In declaring their support for the Commission’s renewed strategy, the ESA’s emphasized in particular the need to expand the Non-Financial Reporting Directive (NFRD) (repeating the positions they set out in response to the Commission’s NFRD Consultation, as summarized in our July 2020 Regulatory Update). The ESAs also identified the regulation of Green Bond Standard verifiers and ESG ratings providers as a priority and flagged the need for social and governance benchmarks (to accompany the legislative arrangements for environmental/climate benchmarks) and an extension of the EU Ecolabel to sustainable finance retail products.
These responses come with a host of other developments in the ESG arena, including publication by the European Commission (and its Sustainable Finance Technical Expert Group) of an updated FAQ on the Taxonomy and Green Bond Standard. As noted in our July 2020 article on the Taxonomy, this comes at a time when several key providers of voluntary ESG frameworks announced their intention to consolidate to compete with the EU regime. Further consolidation also emerged on July 13, 2020, as two voluntary ESG framework heavyweights—the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI)—announced they were also consolidating.
Based on this trend, the 50 or so voluntary frameworks currently in existence are likely to be replaced by three competing frameworks: the EU regulatory regime, and the two consolidated voluntary frameworks. Some niche frameworks will also likely survive around the periphery of this core.
In addition to these developments, other commercial developments are emerging, such as the announcement by a consortium of asset owners of the launch of a platform to identify United Nations’ Sustainable Development Goal-compliant investments.
Labeling and Claim Substantiation Developments
In other ESG-related matters, on July 20, 2020, the Commission formally launched a legislative initiative that would require all companies to substantiate claims they make about the environmental footprint of their products/services by using standard methods for quantifying them. The proposals aim to make all claims reliable, comparable, and verifiable across the EU thereby reducing “greenwashing” and enabling purchasers and investors to make more sustainable decisions, whilst increasing consumer confidence in green labels and information.
Also on the topic of ESG, the ESAs held a surprisingly inculpatory Public Hearing on July 2, 2020, on their proposals for regulatory technical standards (RTS) under the Sustainable Finance Disclosure Regulation(SFDR). The hearing was separated into a series of presentations, summarized in this slide deck, and accompanied by a frank Q&A.
One of the consistent themes throughout the hearing was an acknowledgment by the ESAs that there was still a lack of sufficient and reliable data to meet the requirements of certain SFDR disclosure provisions. Another theme was difficulties with the legislative drafting, not least the disconnect between the SFDR and Taxonomy Regulation, which it was acknowledged had in some instances given rise to problems such as inconsistencies between the “do no significant harm” (DNSH) provisions in each text and the definition of “sustainable investment” under the SFDR, which as currently drafted, can apply to investments that are non-compliant with the Taxonomy Regulation.
The ESAs provided several unofficial interpretive opinions on technical aspects of the RTS during the hearing. However, overall, there were no surprise announcements, suggesting that the final version of the RTS are likely to track close to the current proposals. Nevertheless, the frankness of the concessions at the hearing leaves the door open to potential modifications to the current RTS proposals and possibly even amendments to the level 1 texts to alleviate some of the unintended impracticalities that the texts currently give rise.
Developments on Integration of ESG Factors in Advice
In other developments, the European Fund and Asset Management Association (EFAMA) responded to the proposals to integrate ESG considerations into advisory processes (including client suitability assessments) across the financial sector (as summarized in last month's update), welcoming the intent and purpose behind the proposals but identifying several aspects of the proposed measures it regards as problematic, including several incidents of scope-creep and insufficient distinction on the application of the rules in relation to Article 8 versus Article 9 SFDR products. The EFAMA response also rejects the integration of sustainability risks into organizational requirements and further, it identifies a lack of available data necessary to meet the proposed requirements, noting in particular that this problem will remain until the Non-Financial Reporting Directive is modified.
ESG Prudential Developments
Turning to prudential developments, following the ECB’s May 2020 Supervisory Guide on Environmental Risks (accompanied by FAQs, currently under consultation) and following up on its own April 2019 Supervisory Statement and December 2019 Discussion Paper on “Financial Risks from Climate Change” on July 1, 2020, the UK Prudential Regulatory Authority (PRA) published a letter providing “thematic feedback” on the plans insurers and credit institutions have so far implemented in relation to the topic.
The letter clarifies that regulated firms must have a fully integrated climate-related financial risk management process in place by the end of 2021. The letter also flags several areas for improvement before this new compliance deadline, which include the need for more robust governance, a concomitant upward flow of management information, further adoption of relevant disclosure practices and a significant and rapid enhancement of risk management arrangements that integrate relevant capabilities, data, and tools, together with proxies and assumptions where necessary to meet the demands of scenario testing and the regulator’s broader environmental risk management expectations.
The PRA letter comes just weeks after the UK Climate Financial Risk Forum (CFRF), an industry body co-chaired by the PRA and FCA but published “by the industry for the industry,” published a hefty guide (accessible from the Bank of England website here in four separate substantial chapters and a summary) on managing Climate Risk by financial services firms.
Whilst the Guide does not have official legal status, it does provide useful practical guidance on how to achieve compliance with the regulatory expectations set out by both the FCA and PRA. The four chapters deal in turn with risk management, scenario analyses, disclosures, and innovation that sets out how new approaches to capital allocation can “deliver the change required to meet climate goals.”
MiFID II Developments on Transparency, Research Unbundling, and Sanctions Published
On July 24, 2020, the European Commission issued a press releasesetting out a package of proposals to modify a suite of financial regulatory texts (including MIFID II, the Prospectus Directive and the Securitisation Regulation) to aid the financial recovery of the Union following the global pandemic. The package of proposals includes a consultation on liberalizing research unbundling measures for coverage of small and medium-sized enterprises.
