Newsletter 1/2023 ESG in the Financial Sector

I. Regulatory Framework in the EU

The EU is leading the way in terms of ESG regulation and has a certain pioneering role in this respect. EU regulation on ESG applies in principle to all financial market participants and financial advisors established in the European Economic Area (EEA). However, under certain constellations, Swiss financial institutions can also fall within the scope of EU regulation. This is typically the case if, for example, collective investment schemes are set up by Swiss institutions in the EU and these are thus organised under the law of an EU member state (often Luxembourg or Ireland, for example). In other constellations, the direct applicability of EU regulation for Swiss financial institutions depends on factors such as the management of European collective investment schemes or the active distribution of financial products in the EU. This should be examined on a case-by-case basis.

In order to also include the financial markets in the fight against climate change and to be able to meet the challenges of sustainability, various regulations have been introduced in the EU:

a) EU Taxonomy Regulation

This is a classification system that determines which activities should be considered environmentally sustainable.

b) Disclosure Regulation (SFDR)

This regulation aims to improve transparency with regard to ESG information at institution and product level from financial market participants and financial advisors to end customers.

c) EU Benchmark Regulation

This regulation introduced two new categories of sustainability benchmarks (EU Paris-aligned Benchmark and EU Climate Transition Benchmark). Financial products can align with these benchmarks in order to be brought in line with the objectives of the Paris Climate Agreement.

The regulation on sustainability reporting for large companies (Non-financial Reporting Directive, NFRD) that has applied in the EU up to now will also be replaced by the Corporate Sustainability Reporting Directive (CSRD). With the CSRD, existing rules on non-financial reporting will be significantly expanded. The application of the CSRD rules is expected to take place in three stages and the CSRD will be applicable from 1 January 2024 for companies already subject to the NFRD.

 

 

1. SFDR – Regulatory Technical Standards applicable since 1 January 2023

The SFDR is supplemented by further details in so-called regulatory technical standards (RTS). The RTS on the SFDR were published in the Official Journal of the European Union as Delegated Regulation (EU) 2022/1288 and entered into force on 14 August 2022. However, the RTS are only applicable since 1 January 2023 and define the specific content, the methodology to be used and the way in which the information to be disclosed is to be presented.

 

 

2. MiFID II – Integration of Sustainability Preferences

Since 2 August 2022, it has also been mandatory to identify the sustainability preferences of (potential) clients when providing investment advice and portfolio management investment services.

 

II. Regulatory Framework in Switzerland

Sustainability in the financial sector is also gaining importance at the national level. This is a great opportunity for the Swiss financial centre. The Federal Council has set itself the goal of making Switzerland a leading location for sustainable financial services. The framework conditions are to be designed in such a way that the competitiveness of the Swiss financial centre is improved and at the same time the financial sector can make an effective contribution to sustainability.

As a commitment to responsible corporate governance, Switzerland has introduced new non-financial reporting and due diligence requirements for certain Swiss companies in the Code of Obligations as of 1 January 2022. In financial market law, on the other hand, there are so far no provisions relating to sustainability – neither at the level of a law nor at the level of an ordinance. However, at its meeting on 16 December 2022, the Federal Council specified its position on greenwashing in the financial market and defined the further procedure for avoiding greenwashing in the financial market. Financial products or services should only be offered as sustainable if they are compatible with at least one specific sustainability goal or contribute to achieving a sustainability goal. The Federal Council also takes the view that a clear, general understanding of when a financial product or service can be offered as sustainable is necessary for the functioning of the market. A working group under the leadership of the Federal Department of Finance (FDF) is to examine how the Federal Council's position on greenwashing prevention can be efficiently implemented. Based on the work, the FDF must submit concrete proposals to the Federal Council by the end of September 2023 on how to proceed. The aim is to ensure that the selected solution approach applies across financial markets, is binding and enforceable, and that clients can assert their rights.

