EUROPEAN COMMISSION Brussels,24.5.2018 SWD(2018) 264 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT

Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment



and Proposal for a Regulation of the European Parliament and of the Council on disclosures relating to sustainable investments and sustainability risks and amending Directive (EU) 2016/2341



and Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 2016/1011 on low carbon benchmarks and positive carbon impact benchmarks

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Table of Contents Table of Contents List of Figures List of Tables List of Boxes I. Introduction: Political and legal context 1.1. EU policy context 1.2. High-Level Expert Group on sustainable finance 1.3. The EU Action Plan on Financing Sustainable Growth II. Problem Definition 2.1. What are the problems? 2.1.1. High search costs for end-investors 2.1.2. Lack of incentives for relevant entities to consider ESG factors 2.2. What are the problem drivers? 2.2.1. Lack of clarity and coherence regarding the consideration of ESG factors in the investment and advisory process as part of the duties towards investors/beneficiaries (Driver 1) 2.2.2. Lack of ESG disclosure requirements for institutional investors, asset managers and investment advisors (Driver 2) 2.2.3. Lack of clarity on what constitutes sustainable economic activities (Driver 3) 2.2.4. Out-of-scope drivers 27 2.3. Consequences of the problem and how will they evolve?

III. Why should the EU act? 3.1. Legal bases 3.2. Subsidiarity: Necessity of EU action 3.3. Subsidiarity: Added value of EU action IV. Objectives: What is to be achieved? 4.1. General objectives 4.2. Specific objectives V. What are the available policy options, what is their impact and how do they compare? 5.1. What is the baseline from which options are assessed? 5.2. Methodology 5.3. What is the scope of the various initiatives? 5.4. Duties toward investors/beneficiaries with regards to ESG factors 5.4.1. Description of the policy options 5.4.2. Pros and cons 5.4.3. Impact on stakeholders 5.4.4. Stakeholder’s views 5.4.5. Comparison of policy options 5.5. Increase transparency by disclosing how ESG factors are integrated in the investment and advisors' recommendation process and, for investments targeting sustainable objectives 5.5.1. Description of the policy options 5.5.2. Pros and Cons

5.5.3. Impact on stakeholders 5.5.4. Stakeholder’s views 5.5.5. Comparison of policy options 5.6 Clarity on what are considered sustainable economic activities 5.6.1. Description of the policy options 5.6.2 How will the taxonomy be developed and updated (Policy Option 3) 5.6.3. Pros and cons 5.6.4. Impact on stakeholders 5.6.5. Stakeholders’ views 5.6.6. Comparison of the policy options 5.7. A methodology for low carbon benchmarks 5.7.1. Description of the policy options 5.7.2. Pros and Cons 5.7.3. Impact on stakeholders 5.7.4. Stakeholders’ view 5.7.5. Comparison of the policy options VI. Preferred options and overall impact 6.1. Description of the preferred options for each of the four initiatives 6.1.1. Duties toward investors/beneficiaries with regards to ESG factors 6.1.2. Disclosure on ESG integration and sustainability products

6.1.3. Taxonomy 6.1.4. Low carbon and positive carbon impact benchmarks 6.2. Links between the four initiatives and scope of requirements on asset managers depending on their investment style 6.3. Economic impact 6.3.1. Overall economic impact of the four initiatives 6.3.2. Economic impact of preferred options on integration of ESG factors and disclosure 6.3.3. Economic impact of preferred option on taxonomy 6.3.4. Economic impact of preferred option on low-carbon indices 6.3.5. Competitiveness and impact on third countries 6.3.6. Impact on issuers 6.4. Environmental impact 6.4.1. Overall environmental impact of the four initiatives 6.4.2. Impact of preferred options on integration of ESG factors and disclosure 6.4.3. Impact of preferred option on taxonomy 6.4.4. Impact of preferred option on low-carbon indices 6.5. Social impacts VII. How will actual impacts be monitored and evaluated? Glossary Annex 1: Procedural information Annex 2: Stakeholder consultation

Annex 3: Who is affected and how? Annex 4: Sustainable finance trends in Europe Annex 5: Implementation Timeline Annex 6: Why relevant entities might not consider ESG factors Annex 7: Overview of Sustainability-related initiatives Annex 8: Taxonomy Annex 9: Methodology for low-carbon indexes References



List of Figures Figure 1: ESG factors Figure 2: Visualisation of the ten actions proposed by the Action Plan Figure 3: ESG integration Figure 4: Problem tree Figure 5: carbon emissions Figure 6: the scope of requirements on asset managers depending on their investment style Figure 7: Sustainable investment strategies in Europe (in EUR trillion)

Figure 8: Sustainable investment strategies out of total AUM in Europe (in EUR trillion) Figure 9: AUM on the European sustainable investment fund market (in EUR billion) Figure 10: Policy option decision tree Figure 11: HLEG EU sustainability taxonomy framework Figure 13: Energy mix in major global equity indices Figure 14: Emission scope and methodologies Figure 15: Scope 1 & 2, Scope 3 Emissions and Avoided Emissions. Figure 16: Lack of correlation between carbon intensity and the materiality of climate and environmental risks for credit worthiness at sector level Figure 17: Lack of correlation between carbon intensity and value at climate risk according to equity research analysts, at company level within key sectors



List of Tables Table 1: SRI and ESG disclosure – Legal obligation for institutional investors and asset managers in selected Member States Table 2: Objectives and underlying problem drivers Table 3: Methodology table Table 4: Discarded option for duties towards investors/beneficiaries Table 5: Pros and Cons of options on duties towards investors/beneficiaries

