-industriallevels, for example by phasing out greenhouse gas emissions.Enabling activities are those that enable other activities to makea substantial contribution to one or more of the objectives. Therewill be an obligation to disclose for each financial product theproportion invested in enabling and transitional activities.

One of the difficulties for those tasked with the newevaluations and disclosures is getting the relevant informationfrom the underlying investee companies. The Taxonomy Regulationseeks to assist access to that information by placing an obligationon undertakings that are subject to non-financial reportingrequirements to include details of how and to what extent theireconomic activities are associated with environmentally sustainableactivities and large companies will have to report on certainclimate-related KPIs.

The Taxonomy Regulation is mainly relevant to managers that makeavailable a product that has an express sustainability focus('ESG Products'), however, all managers need to takeaccount of it and managers that do not offer ESG Products will atleast need to make a negative disclosure to confirm that theirproduct is out of scope and does not adhere to the taxonomycriteria.

The Taxonomy Regulation incorporates certain concepts from theDisclosures Regulation and amends certain provisions of thatRegulation. It effectively builds on the three tier categorisationof products set out in the Disclosures Regulation:

For asset managers that promote ESG Products there will beadditional disclosure requirements imposed over and above thosealready set out in the Disclosures Regulation.

Article 9 products must make pre-contractual and periodicdisclosures that include information on the environmentalobjectives to which the product contributes and a description ofhow and to what extent the underlying investments qualify asenvironmentally sustainable and the proportion of investments whichare environmentally sustainable.

Article 8 products must make pre-contractual and periodicdisclosures relating to information on the environmentalcharacteristics that the product promotes, a description of how andto what extent the underlying investments qualify asenvironmentally sustainable and the proportion of investments thatare environmentally sustainable together with a prescribeddisclaimer.

All other products must set out a prescribed disclaimer in theirpre-contractual and periodic disclosures that the investments donot take account of the criteria set by the TaxonomyRegulation.

The Taxonomy Regulation also amends the Disclosure Regulation byinserting an obligation for the European Supervisory Authorities todevelop technical standards specifying the details of the "dono significant harm" principle expressed in the DisclosureRegulation. Draft technical standards are to be provided to theCommission by 30 December 2020.

The requirements of the Taxonomy Regulation will apply on astaggered basis. The requirements in relation to climate changeadaption and migration will apply from 1 January 2022 with theother environmental objectives to apply from 1 January 2023.

For more information on the impact of the EU's ESGinitiative on asset managers, see our overview briefing here.

This article contains a general summary of developments andis not a complete or definitive statement of the law. Specificlegal advice should be obtained where appropriate.

Read the original here:
ESG For Fund Managers: The EU Framework Regulation / The Taxonomy Regulation - Finance and Banking - European Union - Mondaq News Alerts