The formal adoption reflects the EU’s acknowledgement that a robust system of sustainable finance will be essential to the proposed capital markets union.
By Paul A. Davies and Michael D. Green
On 8 November 2019, the Council of the EU published a press release announcing the adoption of legislative reforms that aim to enhance the proposed capital markets union. Notably, two of the reforms are related to sustainable finance: the Low Carbon Benchmark Regulation (LCBR), and the Disclosure Regulation, the full texts of which were published on 24 October 2019.
The LCBR amends the previous Benchmarks Regulation, and was introduced in response to the perceived lack of uniformity among existing low-carbon indices. This inconsistency was considered to be unsatisfactory, as investors were unable to use benchmarks as reliable and easy tools to compare the low-carbon attributes of investments and portfolios.
To combat these issues, the LCBR introduces the following:
- A new category of benchmarks, comprising two types of financial benchmark: an EU climate transition benchmark, and a “Paris-aligned” benchmark that brings investment portfolios in line with the Paris Agreement. Administrators for these benchmarks will have to publish detailed information on whether or not, and to what extent, the benchmarks ensure a degree of overall alignment with the target of reducing carbon emissions or the attainment of the objectives of the Paris Agreement is ensured.
- An obligation for all benchmarks (with the exception of those related to interest rates and foreign exchange) to disclose in their benchmark statement whether or not their benchmarks pursue environmental, social, and corporate governance (ESG) objectives, and whether or not the benchmark administrator offers such ESG-focused benchmarks.
- An extension of the transition regime under the Benchmarks Regulation to 2021, for critical and third-country benchmarks.
Moving forward, the LCBR empowers the European Commission to lay down the specific minimum standards for the two new benchmarks. These standards will specify the criteria for the choice of underlying assets, the weighting of those underlying assets, and the trajectory for the decarbonisation of the climate transition benchmark, as well as determining the method for the calculation of the carbon emissions associated with the underlying assets. In completing this task, the Commission will take into account the work of the Technical Expert Group on Sustainable Finance, which published a final report on the climate-related benchmarks introduced by the LCBR on 30 September 2019. (See EU Issues Final Report on Climate Benchmarks and ESG Disclosures).
Administrators who seek to provide either of the two new benchmarks will need to comply with the LCBR by 30 April 2020.
The Disclosure Regulation governs ESG disclosure requirements for financial market participants and financial advisers, and how those firms integrate ESG factors into their investment decisions. (See EU Issues New Sustainable Investment Disclosure Rules). The next step is for European supervisory authorities to come up with specific and detailed rules for the implementation of the Disclosure Regulation, for which they are expected to begin the consultation process in early 2020.
The adoption of the LCBR and the Disclosure Regulation demonstrates the EU’s continuing interest in sustainable finance and its acknowledgement that a robust system of sustainable finance will be an essential part of the capital markets union. The effectiveness of the new regulations remains to be seen, and may be dependent on the technical input to be provided by the Commission in the near future.
Latham & Watkins will continue to follow and report on developments in this area.
This post was prepared with the assistance of James Bee in the London office of Latham & Watkins.