Table 6: Impact on stakeholders of options on duties towards investors/beneficiaries Table 7: Stakeholder's views on duties towards investors/beneficiaries* Table 8: Benchmarking policy options on clarity concerning ESG integration as part of duties towards investors/beneficiaries Table 9: Summary of pros/cons of options on duties towards investors/beneficiaries Table 10: Pros and Cons of options on disclosure Table 11: Impact on stakeholders of options on disclosure Table 12: Stakeholder's views on options on disclosure* Table 13: Benchmarking policy options on disclosure on ESG integration and sustainability objectives Table 14: Summary of pros/cons of options Table 15: Discarded options for an EU environmental taxonomy Table 16: Pros and cons for options on EU sustainability taxonomy Table 17: Impact on stakeholders of options on taxonomy Table 18: Stakeholders views on an EU taxonomy Table 19: Benchmarking policy options on taxonomy Table 20: Summary of pros/cons of options on taxonomy Table 21: Pros and cons of the options on low carbon benchmarks Table 22: impact on stakeholders of the options on low carbon benchmarks Table 23: Stakeholder's views on low carbon benchmarks Table 24: Benchmarking the options on low-carbon benchmarks Table 25: Summary of pros/cons of the options on low-carbon benchmarks

Table 26: Summary of the preferred options Table 27: Detailed overview of individual responses on duties towards investors/beneficiaries Table 28: Detailed overview of individual responses on disclosure Table 29: Detailed overview of individual responses on low carbon benchmarks Table 30: Overview of benefits Table 31: Overview of costs Table 32: European sustainable investment funds by domicile Table 33: Legislative initiatives within the SRI framework Table 34: Market-led initiatives within the SRI framework Table 35: Illustrative examples of Taxonomy – Option 2 Table 36: Illustrative examples of Taxonomy – Option 3 Table 37: Example showing difference between Option 2 and Option 3 Taxonomy Table 38: Pros and Cons for sub-options on governance taxonomy for preferred policy option 3 Table 39: Detailed stakeholders' views on taxonomy Table 40: Carbon footprint of S&P DJI's major global indices Table 41: Examples of high carbon intensive sectors List of Boxes Box 1: Definition of "sustainable finance" Box 2: ESG integration in the investment process

Box 3: Low-carbon benchmarks Box 4: Existing taxonomies and national financial labels Box 5: A social taxonomy as a second step to get to a complete sustainable taxonomy Box 6: How does the taxonomy reflect EU standards and legal commitments in the area of environment and climate change? Box 7: An EU taxonomy: what it defines and how it will be used Box 8: EU labelling for environmental policy Box 9: Explanation of scope 1, 2 and 3 emissions Box 10: Methodologies adopted by the Commission for calculation of carbon footprint

I. Introduction: Political and legal context 1.1. EU policy context The EU is committed to a development that meets the needs of the present without compromising future generations. Sustainability has since long been at the heart of the European project. The EU Treaties give recognition to its social and environmental dimensions. Governments from around the world chose a more sustainable path for our planet and our economy by adopting the 2016 Paris agreement on climate change and the United Nations (UN) 2030 Agenda for Sustainable Development (UN, 2015). The 2016 Commission's Communication on the next steps for a sustainable European future links the Sustainable Development Goals (SDGs) of the UN 2030 Agenda for Sustainable Development to the European policy framework to ensure that all EU actions and policy initiatives, within the EU and globally, take the SDGs on board at the outset. The EU is also fully committed to reaching the EU 2030 climate and energy targets and to mainstream sustainable development into EU policies. Therefore, many of the European Commission’s policy priorities for 2014-2020 feed into the EU climate objectives and implement the 2030 Agenda for Sustainable Development. These include the Investment Plan for Europe, the Circular Economy Package, other environmental policies including those that protect natural habitats, keep air and water clean and ensure proper waste disposal, the Energy Union package, the Clean Mobility package, the Capital Markets Union and the EU budget for 2014-2020, including the Connecting Europe Facility funds related to the Trans European Transport Network (TEN-T) policy objectives and the Cohesion fund and research projects. In addition, the Commission launched a multi-stakeholder platform to follow-up and exchange best practices on Sustainable Development Goals implementation. Achieving EU sustainability goals requires important investments. In the climate and energy space alone, it is estimated that an additional annual investment of EUR 180 billion is needed to meet climate and energy targets by 2030. A substantial part of these financial flows will have to come from the private sector. Closing this investment gap means significantly and rapidly reorienting private capital flows towards more sustainable investments. Yet, most of the existing sustainability commitments do not explicitly address the role of the financial system in supporting projects in line with the strategic objectives. A mix of measures is needed to meet the EU's immediate and longer-term objectives for sustainability policies. Having in place a strong regulatory framework is part of that, but not always sufficient. To ensure a rapid and orderly transition to a sustainable economy, it is essential to also help reorient capital flows away from polluting to greener activities and therefore increase access to finance for the latter.. 1.2. High-Level Expert Group on sustainable finance The Commission established in December 2016 a High-Level Expert Group (HLEG) to develop an overarching and comprehensive EU strategy on sustainable finance. The HLEG published its final report on 31 January 2018 (HLEG, 2018). This report provided a comprehensive vision on sustainable finance for Europe and identified two imperatives for Europe's financial system. The first is to improve the contribution of finance to sustainable and inclusive growth. The second is to strengthen financial stability by incorporating Environmental, Social and Governance (ESG) factors into investment decision-making. Directive 2016/234 introduced ESG factors in the EU legislation by making a reference to the United Nations-supported Principles for Responsible Investment. Although there is no universal definition of ESG factors within the investment industry, it is widely accepted that ESG factors are a universal concept that include a range of environmental, social and governance factors as illustrated in Figure 1. According to United Nations Environment Programme (UNEP) Inquiry and the United-Nation Backed Principles for Responsible Investment (UNPRI), ESG factors are broadly defined as follows: (i) Environmental (E) issues relate to the quality and functioning of the natural environment and natural systems; (ii) Social (S) issues relate to the rights, well-being and interests of people and communities; and (iii) Governance (G) issues relate to the governance of companies and other investee entities.



