Development of the EU's suite of rules relating to sustainable finance continues.

The EU has led the way on financial services legislation, but other jurisdictions are picking up the regulatory baton.

The new US administration has established a widely acclaimed climate team and is expected to move into standard-setting mode. The EU and the UK have committed in the Trade and Co-operation Agreement not to undermine green standards and to make efforts to increase environmental protection while promoting sustainable trade. EU and UK financial services regulation is diverging though — for example, the UK has said it will draw up its own green taxonomy. Meanwhile, Japan has signed up to the International Platform on Sustainable Finance, which now has 16 members, including the EU, Switzerland and Norway.

The Financial Stability Board (FSB) has issued a report (PDF 1.07 MB) on the potential implications of climate-change risks for financial stability and on mechanisms that might amplify the effects of the risks or their cross-border transmission. The FSB notes that the efficacy of firms' actions to mitigate the risks can be impaired by lack of data to assess exposures and that available data could underestimate connected or concentrated exposures and tail risks. Therefore, the pricing and management of risks need to be reviewed regularly and to evolve. In the same vein, reports issued in December 2020 by EBA (PDF 3.4 MB) and EIOPA highlight climate change as a key risk.

Latest on EU regulation

KPMG's new reality paper, “Delivering Sustainable Finance” set out the range of regulations and guidelines already agreed or being drawn up as of September 2020. They cover risk frameworks and stress testing, investment policy, product governance, remuneration, corporate reporting, and company and product disclosures. The rules relate to all three environmental, social and governance (ESG) factors. Final versions of some of these rules are still awaited.

The Commission has since issued draft Level 2 rules for the first two environmental objectives under the Taxonomy Regulation: climate change mitigation and climate change adaptation. The two annexes total over 500 pages and cover a wide range of sectors, chosen because of their share of overall greenhouse gas emissions, and on evidence regarding their potential to contribute to the avoidance, reduction or removal of those emissions. The criteria for the other four objectives — sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems — will be issued towards the end of 2021.

Industry has expressed concerns about the drafts, which the Commission has until mid-2021 to finalise and which will take effect from beginning 2022. Meanwhile, the Level 2 rules underpinning the Sustainable Finance Disclosures Regulation, which should have been published in final by end-2020 and which also attracted adverse industry comment, have still to be issued. The ESAs have now written to the Commission raising fundamental questions about the application or interpretation of several of the provisions in the Level 1 Regulation.

Taxonomy Regulation - draft Level 2 rules for climate change mitigation and adaptation cover:

  • Agriculture, forestry and wetlands

  • Manufacture of energy-efficient and low-carbon technologies

  • Manufacture of cement, metals and chemicals

  • Energy

  • Water supply, sewage and waste management

  • Transport

  • Construction and real estate

  • Data (information and communication)

  • Research & development


For Climate Change Adaptation, additional sectors are covered:

  • Non-life underwriting and reinsurance

  • Education

  • Residential care activities

  • Arts, entertainment and recreation


Supervisors focus on implementation

EIOPA is consulting on whether climate-change risks would be better captured under the Solvency II national catastrophe risk submodule, and if so, on possible methodological steps and process changes to the solvency capital requirement (SCR) calibration. And EBA is consulting on the incorporation of ESG risks into banks' and investment firms' governance, risk management and supervision. It identifies common ESG definitions, based on the Taxonomy Regulation, and provides an overview of current evaluation methods.

The ECB final Guide on climate-related and environmental risks for eurozone banks is similar to the May 2020 draft, but it strengthens the importance of knowledge, skills and experience at the level of the management body. It also highlights the importance of integrating such risks fully into risk management and business strategies. Banks will be expected to perform self-assessments in early 2021, which the ECB will then benchmark and challenge against supervisory expectations. In 2022, the ECB will carry out a full supervisory review of banks' practices, with follow-up measures where needed.

Also in 2022, Eurozone banks will undergo stress testing to assess the impacts of climate-related risks. The Bank of England is leading the way on stress-testing with its 2021 Climate Biennial Exploratory Scenario (CBES) for the largest UK banks and insurers.

Regulators and supervisors are enhancing corporate reporting requirements, which impact all types of listed firms and some unlisted entities. For insurers and reinsurers in the scope of the EU Non-Financial Reporting Directive, EIOPA has consulted on key performance indicators (KPIs) on sustainability and the methodologies to build the ratios that must be reported. EIOPA suggested that the two most relevant KPIs relate to non-life gross premiums written and total assets.

The UK FCA, in its capacity as Listing Authority, has issued final rules (PDF 1.1 MB) requiring premium-listed firms to state in their annual reports whether they have made disclosures consistent with the recommendations of the global Taskforce on Climate-related Financial Disclosure, or if they have not.

More to come

The European Commission's renewed Sustainable Finance Strategy, which was to have been released in 2020, is expected soon. It is likely to include a legislative proposal on an EU green bond standard, which may be voluntary not binding, and a proposal for an EU ecolabel for investment products.

The European Parliament and Council are understood to be nearing agreement on how best to integrate sustainability into the “simple, transparent and standardised” (STS) framework for securitisations. Banks might be able to choose whether to comply with existing transparency requirements on the environmental performance of underlying assets or to go further by disclosing any adverse impacts.

The Commission has published an interim stocktake of current practices on the integration of ESG factors into the prudential framework for banks and banks' business strategies and investment policies. The final report will be published after April 2021, but preliminary takeaways indicate possible areas for future rules and supervisory guidance:

  • Supervisors and banks do not have a common, clear and granular definition of ESG in place
  • Banks tend to map ESG risks to traditional risk types
  • The different ESG pillars are viewed separately, with a focus on climate change and on banks' (as opposed to customers') governance and compliance
  • The emphasis is on qualitative rather than quantitative indicators
  • There is a lack of standards with respect to the definition of ESG products and services, and voluntary principles have not been universally adopted

DG Justice is consulting on whether to introduce sustainable corporate governance legislation, to incentivise corporate boards to integrate stakeholder interests, sustainability risks, dependencies, opportunities and adverse impacts into firms' strategies, decisions and oversight.

Finally, given the critical dependency on reliable data for regulated firms to calculate their own and their clients' ESG exposures, both firms and supervisors are calling for the regulation of ESG data and ratings providers.

The S in ESG

Social issues are not forgotten. Initial work has begun on extending the Taxonomy Regulation to include “S”, one aspect of which is diversity. In relation to gender diversity, financial services were among Europe's worst industries for unequal pay between men and women in 2018, according to Eurostat. EBA is already on the case. Its proposed guidelines expect EU banks to ensure gender-neutral pay practices as part of sound remuneration policies. The guidelines will not be legally binding, but supervisors will have to apply them or explain why not.