 

 

1. FINMA's Focus on Climate-related Financial Risks and Investor Protection

In line with its strategic objectives and its legal mandate to contribute to the sustainable development of the Swiss financial centre, FINMA is pursuing four strategic directions in the medium term:

 

• Integration of climate risks into supervisory practice;
• Transparency about climate risks;
• Combating "greenwashing";
• Other potential sustainability risks.

 

There are already (non-sustainability-specific) requirements in the fund sector to protect against confusion or deception, which are important for preventing and combating greenwashing. In order for investors to be able to assess whether and how a collective investment scheme described or offered as sustainable fulfils the sustainability promise, the necessary transparency must be created in the fund documents. Due to the complexity of the topic (e.g., lack of definitions of terms, classifications and measurement methods), this represents a significant challenge for financial institutions.

In order to increase and standardise the transparency of collective investment schemes with a sustainable investment policy, FINMA defined specific requirements for the information to be included in the fund documents at the beginning of February 2021. Therefore, additional information on the sustainability objectives pursued, their implementation and the intended impact is required for such products.

FINMA then published Guidance 05/2021 on Preventing and Combating Greenwashing. Therein, FINMA sets out the main features of its expectations and provides information on the current state of practice in the management of sustainability-related collective investment schemes at fund and institution level. It also draws the attention of financial service providers offering sustainability-related financial products to the potential risks of greenwashing in the advisory process and at the point of sale.

FINMA also published Guidance 03/2022 on Climate Risk Disclosure. FINMA has analysed the first disclosure on climate-related financial risks that was made with the institutions' annual reporting for the 2021 financial year. The guidance records the key findings from this and shares them with all supervised banks and insurance companies.

 

 

2. Self-regulation in Switzerland as an Interim Solution?

The Asset Management Association Switzerland (AMAS) sees itself as responsible for further strengthening the central role of the Swiss asset management industry in the area of "sustainable finance" and for taking initiatives to continuously optimise the framework conditions for the creation and management of sustainable collective assets.

The "Self-regulation on transparency and disclosure for sustainability-related collective assets" defines for the first time binding requirements for the organisation of financial institutions that create and manage sustainability-related collective assets, as well as for sustainable product design and disclosures to investors. The self-regulation increases the quality of sustainability-related collective assets and establishes transparency through comprehensive documentation and reporting obligations.

With its respective reference to the institution and product level, the AMAS self-regulation is complementary to the self-regulation of sustainability in client advisory services introduced by the Swiss Bankers Association (SBA). This came into force on 1 January 2023, whereby various transition periods are provided for the adaptation of the bank's internal processes.

The SBA's "Guidelines for the financial service providers on the integration of ESG-preferences and ESG-risks into investment advice and portfolio management" define binding sustainability-related requirements for investment advice and asset management. The topics of sustainability or ESG and energy efficiency become an integral part of the respective advisory discussions with the client. The SBA member institutions undertake to systematically integrate the topic of ESG into their training and continuing education. Self-regulation is intended to ensure that all advisors have a sufficient understanding of sustainability issues and bring this into the advisory process.

The existing self-regulations in the area of sustainability can be seen as a kind of interim solution in Switzerland – at least as long as there is no legal basis for regulating a sustainable financial market in Switzerland. In view of current developments – especially taking into account the Federal Council's communication published in December 2022 regarding greenwashing prevention in the financial sector – as well as the European pioneering role with regard to sustainability, it is probably only a matter of time before sustainability principles are also legally anchored in financial market law in Switzerland. For reasons of legal certainty and to ensure a level playing field, this is certainly to be welcomed. It can also ensure the credibility of the Swiss financial centre as a whole, which in turn is a prerequisite for Switzerland to become a leading location for sustainable financial services.

 

III. Conclusion

The topic of sustainable development has arrived on the agenda of the financial sector. It represents a significant challenge for the financial market in all its dimensions. We recommend that institutions actively address the issue of sustainability and the new requirements and ensure that these are implemented at the strategic and operational level (especially at the point of sale) and are also included in the documentation of financial instruments (e.g., fund documents).