Box 1: Definition of "sustainable finance" Sustainable finance generally refers to the process of taking due account of environmental social and governance considerations in investment decision-making. This would require that sustainability risks are always taken into consideration when making investment decisions, and not only when sustainable impact investments are selected based on very explicit sustainability preferences of investors. Investors can invest sustainably either by integrating ESG factors/risks in investment decision making, or by investing directly into economic activities that positively contribute to sustainability. In this impact assessment, the concept of sustainability is operationalised by referring to so-called ESG factors. Although there is no definitive list of which issues or factors are covered by the terms "ESG", they are - according to UNEP Inquiry and the PRI, broadly defined as follows: (i) Environmental (E) issues relate to the quality and functioning of the natural environment and natural systems; (ii) Social (S) issues relate to the rights, well-being and interests of people and communities; and (iii) Governance (G) issues relate to the governance of companies and other investee entities. Figure 1: ESG factors - climate change - greenhouse gas (GHG) emissions - resource depletion, including water - waste and pollution - deforestation - biodiversity loss - changes in land use - ocean acidification - changes to the nitrogen and phosphorus cycles - human rights - working conditions, including slavery and child labour - freedom of association and freedom of expression - local communities - conflict areas - health and safety - employee relations and diversity - consumer protection - executive pay - bribery and corruption - political lobbying and donations - board diversity and structure - shareholder rights - stakeholder interaction - tax strategy Source: UNPRI (2018b) The HLEG issued a series of recommendations, which it believes are essential building blocks of a sustainable European financial system. Among these recommendations, the HLEG calls for the establishment of a technically robust classification system at EU-level to provide clarity on what is 'green' or 'sustainable' – a so-called sustainability taxonomy. A second recommendation of the HLEG is to clarify that asset managers and institutional investors, such as pension funds and insurance companies, integrate ESG factors in their investment decision process and enhance disclosure to their end clients in that regard. The HLEG's report also recommends that investment preferences of end-investors on sustainability objectives be taken into account along the investment chain and in the advisory process. Another recommendation of the HLEG is on benchmarks, which are used to gauge the performance of financial products. In the HLEG's view, greater transparency and guidance on sustainable benchmarks is needed. 1.3. The EU Action Plan on Financing Sustainable Growth To follow-up on the work of the HLEG and contribute to broader efforts to connect finance with the needs of the planet and society, the Commission published on 8 March 2018 an Action Plan on Financing Sustainable Growth (EC, 2018a). The proposed approach is part of the EU implementation of the Paris Agreement, which specifically committed (in article 2(1)(c)) to aligning financial flows with global climate objectives. It is also crucial to reduce the fall-out from possible stranded assets and ensure an orderly transition. Finally, it is also part of the EU implementation of the UN 2030 Agenda for Sustainable Development. The Action Plan has three overarching objectives, namely: (i) reorienting capital flows towards sustainable investments to achieve sustainable and inclusive growth; (ii) managing financial risks stemming from climate change, resource depletion, environmental degradation and social issues; and (iii) fostering transparency and long-termism in financial and economic activity. To achieve these goals, the Commission put forward ten actions (Figure 2), including those supported by this impact assessment. In particular, this impact assessment is related to action #1 (EU sustainability taxonomy), action #4 (investment advice to integrate ESG factors), action #5 (developing sustainability benchmarks), and action #7 (investors' duty to integrate ESG and increased disclosure, which touches also on parts of action #9). Those actions are circled in red in Figure 2. These actions should be seen as key parts of a broader and further-reaching strategy to make the European economy truly sustainable. The actions are complementary and mutually reinforcing in achieving the overarching objectives of the Action Plan and fostering transparency in particular, as further explained in this impact assessment. Specifically, establishing a framework to develop a common language on what sustainable activities are (action #1) will serve as a basis to launch other components of the Action Plan, such as action #2 on standards and labels and action #3 on investment in sustainable infrastructure projects. Clarifying the duties of care, loyalty and diligence of institutional investors, asset managers, insurance distributors and investment advisors (actions #4 and #7) will allow mainstreaming sustainability into risk management. In addition transparency will increase by improving disclosure on sustainability in investment decisions and advice (action #7 and part of action #9). Ultimately, these combined actions will help reorient capital flows towards sustainable investments. As regards timing, some of these actions – and the taxonomy in particular – will require several steps to become fully operational and start contributing to the achievement of the most pressing EU policy priorities, especially on climate change. This is why those actions are being proposed in parallel. In turn, the need to follow these intermediate steps is also reflected in the analysis of the different policy options presented in this impact assessment. In some cases (actions #4, #5 and #7 and part of action #9), the expected impacts of the various policy options are assessed in this impact assessment in greater depth. For action #1, this impact assessment mainly focuses on the problems that the action is meant to address, on the overall approach and guiding principles underpinning the taxonomy, the procedural and governance arrangements envisaged to make it operational and, where relevant, the legislative and procedural safeguards to be respected while moving along the various implementation steps and from one building block to the next. A more detailed assessment would then follow once the relevant implementation measures are put in place, as well as the future uses of the taxonomy are agreed on. Section 6.1 provides a detailed description of the timeline and of the logical sequencing for the proposed initiatives. Figure 2: Visualisation of the ten actions proposed by the Action Plan Source: EC, 2018a, p. 19 II. Problem Definition

