How much ESG regulation starts its life as an EU directive and how much is introduced by individual member states? Jonathan Williams investigates 

Ahead of the UK’s vote on European Union membership, campaigners repeatedly raised the positive impact of environmental regulation on British waterways. They noted the country had gone from a quarter of beaches falling foul of minimum standards in 1991 to 95% of beaches allowing swimmers to bathe in clean water. 

But can the EU make a similarly plausible claim in relation to environmental, social and governance (ESG) standards across the pension and asset management industry? Or is the European Commission more likely to be following member states’ own initiatives when it comes to improving standards? The question is not easily answered and depends on how broadly ESG impact is defined.

The EU has, without a doubt, championed climate change mitigation while carefully balancing the views of individual member states concerned about the impact on their economy of cutting carbon emissions. Its members also backed an emissions trading system in 2005, well before other countries weighed up the option. And its inclusion of decarbonisation within EU energy policy will have a positive long-term impact on the development of the renewables market.

Despite such initiatives, its leadership on climate matters has not trickled down into action on sustainability in financial markets. “Wider ESG policies and regulation in the EU have been harder to implement and less influential so far,” says Alix Chosson, energy fundamentals analyst at AXA Investment Managers. “Most of the ESG standards and reporting requirements have been set up at a national or industry level.”

Camilla de Ste Croix, senior policy officer at ShareAction, whose work involves engaging with MEPs, agrees, pointing towards the lack of progress passing the Shareholder Rights Directive, first published in early 2014.  She says that, even once ratified, owing to the two-year implementation period for EU Directives, effecting new laws can be “very, very slow. Member states, acting on their own, can be a lot faster,” she says.

Chosson’s point about the Commission’s influence is reflected in its first draft of the revised IORP Directive, which was vague on ESG despite including a call for climate-related stress testing of portfolios. However, in the compromise text agreed earlier this year there was an even greater emphasis on engagement, environmental and carbon risk assessment, courtesy of amendments by several MEPs on the Economic and Monetary Affairs Committee. 

But even where MEPs have taken a more proactive role than the Commission, they point towards established international standards, in the shape of the Principles for Responsible Investment, rather than attempting to draft new, binding standards for the European pensions market. 

Similarly, the pensions sector itself has long called for a European Stewardship Code emulating the UK document published in 2010. But despite the idea being embraced by

PensionsEurope, it took until 2014 for elements of the voting reform to be embraced in the Shareholder Rights Directive. It has since stalled in trialogue negotiations owing to attempts by parliamentarians to include tax transparency in the law.

Some of the most radical reforms in recent years have emanated in EU member states, and have clearly been noted by those within the Commission. The French government introduced a carbon emissions reporting law as part of its energy transition and green growth law (TEE), unveiled ahead of last year’s climate change conference in Paris, and the country has long had a socially responsible investment (SRI) labelling system for funds, as has Luxembourg. 

“French initiatives such as SRI and Climate labels, ESG policies for investors, assessments of carbon risks, represent a robust base through which Europe can start addressing a crucial challenge,” head of socially responsible investment research at Mirova, Hervé Guez, notes.

“Most of the ESG standards and reporting requirements have been set up at a national or industry level”
Alix Chosson

The UK has also been paving the way in several areas, largely through ideas emanating from economist John Kay’s 2012 review of UK equity markets and long-term decision making. Kay’s calls for a review of fiduciary duties have since been championed by a number of ESG stakeholders, and MEPs attempted to introduce a definition while scrutinising the Institutions for Occupational Retirement Provision (IORP) Directive. 

More pertinently, the report’s initial draft was read by Brussels with such interest that it commissioned its own Green Paper on Long-Term Investing. This took on board the Kay Review’s call for an end of quarterly reporting and incorporated the proposals in the revised Transparency Directive.

“French initiatives such as SRI and Climate labels, ESG policies for investors, assessments of carbon risks, represent a robust base through which Europe can start addressing a crucial challenge”
Hervé Guez

Chosson also emphasises the importance of the Accounting Directive pushed by the Commission. While its reporting standards for listed companies does not directly affect pension funds, it will help with engagement efforts when it comes into force in 2017. “The first company reports under these new standards will thus be published in 2018,” Chosson says. “Although these new obligations will not significantly improve the quality of ESG information provided, they should provide some degree of standardisation and consistency.”

Standardisation and consistency, especially in reporting standards, should also be in place in other, non-EU, nations. Therefore, efforts by the Financial Stability Board (FSB) – a global organisation – to draft consistent climate-related reporting is noteworthy. While the Commission could attempt to lead in such an area, the involvement of the FSB will yield results faster for those wishing to compare companies across domiciles.

However, even where the EU attempts to lead, its ability to create comparative information is hampered by the fact the ESG requirements are contained within directives, where the transposition into national law allows member states some flexibility. 

In a 2010 edition of the Sustainability Accounting, Management and Policy Journal, academic Mark Camilleri points to how differently member states imposed the reporting requirements of the Modernisation Directive, which covers company reporting requirements. He notes that, as is the case with much of the EU’s regulation, it sets minimum standards which are often exceeded when transposed into national law – in turn leading to an uneven level of disclosure.

This is a unavoidable consequence of the use of directives, which can interpreted when transposed, compared with regulations, which have to be accepted by member states as drafted. It is for this reason that the impact of IORP II’s ESG requirements remains unclear.

“We want to be monitoring the transposition,” says de Ste Croix, “and push the member states to be as ambitious as possible when they transpose it, and potentially introduce even clearer measures on ESG.”

There are no doubt instances where the Commission has elevated the level of discourse around ESG matters. However, as the current Commission president Jean-Claude Juncker has repeatedly stressed there is a need to do less regulation better – going so far as to award one commissioner the portfolio of ‘better regulation’.  It will likely remain for individual member states to lead where Brussels can follow.