ESG: The Transition to ESG Benchmarks and new ESG disclosure requirements

The regulations will require benchmark administrators to disclose information on how environmental, social and governance (“ESG”) factors are reflected in a benchmark’s methodology, and to set minimum standards for specific ESG benchmarks. These rules will affect benchmark administrators, who must review and if necessary amend their benchmarks. In practice, the new rules aim to provide investors with more transparency when performing due diligence concerning whether a product is suitable in terms of ESG objectives.

Background

Since the Paris Agreement in 2015, the European Union has intensified its efforts to transition to a sustainable financial system with ECG considerations at its core. As part of this transition, in March 2018 the European Commission (“EC”) published the EU Action Plan of Sustainable Growth, with the aim to: (1) manage financial risks stemming from sustainability issues, (2) reorient capital flows towards sustainable investments, and (3) promote transparency and long-term thinking. In order to realise these aims, the Action Plan outlines a number of legislative initiatives. One of these initiatives includes the development of sustainability benchmarks.

Sustainability benchmarks

Amendments to traditional benchmarks were deemed necessary by the EC as they reflect the status quo, and therefore demonstrate that current methodologies do not sufficiently reflect the societal sustainability goals. As such, current benchmarks are not suitable for measuring the performance of sustainable investments. In addition, the EC notes that various index providers have been developing ESG benchmarks, using a variety of methodologies. Consequently, the EC concludes that there is a need for transparent and robust methodologies for sustainability benchmarks.

As a first step, the EC has proposed the adoption of delegated acts within the framework of the Benchmarks Regulation (Regulation (EU) 2016/1011) in order to (1) promote the transparency of the methodologies and features of benchmarks; and (2) harmonise benchmarks comprising low-carbon issuers.

In December 2019, the EC put its plans into practice by amending the Benchmarks Regulation through Regulation (EU) 2019/2089 (“Low Carbon Benchmarks Regulation”). This regulation introduces two types of benchmarks: (1) the EU Climate Transition Benchmarks; and (2) the EU Paris-Aligned Benchmarks. Climate Transition Benchmarks provide indexes that are aligned with the Paris Agreement through measurable and science-based methodologies. while Paris-Aligned benchmarks provide indexes that consist of assets that actively contribute to the objectives of the Paris Agreement.

The establishment of these benchmarks increases transparency and thereby helps to prevent greenwashing. In addition, the Low Carbon Benchmarks Regulation intends to provide investors with a user-friendly tool to compare benchmark methodologies.

Applicability of the regulations

The Low Carbon Benchmarks Regulation states that benchmark administrators were to comply with the regulations by 30 April 2020. On 29 April 2020, the European Securities and Markets Authority (“ESMA”) published a No Action Letter, in which it states that, as the regulations have not been further developed through delegated acts, there is no specific selection of ESG factors, or level of transparency, specified for benchmark administrators. As this gives rise to significant issues for the application of the regulations, ESMA urges the competent authorities not to prioritise the supervision and enforcement of these regulations.

Subsequently, on 17 July 2020, the EC published three delegated acts supplementing the requirements introduced in the Low Carbon Regulation. The Low Carbon Benchmarks Regulation obliges administrators of all benchmarks to explain whether, and how, benchmark methodologies take ESG factors into account. Delegated Regulation (EU) 2020/1816 sets out the information that needs to be included in the disclosure on how ESG factors are reflected in each benchmark which is provided and published. In addition, Delegated Regulation (EU) 2020/1817 elaborates the minimum content administrators must provide in relation to the explanation on how ESG factors are reflected in the benchmark methodology. Moreover, Delegated Regulation (EU) 2020/1818 describes the minimum standards for the EU Climate Transition Benchmark and the EU Paris-Aligned Benchmark.

The delegated regulations were published in the Official Journal of the European Union on 3 December 2020 and will enter into force on 23 December 2020. Once they come into force, we expect authorities to intensify their supervision of the disclosure requirements set out in the Low Carbon Benchmarks Regulation. This will mean that benchmark administrators will have to assess whether their internal processes are compliant with new regulations. 

If you have any questions about the implementation of the Low Carbons Benchmarks Regulation, please contact Stibbe’s ESG Finance and Corporate teams.