There is a lack of clarity and transparency on how ESG factors are currently being integrated in the investment decision and advisory process. Considering these factors is important for all investors because ESG factors could affect the long-term risk-return trade-off. A recent European Commission consultation (EC 2016b) concluded however that markets "do not sufficiently internalise ESG risks and respond to ESG opportunities". In addition, certain investors have explicit ESG preferences that are not sufficiently addressed. For these investors, it is essential that their personal values are considered in the advisory process and reflected in the investment product selection. Insufficient integration of ESG factors in the investment and advisory process is related to two problems. End-investors face high search costs in order (i) to identify sustainable economic activities and (ii) to find out how ESG factors are integrated in the investment decision process. Hence, investors face imperfect information. Secondly, relevant entities might not be properly incentivised or have the tools to consider ESG factors in the investment and advisory process. Five drivers underpin the above problems, three of which stem from a regulatory failure, either because the design and implementation of existing EU law is not optimal, or because specific provisions on ESG disclosure to address the issue of imperfect information do not exist. These drivers are: (i) lack of clarity and coherence of EU rules on duties towards investors/beneficiaries with respect to ESG integration in the investment and advisory process; (ii) lack of disclosure regarding the level of ESG integration in the investment process; (iii) lack of clarity on what can be considered a sustainable economic activity. Two other drivers fall out of the scope of this impact assessment: (i) the lack of comparable and readily available ESG information from firms and issuers and (ii) short-termism. Although the last two drivers are important in nature, they refer to broader structural issues that are tackled by separate initiatives, as reflected in the European Commission's Action Plan (EC, 2018a). Regarding the lack of sustainability disclosure at the level of firms and issuers in particular, it is worth recalling that, as part of the requirements of the Accounting Directive, companies (including small issuers), have to report non-financial information as part of their management report to the extent necessary for an understanding of the company' development, performance or position. Furthermore, as of 2018, large listed companies will have to disclose a non-financial statement containing material information on key environmental, social and governance aspects and how related risks are managed. In addition, relevant legislation on public reporting by companies is currently being subjected to a fitness check by the European Commission. Possible follow-up actions on this problem driver will thus draw on the results of the fitness check, which are expected around mid-2019. 2.1. What are the problems? 2.1.1. High search costs for end-investors As regards ESG information, retail and institutional end-investors face increased search costs due to imperfect information. The availability of ESG information is crucial to ensure that investors who have the intention to invest in accordance with ESG criteria will actually do so. Those investors search actively for this information: they tend to look more for social and environmental information than for traditional financial information. However, they might have difficulties in finding relevant ESG information. Currently, the search for this type of information is hindered by (i) a lack of transparency on how ESG factors and ESG preferences are integrated in the investment and advisory process, including a lack of ESG-related disclosure; and (ii) the existing ambiguity with respect to what can be considered a sustainable economic activity, coupled with a lack of harmonisation of the methodologies to assess for instance climate-related risks and opportunities in line with low-carbon investment strategies. Hence, investors are confronted with imperfect information, which makes it difficult to retrieve relevant ESG information. As a result, end-investors face unnecessarily high search costs. Evidence from the public consultation (EC, 2018b) confirms that the available information for some sustainability factors is insufficient. In this consultation, the vast majority of end-investors indicated that they are unable to make informed investment decisions based on the available sustainability information. In particular, information on environmental and social factors is lacking. Corroborating evidence is also provided in a recent study (EC, 2015) that concludes that, although many institutional investors claim to apply sustainable and responsible investment strategies, the final impact of the inclusion of ESG criteria on investment decisions is rarely disclosed. In line with these observations, the 2018 HLEG final report highlighted that, without consistent and readily available information, it is difficult for end-investors to compare the ESG features of different investments. A prerequisite for doing so is to have an unambiguous way of qualifying what can be considered to be a sustainable economic activity and to have appropriate tools to assess ESG investment performance. These issues lead to behavioural biases that affect the investment decisions of end-investors. The availability and quality of ESG information from relevant entities is a key element to assess how ESG factors are integrated in the investment process, and to decide whether one would like to consider ESG factors when making an investment decision. In case investors are not properly made aware of sustainable investment options, they will be biased towards investing in the default setting (i.e. conventional investment without considering ESG factors). In addition, it will be difficult for them to develop their preferences towards ESG integration and make them known, given the lack or opaqueness of information, together with the perceived lack of impact. Finally, some studies note that it is unlikely that sustainability will become part of the financial decision making of end-investors, given that investment advisors do not discuss it, unless explicitly asked for by the client (Pilaj, 2017). 2.1.2. Lack of incentives for relevant entities to consider ESG factors Relevant entities are required to act with prudence and in the best interest of their clients. This implies that they have to act loyally and exercise prudence, skill, care and diligence, in managing funds for their clients or beneficiaries. These principles are captured by fiduciary duty obligations in common law jurisdictions or analogous concepts like investor or beneficiary protection (e.g. policy holder protection) in pieces of EU legislations that apply to different market participants managing assets on behalf of clients and/or providing investment advice. From a legal perspective, the extent to which these duties are compatible with taking ESG concerns into account has been subject to considerable debate. Nevertheless there is a growing consensus that the consideration of ESG factors is compatible with fiduciary duties when: ·ESG factors have a financial material impact on the investment performance or valuation; ·It is reasonable to assume that taking into account ESG factors is supported unanimously by the beneficiaries; ·ESG factors are a distinctive element when comparing investments with otherwise similar characteristics. EU legislation does not constitute a barrier to integrate ESG factors. While ESG factors are not explicitly mentioned in the relevant EU legislation – with the exception of the IORP Directive – existing financial regulation provides scope to incorporate them, given that all factors that have a material impact on financial performance should be considered in the investment and advisory process. This view is also shared within the industry: the public consultation (EC 2018b) reveals that the vast majority of respondents do not view European or national regulation as a barrier to incorporating ESG factors in their investment decisions. There is however an issue with the implementation of existing legislation. While there are no legal barriers to integrate ESG factors, many relevant entities do not consider these in a consistent way in their investment process, and the number of entities that do consider ESG factors is only increasing slowly (see Box 2). In a similar spirit, the Commission’s study (EC 2015) mentioned above indicated inter alia that the investment community should be incentivised to integrate environmental and resource efficiency issues into their decision-making process. Box 2: ESG integration in the investment process Overall, the level of integration of ESG factors remains moderate, despite an increasing awareness of the importance of ESG factors. More and more asset managers and institutional investors believe that sustainability factors affect the risk/return trade-off (OECD 2017).

