Insights

Originally enacted on the 27th November 2019 to very little fanfare, Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (the “Regulation”) has fast become the topic on everyone’s lips owing to its fast-approaching entry into force on the 10 March 2021. Quite a bit has been said thus far on the broader impact which the Regulation is expected to have on the financial services sector generally, but little focus has been shown towards its applicability to the insurance sphere specifically – i.e. in the context of insurance-based investment products (“IBIPs”). Indeed, amongst the various players on whom the obligations set out in the Regulation are incumbent, one finds financial market participants which include: (i) insurance undertakings which make IBIPs available to the general public; and (ii) manufacturers of pension products; as well as financial advisers including insurance intermediaries and/or undertakings which provide insurance advice in relation to IBIPs.

Prior to delving into the Regulation proper, it may be beneficial to de-mystify the rationale behind its enactment and implementation by going through some of the more salient trigger points leading to its adoption.

Why was the Regulation needed?

The Regulation in its current form is the culmination of years’ worth of environmentally conscious decision-making at supranational level – tracing back to the 2030 Agenda for Sustainable Development adopted by the UN General Assembly in 2015, as well as the formal adoption of the Paris Agreement in 2016. Indeed, the latter immediately sought to strengthen the response to climate change by making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development, amongst other commendable initiatives. The Regulation recognises the potential catastrophic impact of climate change, and the corresponding need to mobilise capital in the financial services sector to combat this threat, thus requiring (in essence) financial market participants and advisers alike to disclose specific information regarding their approaches to the integration of sustainability risks in their investment decisions, as well as the consideration of adverse sustainability impacts which their investment decisions may have on the so-called ‘sustainability factors’ (i.e. environmental, social and employee matters, respect of human rights, anti-corruption and anti-bribery matter).

The Regulation however acknowledges that the absence of a harmonised, pan-European approach on sustainability disclosures to end investors would likely cause a distortion of competition owing to the glaring differences in disclosure standards amongst the various members of the EU bloc. This would, in turn, make it very difficult to compare different financial products – thereby adversely affecting the investment decisions of end investors. Hence, in order to cut down on these information asymmetries, the Regulation requires financial market participants and financial advisers (as defined therein) to make pre-contractual and ongoing disclosures to end investors when acting as their agents; thus ensuring a level playing field for end investors.

What are insurance undertakings and intermediaries expected to do?

The long and short of it is that insurance players to which this Regulation applies shall be obliged, as of the 10 March 2021, to make sustainability-related disclosures at entity and financial product level (where applicable). Draft regulatory standards (“RTS”) geared towards providing further guidance as to the content, methodology and presentation of sustainability-related disclosures were issued on the 2 February 2021, but these will come into force at a later date, possibly in January 2022. This therefore means that, in the interim period, insurance undertakings and intermediaries should focus on meeting their short-term disclosure obligations on a principle-based, “best efforts” basis, with an eye towards analysing and adopting the practices set out in the RTS in the longer term.

1. Requirements at Entity Level

Website disclosures are high on the agenda at entity level; with the Regulation requiring the aforementioned financial market participants and advisers to publish information on their respective websites regarding their policies on the integration of sustainability risks in the investment decision-making process and/or in their investment or insurance advice. Similarly, these same players are also required to publish and maintain on their websites information as to whether they consider the principal adverse impacts of investment decisions on sustainability factors (as previously defined).

Where insurance undertakings which make IBIPs available to the public consider these principal adverse impacts, they must publish a statement in relation to their due diligence policies with respect to those impacts – taking into account their size, the nature and scale of their activities and the types of financial products which they make available. In concrete terms, the Regulation speaks of uploading, inter alia, information as to a particular undertaking’s policies on identifying and prioritizing principal adverse impacts on sustainability factors, a description of said impacts, as well as action taken (or to be taken) in order to mitigate these impacts.

An insurance undertaking may, however, opt not to consider the aforementioned impacts, in which case clear reasons for not doing so must be published, as well as whether (and when) the undertaking intends to consider such impacts. This derogation will, however, cease to apply as of the 30 June 2021 in certain prescribed instances, including where an undertaking’s average cohort of employees exceeds 500 individuals.

Other requirements at entity level also include the amendment of remuneration policies in order to adequately integrate sustainability risks, as well as pre-contractual disclosures tackling the manner in which sustainability risks are to be integrated in investment decisions and/or insurance advice, and the result of the relevant party’s assessment of the likely impacts of sustainability risks on the returns of the financial products made available/advised on.

2. Requirements at Product Level

By the 30 December 2022, financial market participants (meaning therefore, in our context, insurance undertakings making IBIPs available to the public) which consider principal adverse impacts of investment decisions on sustainability factors (as previously explained), shall be expected to include for each financial product a clear explanation of how this is achieved in practice, as well as cross-refer to the content of periodic reports which will have become the norm by that stage (i.e. the relevant entry date for this requirement is the 1 January 2022).

For the time-being, a number of pre-contractual disclosures will be required, namely:

• Where a financial product promotes environmental or social characteristics (or both), and provided that the companies in which the investments are made follow good governance practices, the pre-contractual disclosures previously referred to at an entity level shall be supplemented further so as to include inter alia information on how those environment or social characteristics are met; and
• Where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark, the pre-contractual disclosures previously referred to at an entity level shall be supplemented further so as to include inter alia information on how the designated index is aligned with that objective.

Other pre-contractual disclosures in the context of financial products having the reduction of carbon emissions as their objective shall also be applicable.

Further to the abovementioned pre-contractual disclosures, insurance undertakings making IBIPs available to the public shall also publish and maintain on their websites a description of the environmental or social characteristics, or the sustainable investment objective of the IBIP in question, as well as the methodologies used to assess, measure and monitor these characteristics/objectives.

Concluding Remarks

The Regulation maintains that the consideration of sustainability factors in the investment decision-making and advisory processes can realise benefits beyond financial markets. For starters, it can increase the resilience of the real economy and the stability of the financial system, and, in the long run, ultimately impact on the risk-return of the underlying financial products.

Albeit considered as rather onerous requirements at this stage, sustainability-related disclosures are but another cog in the fast-moving wheel that is the ESG space, and operators would do well to assess and amend their policies and documentation where necessary to achieve compliance with the requirements set out in the Regulation.

First published in The Malta Independent.