23 August 2018

AFME’s Response to the EC proposal for a Regulation on the establishment of a framework to facilitate sustainable investment

AFME agrees that a lack of clarity as to what constitutes “sustainability” is a key obstacle for increasing and directing capital flows towards sustainable investments, which as a small and nascent market requires appropriate and proportionate impetus.

AFME sees this Taxonomy proposal as being a fundamental building block, indeed as being the cornerstone, of the project to build, in the words of the High-Level Expert Group, “the world’s most sustainable financial system”.

In consequence, AFME believes that it is critical that this Taxonomy proposal be as effective as possible in delivering its core objective set out in the European Commission Action Plan to “provide clarity on which activities can be considered ‘sustainable’ ”. It would warn against attempts to broaden the scope of the Commission’s current text to achieve other objectives, no matter how desirable in the long term, as such attempts may well be premature, and consequently ineffective.

Accordingly, AFME believes that the review of the Taxonomy proposal should consider the following key principles:

1) Develop the Taxonomy prior to any important review of existing financial regulations: the establishment of an EU Taxonomy and creating standards and labels for investments products are crucial enabling factors for the success of the European Commission’s Action Plan.

2) Ensure clarity as to the product scope with respect to the different components of the proposal: the stated purpose of the proposal is to establish criteria for determining which economic activities are sustainable. It then permits extrapolation to determine the sustainability of assets.

3) Ensure clarity as to the scope of market participants: the main purpose of the proposal is to help provide information as to the environmental sustainability of economic activities and of financial investments. This information will be relevant and of use for all market participants and for a variety of different business activities.

4) Ensure clarity as to the territorial scope: the draft Regulation does not clearly specify whether the Taxonomy also applies to economic activities outside of the EU. The Taxonomy is intended to enable classification of economic activities but does not say whether the geographical location of these activities is relevant for its application. AFME expects the Taxonomy to apply to any economic activity regardless of their geographical location.

5) Remain open to the variety of existing ESG strategies, practices and taxonomies: as currently drafted, the application of the Taxonomy seems to be limited to green thematic funds or capital market products such as green bonds but ignores or even perhaps rejects other sustainable investing strategies adopted by European investors such as exclusionary screening, best-in class screening for ESG performance, norms-based screening, sustainability themed investing, integration of ESG factors, shareholder engagement and stewardship.

6) Ensure flexibility and regular updates: the proposal recognises the importance of ensuring that “the taxonomy will only be used once it is stable and mature”. However, it is worth noting that sectors and associated business models are themselves evolving quite rapidly in response to numerous challenges, so that it may be unlikely that a “stable and mature” Taxonomy could ever be achieved.

7) Clarify the potential impact on liquidity of assets becoming stranded: Article 14(h) specifies that the technical screening criteria “shall take into account the potential impact on liquidity in the market, the risk of certain assets becoming stranded as a result of losing value due to the transition to a more sustainable economy”. Although AFME recognises the vital importance of identifying potential stranded assets and mitigating the risks of a transition on their value, it considers that paragraph (h) goes beyond the objective of building a Taxonomy.

8) Finding the right balance: the proposed Regulation should acknowledge the fact that economic activities are very heterogeneous, and wide variations in business models exist, even within the same sector.

Full response

© AFME