A survey from the CFA Institute (CFA 2017) shows that a number of respondents considered ESG factors in their investment analysis, but mainly with regard to governance issues. The management of investment risks is the main reason to consider ESG factors. Environmental issues were considered by only 54% of them in 2017 – with a compound annual growth rate of 3.9% since 2015, which is slow. Figure 3: ESG integration [+10%] [+5%] [+0%] Note: Y-axis represents the respondents of the total sample that take the ESG factor into account. Respondents can indicate more than one factor (if applicable). 2015-17 growth rate per category in vertical brackets. Source: European Commission analysis based on CFA (2017). Concerning asset managers, a survey by Ernst & Young (2015) found that less than a quarter of investment professionals consider extra-financial information frequently in their investment decision process. As regards pension funds, a survey by Mercer (2017) reported that typically only around 20% integrate ESG risks in their investment process, mainly because of the financial materiality of these risks. Climate change risk is largely ignored, with only 5% of the respondents taking it into account, although both for the consideration of climate change risk as well as for the recognition of the financial materiality there is an increase compared to the previous year. Although insurance companies do have to take into account material risks into their investment process, insurers responding to the public consultation (EC 2018b) state that insurance companies would benefit from improved integration of ESG factors in their investment process. In the same public consultation (EC 2018b), approximately 60% of pension providers, insurance companies and asset managers reported that the level of ESG integration is ‘low/no integration’. As to individual portfolio managers, 76% reported that the level of integration is ‘low/no integration’ (only some stakeholders saw a medium level of integration). Annex 4 provides a more in-depth analysis of sustainable finance trends in Europe. Taken together, the evidence above demonstrates that relevant entities lack incentives to consider ESG factors. This lack is fuelled by an absence of clarity and coherence in EU legislation and other possible determinants as discussed in Section 2.2.2 and Annex 6. Generally speaking, the problems described above directly affect all relevant entities and end-investors and any improvements would require changes in their behaviour. For relevant entities this could imply changing the way they execute their duties towards investors/beneficiaries, integrate ESG factors and disclose such information. Providers of investment advice might have a stronger incentive to incorporate ESG factors in their advice as ESG concerns become more part of industry practices. End-investors could adapt their investment behaviour in order to have a more comprehensive integration of ESG factors when making investment decisions. Figure 4: Problem tree 2.2. What are the problem drivers? As mentioned above, three drivers are directly relevant for the initiatives which this impact assessment supports, and are described in greater detail below. 2.2.1. Lack of clarity and coherence regarding the consideration of ESG factors in the investment and advisory process as part of the duties towards investors/beneficiaries (Driver 1) The lack of incentives for relevant entities to consider ESG factors is related to several concerns, but the lack of clarity and coherence in EU legislation is a key factor. In the public consultation (EC, 2016b), institutional investors and other stakeholders reported that duties towards investors and beneficiaries —as they are articulated in the relevant financial legislation— are not sufficiently clear on how they have to consider financially material risks stemming from sustainability factors. More generally, stakeholders also indicated that they would welcome clarification regarding the fact that the integration of ESG factors in the investment process fits with their duties towards investors and beneficiaries. This uncertainty has also spurred considerable debate in the academic literature, indicating that without a sufficiently explicit legal framework, the integration of ESG factors under the duties toward investors and beneficiaries is often not straightforward. The current EU legislative framework does not prevent relevant entities from integrating ESG factors. However, the high-level nature of the relevant provisions contributes to a heterogeneous implementation. As mentioned before, relevant entities are required to act with care, loyalty and diligence and in the best interest of their investors and beneficiaries, but practically none of the (sectoral) legal frameworks explicitly requires relevant entities to consider ESG factors in their investment decisions.