Meanwhile, on July 17, 2020 ESMA announced publication of an opinion on MIFIR pre-trade transparency waivers arrangements, setting out detailed technical requirements and expectations of how such waivers should be granted across the Union. The Opinion replaces the former Committee of European Securities Regulators (CESR) Guidance and ESMA’s Opinions on Waivers under the first MIFID directive.
In a related development, ESMA also published its annual RTS 2 review, recommending that bond liquidity calculations (average daily trades (ADT)) move to the next stage as specified in the delegated regulation, which would bring more bonds within the scope of the MIFIR transparency requirements and limit the availability of “illiquid” pre-trade waiver and post-trade deferral arrangements.
On July 16, 2020, ESMA also published two final Reports on the MIFIR transparency regime, one on the equities regime and the other on non-equity pre-trade transparency rules for systematic internalisers. The reports set out substantive proposals to simplify the transparency regime whilst improving transparency by transforming the Double Volume Cap mechanism to a Single Volume Cap mechanism, simplifying aspects of the systematic internaliser regime, clarifying aspects of the trading obligation, and limiting the application of the equities reference price waiver.
Finally, on July 13, 2020, ESMA published its second annual report into the sanctions imposed under MIFID II over the last year. Just as the year before, the analysis was underwhelming, with only half of EEA member states imposing sanctions. 371 sanctions and measures were imposed, totaling €1.8 million in terms of fines, and tellingly, with no measures taken by most of the EU’s largest economies including Germany, France, Italy, Spain and the Netherlands.
ESAs Deliver PRIIPS Damp Squib
On July 21, 2020, the ESAs published a letter to the European Commission stating that the controversial and long-awaited proposed amendments to the PRIIPS Delegated Regulation (Regulation (EU) 2017/653) on the content and presentation of the Key Investor Document (KID) (including on presentation of costs and charges and past performance, etc.) had failed to get sufficient votes from EIOPA’s board to achieve a qualified majority, such that the ESAs could not formally recommend the proposals to the Commission.
Reasons for rejecting the proposals included the fact that a partial revision of the PRIIPs Delegated Regulation was not seen as appropriate given a statutory review of the broader regime under Article 33 of the PRIIPS Regulation (Regulation (EU) No 1286/2014) was imminent. There were also substantive concerns on several matters including the presentation of past performance in a separate document. The ball is now back in the Commission’s court.
The Act introduces a new “Magnitsky-style” Global Human Rights Sanctions Regime, and under the delegated regulations, 49 individuals and organizations have been added to the official UK Sanctions List, “with further sanctions expected in the coming months,” according to the government press release.
The measures have been dubbed “Magnitsky-style” since they target individuals and organizations, rather than states. The regime marks the first time the UK has sanctioned people or entities for human rights violations and abuses under a UK-only regime.
The current list includes those 25 Russian nationals identified as involved in the mistreatment and murder of Sergei Magnitsky (who had uncovered widespread corruption in Russia), 20 Saudi nationals involved in the killing of journalist Jamal Khashoggi, two Myanmar military generals involved in human rights violations relating to the Rohingya and other ethnic minorities, and two organizations involved in forced labor, torture, and murder in North Korea.
SEC Proposes to Raise the Form 13F Reporting Threshold from $100M to $3.5B
On July 10, 2020, the SEC proposed an increase to the reporting threshold for Form 13F reports by institutional investment managers, raising the reporting threshold from the current $100 million (the threshold that was first set in 1975) to $3.5 billion. The SEC highlighted the impact the static threshold has had on the U.S. fund industry, as thousands of additional managers have been required to report holdings on Form 13F over time. The SEC estimates that the new threshold will reduce the number of reporting managers by an order of magnitude—from over 5,000 today to about 550. As part of the proposal, the SEC has included a number of technical amendments to modernize the structure of data reporting and amend the instructions on Form 13F for confidential treatment requests. Public comments on the proposal are due by September 29, 2020.
SEC Amends 1940 Act Rule 0-5 to Expedite Applications Process
On July 6, 2020, the SEC adopted a final rule amending rule 0-5 under the Investment Company Act of 1940, establishing (i) an expedited review procedure for applications that are substantially identical to recent precedent and (ii) an internal timeframe for review of applications outside of such expedite procedure, and (iii) deeming an application withdrawn when the applicant does not respond in writing to comments within 120 days. The amendments will go into effect 270 following publication in the Federal Register.
As discussed in the proposing release, the suite of amendments is intended to make the 1940 Act applications process more efficient and transparent.
SEC Amends Exchange Act Proxy Solicitation Rules
Following a lengthy engagement between activists and industry lobbyists, on July 22, 2020, the SEC adopted amendments to its rules governing proxy solicitations to ensure that investors who use proxy voting advice “receive more transparent, accurate, and complete information,” without undue costs or delays. The amendments add conditions to the availability of existing exemptions from the information and filing requirements of the Federal proxy rules, including compliance with disclosure and procedural requirements, and conflicts of interest disclosures by proxy voting advisers, as well as principles-based requirements, requiring the adoption of policies and procedures by proxy voting advisers to ensure (i) the advice is made available to registrants and (ii) clients have a means by which to become aware of registrants’ views of the advice. In addition, the amendments codify the SEC’s interpretation that proxy voting advice generally constitutes a solicitation within the meaning of the Securities Exchange Act of 1934. The amendments will be effective 60 days following publication in the Federal Register.