In the private equity sector, too, more and more attention is being paid to the issues of sustainability and social responsibility. Institutional investors and alternative investment fund managers are increasingly concerned with the social and environmental impact of their activities. At the same time, the legal requirements in the area of ESG compliance (Environmental Social Governance) are increasing and market participants will have to comply with, among other things, directly applicable EU regulations.
Taxonomy Regulation
The “Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment” (“Taxonomy Regulation”) aims at bindingly defining the relevant concepts in the field of ESG compliance. Among other things, this should prevent the issuer of a financial product from promoting the financial product as “green” or “sustainable” despite poor environmental performance (i.e. so-called greenwashing) and enable comparability between different financial products marketed as environmentally sustainable. However, it is not intended to oblige market participants to engage in sustainable business activities or investments.
The Taxonomy Regulation is addressed on the one hand to the Member States if they wish to lay down regulations in the area of “sustainable” investments and, on the other hand, to so-called “financial market participants”. This includes, for example, capital management companies, institutional investors, insurance companies, portfolio managers and providers of pension products.
Insofar as the European Parliament’s draft remains essentially unchanged, all financial market participants offering financial products are generally obliged to disclose information in accordance with the Taxonomy Regulation in order to determine the sustainability of their financial products. However, the Taxonomy Regulation also provides for a possibility of exemption by the financial market participant declaring in its prospectus that the financial product does not pursue sustainability objectives and that the product is at an increased risk of supporting economic activities that are not considered sustainable.
An economic activity is environmentally sustainable according to the current draft of the Taxonomy Regulation if, first of all, it substantially contributes to one or more of the following environmental objectives: (i) climate change mitigation, (ii) climate change adaptation, (iii) protection of water and marine resources, (iv) transition to a circular economy (recycling), (v) pollution prevention and (vi) protection of healthy ecosystems. Furthermore, it must not significantly harm any of the environmental objectives, is carried out in compliance with the minimum safeguards and, finally, must comply with technical screening criteria to be determined.
The Taxonomy Regulation should be adopted this year and the delegated regulations, which will contain the technical screening criteria for the first two environmental objectives, should also be adopted this year. Further delegated regulations are due to enter into application gradually by the end of 2022.
If financial market participants do not make use of the exemption option, they must first indicate the degree of environmental sustainability of an investment. The exact additional information to be made public will be regulated by a further delegated act.
Transparency Regulation
The Transparency Regulation is also aimed at “financial market participants”; in addition, it obliges also financial advisors to disclose information.
All financial market participants must always explain on their website and in pre-contractual disclosures how they integrate sustainability risks in their investment decision-making process. If they offer sustainable financial products, they must also publish the environmental or social characteristics of the financial product or the sustainable investment objectives on their website and in pre-contractual disclosures. Furthermore, they must include information in their periodic reports, for example, on the overall sustainability-related impact of financial products or the extent to which the sustainable investment objectives have been achieved in relation to the environmental or social characteristics.
The harmonisation of reporting obligations is intended to counteract distortions of competition and enable end investors to compare different financial products in terms of ESG risks and sustainable investment targets.
The Transparency Regulation must first be adopted by the European Parliament, which is supposed to take place in 2019. In principle, the reporting obligations apply for the first time after fifteen months of the date of their publication.
This article was written as part of the MUPET 2019. Learn more about Munich Private Equity Training.