There is a lack of coherence in the obligations regarding duties towards investors and beneficiaries across sectors. Only IORP II explicitly states that occupational pension funds should consider ESG factors in their investment decisions, governance and risk management systems. In addition, entities subject to the IORP Directive have to disclose how ESG factors are taken into account in their investment policy. For entities in other sectors there are no explicitly pre-scribed requirements. ESG preferences are insufficiently considered in the advisory process. The assessment of suitability under MiFID II and IDD does not foresee that information on non-financial objectives and preferences is gathered by investment advisors. Investment advice typically consists of two elements: (i) client profiling to understand a client's risk preference, investment objectives, financial situation and investment experience; and (ii) product selection in order to assure that the final investment products recommended to the client are in line with the client's profiling. In practice, product selection appears to be primarily driven by a client's risk profile, but ESG preferences are not systematically assessed. Suitability assessment questionnaires appear not to include questions on ESG preferences: a sampling of 19 questionnaires of mainstream retailers in five EU countries (France, Germany, Italy, Spain, and the United Kingdom) revealed that none of them contained questions on non-financial objectives and preferences. Overall, it might therefore be difficult for a client to communicate their ESG expectations clearly as they are not integrated in the client profiling and product selection process. At the same time, investors are not sufficiently aware of ESG risks to enable them to raise their ESG expectations on their own. In the public consultation (EC 2018b), end-investors also argued that inadequate consultation of retail investors and beneficiaries could lead to a misunderstanding of what constitutes "the best interests" of end-investors. A large majority of overall respondents think that insurance and pension providers should consult their beneficiaries on an annual/periodic basis with respect to their sustainability preferences. However, a majority of pension funds and insurance companies do not agree with this statement, mainly because of the lack of in-house expertise on sustainability factors and the potential costs to train their employees in this area. On the side of asset managers, a majority of respondents do agree with the approach. Intermediaries might also shy away from raising ESG concerns themselves as there is doubt that commercial and marketing incentives would support the sale of ESG products (2Dii 2017). In the same spirit, anecdotal evidence from the Commission consultation (EC 2018b) mentioned that investment advisors refrained from discussing sustainability topics as it increased the complexity of their advisory work, whilst incentives to raise ESG issues were perceived to be low. Overall, the evidence also points to a regulatory failure in terms of implementation regarding the consideration of ESG preferences/factors in the investment and advisory process. The analysis of current regulatory and market practice leads some stakeholders to conclude that the consideration of environmental objectives in the advisory process should be made mandatory (2Dii, 2017). In line with this, some respondents in the recent Commission public consultation (EC, 2018b) also called for more guidance by regulatory authorities in view of the complexity of the advisory process. In addition, as part of their duties towards investors/beneficiaries, benchmarks used by asset managers and investors to track/measure the performance of a fund/portfolio should be appropriate and reflect the clients' investment style in accordance with their investment recommendation/investment mandate. In this regard, existing low-carbon benchmarks are not always appropriate neither for a passive investment strategy nor as a performance benchmark for an active low-carbon investment strategy. They cannot always be used as an objective tool to evaluate to what extent a low-carbon investment strategy pursues a low-carbon investment style during the lifecycle of an investment mandate. Asset managers who responded to a targeted consultation (see Annex 2 for more details) explained that they currently do not use a low-carbon index because they believe that: (i) the current methodologies do not reflect all sources of CO2 emissions; (ii) their clients (investors) have no confidence in the methodology employed by available low-carbon indices; and (iii) low-carbon indices reflecting their investment approach and style are missing. In addition, the level of disclosure on the benchmark an asset manager uses to assess the portfolio/fund performance is insufficient, especially as regards if and to which extent this benchmark is aligned with the sustainability objectives that the manager pursues. Box 3: Low-carbon benchmarks Benchmarks play a central role in measuring the performance of investments consisting of traded assets. Several respondents to the stakeholder consultation on the HLEG's interim report (2017a) mentioned that indices and performance benchmarks are a key lever to best align the investment and analyst community with long-term sustainability considerations and the transition towards a low-carbon economy. Since conventional benchmarks do not reflect low-carbon considerations in their methodologies and are not appropriate to measure the performance of sustainable investment strategies, over the past decade, index providers (such as MSCI, Euronext, FTSE-Russell, STOXX, S&P) have designed hundreds of ESG and low-carbon benchmarks in order to capture sustainable and climate-related goals and respond to the growing demand from investors to invest in sustainable companies and projects and thus accelerate the transition to a low-carbon economy. However, while the supply is there, these benchmarks lack reliability and standardisation. The lack of harmonisation of the methodologies (especially the lack of consensus on how comprehensive the assessment of a carbon footprint should be) has affected the low-carbon indices' comparability and reliability. Some asset managers explained, in the targeted consultation, that methodologies employed by currently available low-carbon indices do not adequately reflect all sources of CO2 emissions for the calculation of the carbon footprint of the index components. Therefore, the current use of low-carbon indices raises various concerns from an investor-protection perspective. Acceptance by the market has thus been limited - in February 2018, only 4 out of the 59 funds marketed as low-carbon/climate funds used a low-carbon benchmark (Morningstar data on funds registered for sale in the EU as of February 2018). Furthermore, the performance of the majority of funds (41 out of 59 funds) is still assessed against a conventional benchmark which is not appropriate to reflect low-carbon investment strategies. The latter is likely a result of benchmark providers generally using 'decarbonised' standard market cap indices by re-weighting portfolios based on the 'carbon intensity' of issuers included in the benchmark. Finally, the benchmarks currently provided by the market do not align with the objective of limiting global warming to below 2°C pursuant to the Paris Agreement as decarbonisation of standard benchmarks is expected to result in temperatures rising by 4 to 6°C. Based on relevant literature and stakeholders' views expressed in public consultations, other major obstacles to considering ESG factors as part of the duties towards investors and beneficiaries are: (i) possible heterogeneity of beneficiaries' ESG preferences; (ii) lack of reliable and comparable ESG information; (iii) lack of data and tools to analyse ESG risks; and (iv) the impact on costs and risk-adjusted performance. A discussion of these factors is provided in Annex 6. 2.2.2. Lack of ESG disclosure requirements for institutional investors, asset managers and investment advisors (Driver 2) Information disclosed by relevant entities does not allow end-investors to assess how relevant entities consider ESG factors in their investment and advisory process. This lack of transparency follows from the fact that this kind of information is not very detailed or easily accessible for end-investors or is not comparable. End-investors may thus have insufficient elements to make informed investment decisions. Indeed, as suggested in the HLEG’s final report (2018), a lack of consistent information hinders investors and others from considering ESG-related issues. End-investors can only make an informed sustainable investment choice if they can assess both the financial characteristics and ESG features of a financial product. The existing ESG-related information is not sufficient for a sustainability assessment of their investment, nor are existing rules considered to be sufficient to address this issue (Nilsson et al. 2010). Although the feedback from the public consultation (EC, 2018b) indicates that the availability of ESG-related information has improved recently, it also shows that there is still ample scope to further improve the quality and quantity of ESG information. In this respect, the majority of respondents argued that, to guarantee transparency, relevant entities should disclose how they consider sustainability factors within their investment process. According to respondents, more disclosure is required to identify whether risks stemming from sustainability issues are properly addressed, as well as to ensure that investors' ESG preferences are reflected in the investment and advisory process. They suggested that this information should be disclosed in semi-annual/annual reports and in pre-contractual information documents. Websites and, to a lesser extent, marketing materials were mentioned as other useful means of disclosure. There is also a lack of coherence in the prevailing national legal obligations on ESG disclosures. The various national legal obligations regarding Socially Responsible Investments (SRI) and ESG disclosures for a selected group of Member States are summarised in Table 1. The table shows large differences. Firstly, countries like Austria, Luxembourg, Portugal and Sweden have no legal obligations for any of the institutional investors or asset managers. A second group of countries only regulates one of the relevant groups. Given that pension funds generally have long-term investment policies, for which ESG risks are more relevant, pension funds seem to be a natural first choice to impose ESG disclosure requirements. A third group of countries, like France, Denmark and Italy impose disclosure measures for all entities. Although countries like France and Denmark impose the same disclosure rules for different entities, the cross-country variations in disclosure requirements remain. Yet, it should be noted that IORP II requires Member States to ensure that entities subject to the Directive disclose the relevance and materiality of ESG factors. As the transposition deadline is January 2019, not all Member States will have necessarily implemented those rules already.

