EU Mandates that Investment Advisors Consider ESG Factors

In a landmark decision, the European Union announced an agreement on March 7th 2019 that will require institutional investors and advisors to consider and make public disclosures regarding the environmental, social, and governance (ESG) impacts of their investment products.  

According to the UN-backed organization Principles for Responsible Investment (PRI), the new rules will apply to all European financial market participants, including “private and occupational pension funds, insurance funds, portfolio management and investment advisors.”

In a press release that announced this watershed agreement, the European Commission outlined the major provisions of the new rules:

“The new regulation sets out how financial market participants and financial advisors must integrate environmental, social or governance (ESG) risks and opportunities in their processes, as part of their duty to act in the best interest of clients.  It also sets uniform rules on how those financial market participants should inform investors about their compliance with the integration of ESG risks and opportunities.   By so doing, it addresses information asymmetries on sustainability issues between end-investors and financial market participants or financial advisors.  The availability of information is crucial to the integration of risks related to the impact of ESG events on the value of investments, for example in assets located in flood-prone areas.   The regulation also requires the disclosure of adverse impact on ESG matters, such as in assets that pollute water or devastate bio-diversity, to ensure the sustainability of investments.”

The EU statement goes on to explain that the new regulation is built around three essential pillars:

1. Elimination of greenwashing (unsubstantiated or misleading claims about sustainability characteristics and benefits of an investment product), and an increase of market awareness on sustainability matters;

2. Regulatory neutrality: the rules introduce a disclosure toolbox to be applied in the same manner by different financial market operators. The three European Supervisory Authorities (ESAs), and in particular the Joint Committee of the Authorities, will ensure further convergence and harmonization of disclosures in all the sectors concerned.

3. Level playing field: the regulation covers the following financial services sectors: (i) investment funds; (ii) insurance based investment products (life insurance products with investment components available as individual retail life policies as well as group life policies); (iii) private and occupational pensions, (iv) individual portfolio management; and (v) both insurance and investment advice.

Will Martindale, the PRI’s director of Policy and Research, hailed the new measure and highlighted how it:

1. Explicitly links financial regulation to global sustainability objectives such as the UN Sustainable Development Goals and Paris Climate agreement.

2. Uses the word “must” -- which removes any ambiguity regarding ESG: financial market participants face an imperative to integrate ESG factors into their analysis.

3. Uses the word “opportunities”: ESG issues helps investors to avoid investment risk, and also to capitalize on new opportunities.

4. Requires disclosure of the adverse impact of not attending to ESG matters. This would be the first regulatory-backed disclosure framework to incorporate the adverse sustainability impacts attributable to investment activity.

We wholeheartedly agree.  As we and our social investment colleagues have argued for decades, a true fiduciary is compelled to take ESG factors into account.  While Wall Street has grudgingly started to pay attention in recent years, this move by the EU represents a significant step toward bringing ESG considerations into the mainstream the world over.  

We congratulate the EU for both its prescience and its leadership.

[feature photo credit: Flickr user tiseb]