The EU financial markets watchdog has thrown its weight behind stewardship as a means by which investors can help bring about the transition towards a sustainable economy.

In a report containing technical advice to the European Commission on the integration of sustainability risks and factors by investors, the European Securities and Markets Authority (ESMA) said the transition could not be achieved “by simply implementing a binary approach between ‘green’ and brown’ assets”.

“To this end, sustainability must be assessed in a more nuanced manner,” it said.

The supervisor said some respondents to a recent consultation had called on ESMA to clarify whether “integration of sustainability risks in the investment process” was only concerned with the potential for environmental or social matters to adversely affect the financial value of a portfolio, or whether investors should also – or instead – assess the impact of their investments on environment and society.

The answers to these questions, said ESMA, were “of paramount importance for the overall scope and actual impact of the sustainable finance initiative”.

The comments were made in ESMA’s report on integrating sustainability risks in the UCITS and AIFMD frameworks for fund management.

Investors’ due diligence processes were most effective where sustainability was assessed from both perspectives, according to the watchdog, and should not become “a mere tick-box exercise”.

Investors should be able to integrate emerging risks and identify potential and actual adverse impacts and seek to mitigate them “where possible”, said ESMA.

This included active engagement with investee companies as well as employing investment strategies such as negative, norms-based and positive screening, sustainability-themed investments or impact investing.

Institutional investors already applied engagement strategies and the stewardship principle was already recognised in EU regulation, ESMA said, referring to the revised Shareholder Rights Directive.

“ESMA is of the view that the transition towards a more sustainable and inclusive growth should also rely on this important principle,” said the supervisor.

Consideration of adverse impacts not mandatory for all

The EU’s draft sustainable finance disclosure regulation “clarifies that the consideration of principal adverse impacts of investment decisions on sustainability factors in the due diligence process” would not be mandatory for all market participants, ESMA said. It proposed wording in the delegated acts to reflect this.

The disclosure regulation is one of the three main legislative proposals the European Commission has put forward to implement its sustainable finance action plan. Political agreement was reached on it in March.

ESMA’s technical advice relates to various pieces of EU financial legislation already in force, which the Commission is planning to add to via the introduction of so-called delegated acts on the integration of sustainability risks in investment decision-making or advisory processes.

The EU insurance and workplace pensions supervisor, EIOPA, received a similar mandate from the Commission with regard to existing legislation under its remit  – Solvency II and the Insurance Distribution Directive – and the two supervisors said they co-operated with each other to ensure consistency across sectors.

When the Commission tasked them to provide the technical advice last year, it said they should be aware that a delegated act could be adopted under IORP II, but based on the text of the provisionally agreed disclosure regulation this did not appear to have happened.

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