Table 1: SRI and ESG disclosure – Legal obligation for institutional investors and asset managers in selected Member States Pension Funds (IORP) Insurance companies Asset managers AT / / / BE / / Clarify to what extent ESG factors are taken into account in the implementation of their investment policy DK Report their responsible investment policy annually Report their responsible investment policy annually Report their responsible investment policy annually FR Describe how ESG factors are taken into account in their investment policy Describe how ESG factors are taken into account in their investment policy Describe how ESG factors are taken into account in their investment policy DE Inform investors on whether and how ethical, social and environmental concerns have been considered / / IT Report and disclose to what extent ESG criteria are adopted in the management of assets For financial products labelled as “ethic” or “socially responsible” investors to be informed on how those qualifications affected their investment choice For financial products labelled as “ethic” or “socially responsible” investors to be informed on how those qualifications affected their investment choice LU / / / NL Be transparent about their responsible investment strategies / / PT / / / ES Disclose whether or not, and how, ESG factors have been taken into account in their investments policies – Disclose extra-financial risks / / SE / / / (*) UK Include in the Statement of Investment Principles (SIP) to what extent they take into account ESG factors / / (**) Source: EFAMA (2016) (*) No specific legal obligation but self-regulation: Swedish Investment Fund Association Guidelines covering transparency and comparability of asset managers dealing with sustainability issues. (**) No specific legal obligation but asset manager should disclose how it delivers stewardship responsibilities on behalf of its clients (UK Stewardship Code). 2.2.3. Lack of clarity on what constitutes sustainable economic activities (Driver 3) While there is a consensus on what falls under each of the broad ESG concepts (see Figure 1 in section 1.2.), such high-level consensus is however not sufficient to increase investments into sustainable economic activities. In the recent public consultation (EC 2018b), stakeholders indicated that there are too many standards without a single, commonly-accepted framework. Clarity is needed on the conditions that economic activities need to fulfil in order to qualify as positively contributing towards sustainability. However, at present, a coherent and uniform classification system of what constitutes a sustainable economic activity, for the purposes of sustainable investment, does not exist at EU level. A number of market-based practices or market-led initiatives have emerged in recent years. These, however, are not always comprehensive and do not necessarily reflect all the EU's environmental and sustainability priorities. At Member State level, some EU countries have built on these market initiatives to develop classifications for climate-related or environmental economic activities, to serve as a basis for national standards and labels. This parallel development of market-based and national practices is likely to give rise to divergent classifications, also because these kinds of initiatives are pursuing a specific national policy agenda, are targeting only particular topics, or are based on commercially-driven priorities. In turn, this fragmentation can confuse investors, especially retail investors who would like to invest into sustainable or 'green' activities, but are faced with financial products that are based on divergent criteria as to what qualifies as a green activity. If the activities classified as green in one Member State are different from the activities classified as green in another Member State, consumers face difficulties in comparing and understanding the cross-border differences between green financial products. Therefore, they will be discouraged from investing into these kinds of assets across borders, hindering cross-border sustainable investment. Moreover, the coexistence of diverging classifications of economic activities with varying scopes and based on different criteria and metrics also leaves room for greenwashing. Greenwashing refers to the practice of marketing financial products as green or sustainable, when in fact they do not meet basic environmental standards. This phenomenon can have a direct negative effect on the functioning of the internal market for the following reasons: It can undermine investor confidence in the concept of sustainable investment and, greenwashing can result in unfair competitive advantage. Box 4: Existing taxonomies and national financial labels An overview of existing market-led initiatives and of taxonomies used at the national level in the field of environment and climate provides a useful illustration of the variety of classifications that currently coexist across the EU, leaving room for the potential risks of growing inconsistencies and market fragmentation in the future. Currently, three taxonomies are being used as the basis for existing national eco-labelling initiatives. These are the Climate Bonds Taxonomy, produced by the Climate Bonds Initiative (CBI) to notably certify climate and green bond issuances, the Common Principles for Climate Change Mitigation and Adaptation Finance Tracking, produced by the International Development Finance Club (IDFC) and a number of Multi-lateral Development Banks for their lending to climate-related investments, and the Green Bond Principles, produced by the International Capital Markets Association (ICMA). Of the five existing national labelling schemes, four are based on one of the above taxonomies: ·The TEEC Label (France) and the FNG Siegel (Germany) are based on the CBI taxonomy ·The Luxflag Climate Finance Label (Luxemburg) is based on the IDFC taxonomy ·The Nordic Swan Ecolabel is based on ICMA's Green Bond Principles The Austrian Ecolabel only specifies exclusion criteria but does not stipulate the use of a specific taxonomy. In each case the taxonomies have been adjusted to reflect national priorities, as well as having been narrowed down or made more granular for certain sectors. Using the French case as an example, the taxonomy used for the TEEC label is based on that of the CBI, with a few amendments to take account of the considerations of the stakeholders consulted and national public policy guidelines. Among others, certain activities that appear in the CBI taxonomy have been excluded from the TEEC label taxonomy, or, in some cases, descriptions of certain activities appearing in the CBI taxonomy have been specified in the French example. 2.2.4. Out-of-scope drivers The problems that are central to this initiative are also influenced by other factors, such as: (i) the lack of readily available and comparable ESG information by firms and (ii) short-termism. These factors are considered to be out-of-scope as they are related to a broader structural issue (i.e. short-termism is an issue that goes beyond sustainability concerns and that is embedded in investment industry practices) or focus on the behavior of firms that surpasses this initiative's scope. In addition, they are/will also be addressed via other initiatives of the Commission, as reflected in the Commission's Action Plan. 2.3. Consequences of the problem and how will they evolve? The lack of incentives to consider ESG factors in the investment decision will persist, even though, the problem is likely to become less prominent over time. Although the consideration of ESG factors by the industry currently remains moderate, the inclusion of sustainability factors in the investment decision process is likely to increase, but only at a slow pace. A growing number of relevant entities believe that integrating ESG factors is consistent with their responsibilities towards investors/beneficiaries, reflecting the trend towards further ESG integration as discussed in section 2.1. The evidence in Box 2 showed that the number of respondents considering environmental factors increased by 8% over the period 2015-2018. At the corresponding compound annual growth rate of 3.9%, it would take more than 10 years before 75% of the industry would consider environmental factors in their investment decisions. Even if this trend continues, national initiatives will not lead to a coherent and comprehensive approach. While a few Member States already require institutional investors and asset managers to consider ESG factors in their investment decisions, most Member States have not taken any action in this area (EC, 2015). If other Member States decide to do so in the future, this is likely to result in different approaches across the EU. The coexistence of heterogeneous approaches is likely to increase market fragmentation, limit transparency for end-investors, and ultimately hamper capital flows towards the achievement of EU sustainability objectives.

