European Central Bank Warns of Lack of Meaningful Reduction in Emissions Exposure and Potential Climate Shock Effects on Euro Market

Last month, the European Central Bank, supervisor of the largest banks within the euro area, released a joint report through its watchdog, the European Systemic Danger Board, presenting evidence of the systemic nature of climate risks on the financial system.

The report, titled “The Macroprudential Challenge of Climate Change”, notes that, in a disorderly transition scenario, climate change shocks could quickly spread and create an abrupt harmful impact that would hit portfolios of investment funds, pension funds and insurance companies.

The impact on market prices could lead to fire sales and the disposition of a great number of affected assets at distressed costs, which could cause a ripple effect of losses across the market. Defaults for lenders could rise by 13-20%. Market losses of insurers could potentially amount to 3% of stress-tested assets or 25% of investment funds.

Despite these risks and the ECB’s efforts to encourage lenders to reduce their exposure, the report noted that it had seen “no meaningful reduction in emission intensity in the loan portfolios of euro area banks.” The report concluded, however, that the adoption of systemic risk buffers or concentration thresholds by carbon-intensive sectors could shrink vulnerability, and a transition to climate-friendly practices would reduce corporate defaults by up to 20% in 2050.

Links:
European Central Bank - Report Press Release
Report

ESMA Amends Markets in Financial Instruments Directive to Increase Accountability for ESG Funds

On 2 August, 2022, amendments to the European Securities and Markets Authority’s (ESMA) Markets in Financial Instruments Directive (MiFID II / MiFIR), which is aimed at increasing transparency among sustainable investments, came into force.

MiFID II / MiFIR entered into force on 3 January 2018 as a successor of MiFID. It is a legislative framework aimed at facilitating transparency in financial markets.

The recent amendments require financial advisers to discuss sustainability factors in investments with their clients and to accommodate client preferences. The success of this directive will depend on the availability of sustainability data from participants, as well as the enforcement mechanisms that are eventually established. There is currently uncertainty as to how different countries will enforce the new rules. Relatedly, the International Capital Markets Association, a financial trade group, is calling for a one-year moratorium on enforcement. Other industry actors have commented that the current lack of reliable sustainability data also affects the ability of financial advisers to put the legislation into action.

Links:
Bloomberg - New ESG Rules to Protect Everyday Investors Cause Confusion
Mondaq – European Newsletter – July 2022
Capital Monitor – Mifid II: Greenwashing concerns rise as new rule kicks in
ESMA - Markets in Financial Instruments Directive (MiFID II / MiFIR)

UK Competition and Markets Authority Investigates Greenwashing in Fashion

On 29 July, 2022, the UK Competition and Markets Authority (CMA) announced that it is investigating concerns about claims that by ASOS, Boohoo and Asda that their fashion products are eco-friendly and sustainable. Specifically, the investigation will look into:

• broad and vague statements that create the false impression that clothing collections are environmentally friendly;
• criteria used to determine whether to include a product into eco-friendly collections which may be lower than a reasonable customer would expect;
• items marked as produced sustainably which do not meet the criteria;
• lack of information on why the products are labelled eco-friendly; and
• potentially misleading statements about fabric accreditation schemes.

The CMA also announced that it continues its investigation into the fashion industry more generally and may target other companies. The CMA interim Chief Executive added that “should [the CMA] find [that] these companies are using misleading eco claims, [the CMA] won’t hesitate to take enforcement action – through the courts if necessary”.

In September 2021, the CMA published a Green Claims Code containing six key principles to be followed in making “green” claims. The principles are largely based on existing consumer law and focus on the full life cycle of a product or service:

• claims must be truthful and accurate;
• claims must be clear and unambiguous;
• claims must not omit or hide important information;
• comparisons must be fair and meaningful;
• claims must consider the full life cycle of the product or service; and
• claims must be substantiated.

Links:
Press release
Green Claims Code

Hong Kong Monetary Authority Launches Climate Risk Supervision Plan

In a statement published on 30 June, 2022, the Hong Kong Monetary Authority (“HKMA”) announced the completion of a formal review of its existing supervisory processes, culminating in a two-year plan to integrate climate risk considerations into these processes. The changes are aimed at encouraging individual authorised institutions (“Authorised Institutions”) in Hong Kong to adjust their climate strategies to correspond to the new processes.

The HKMA’s two-year plan is comprised of the following:

1. Including climate risk management as a standing item of prudential meetings
Climate risk management will be discussed at annual meetings between the HKMA and Authorised Institutions, to check the progress being made by such institutions on integrating climate risk considerations.

2. Updating the CAMEL rating framework and the SPM module SA-1 on “Risk-based Supervisory Approach”
The CAMEL rating system addresses the financial condition of banks in Hong Kong, and will be updated to reflect climate risk, together with the Supervisory Policy Manual setting out the regulation guidelines by the HKMA.

3. Conducting thematic examinations on selected areas of climate risk management
The HKMA will examine Authorised Investors’ due diligence processes to examine how the industry is mitigating and managing potential greenwashing risks.

4. Integrating climate risk stress test into the supervisor-driven stress-test framework
The HKMA conducted a pilot climate risk stress test last year, and it is looking to refine its approach to evaluate the overall climate resilience of the banking sector. These tests are set to take place between 2023 and 2024, and they require participating Authorised Institutions to assess their resilience in multiple climate-related stress scenarios.

5. Enhancing the “greenness assessment framework”
The first “greenness” assessment took place in 2020, which produced a baseline assessment of the “greenness” of Authorised Institutions. The second such assessment is expected to commence in the second half of 2022. The updated assessment framework will have a wider scope than the 2020 assessment, incorporating a broader array of environmental risks and transition considerations.

6. Keeping the regulatory framework under review
The HKMA will keep its regulatory framework under review, taking into consideration the international developments in this area.

Links:
HKMA Press Release
2020 Assessment

EU’s Social Taxonomy Delayed

The Social Taxonomy is part of the EU’s sustainable finance strategy, which focuses on the social benefits and impacts of, and safeguarding, investments. In February 2022, the EU Platform on Sustainable Finance, the European Commission’s independent advisory body, published its Final Report on Social Taxonomy, which highlighted three overarching objectives: (i) “decent work including value-chain workers,” (ii) “adequate living standards and wellbeing for end-users”, and (iii) “inclusive and sustainable communities and societies”.

The European Commission was expected to publish its own report on the Social Taxonomy later this year. However, it has been reported that the report’s publication will be postponed until 2024. The delay may be the result of the Commission’s heavily criticized decision to include certain nuclear and natural gas investment in its green taxonomy, which has put both taxonomies under pressure.

Links:
EU Platform on Sustainable Finance – Final Report on Social Taxonomy
Euractiv
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