Similarly, no significant change is expected with regard to the integration of ESG factors in the advisory process. Although investors might become more aware of sustainability concerns over time and raise them in the advisory process, it is unlikely that this would lead to a significant change if the need for ESG integration is not structurally embedded in the advisory process. High search costs for end-investors will largely persist, as information on the inclusion of ESG factors in the investment decision and advisory process will depend on national rules in Member States and/or on voluntary disclosure by the relevant entities. Although increased awareness from investors regarding the relevance of ESG factors and the reputational benefits of (voluntary) communication on ESG integration may lead to enhanced disclosure by relevant entities, the information is likely to remain high-level and not harmonised. Transparency will remain limited, and this will hinder end-investors’ ability to compare the ESG features of different investments and choose appropriate investment products to pursue their ESG/climate-related strategy. In addition, the ambiguity regarding what can be considered a sustainable economic activity, is expected to persist. As explained in the baseline scenario (Section 5.1), market-based or marked-led initiatives with different scopes are likely to be further developed and compete with classifications developed by public bodies in the future (e.g. the EIB).Without EU action, no coherent and univocal classification system on sustainable economic activities for the purposes of sustainable investment in the medium to long-term will emerge. For investors that intend to invest in sustainable economic activities it will thus remain difficult to identify such assets in a consistent fashion. Overall, this is likely to limit the possibility of redirecting capital flows towards sustainability goals and to close, among others, the investment gap to achieve the EU's sustainability objectives. Similarly, the same conclusions can be applied to the tools available for investors to support the development of sustainable finance. Different categories of low-carbon indices with various degrees of ambition have emerged in the marketplace. Despite the differences in objective and strategy, all of these benchmarks are commonly promoted under the uniform denomination of low-carbon benchmarks. Those divergent approaches to benchmark construction would result in fragmentation of the market since users of benchmarks would not have clarity on whether a particular low-carbon index would be considered merely as a decarbonised version of a standard market capitalisation benchmark or as a benchmark aligned to the 2°C global temperature target of the Paris Agreement (see Box 3). Without EU action, low-carbon benchmarks will still not be objective nor appropriate for investors who would like to pursue a low-carbon strategy that aligns with the goal of limiting global warming to below 2°C. Thus, they will not sufficiently contribute to the urgent shift towards a highly energy-efficient, low-carbon economy. In addition, due to the lack of transparency and existing discrepancies between the methodologies of low-carbon benchmarks, investors will have no objective tool nor sufficient information to assess if the investment strategy of a fund/portfolio is consistent with the benchmark used. In turn, the trends described above would not sufficiently curtail the documented behavioural biases in the investment and advisory process: distortions in the investment decision process and savings allocation (FCA 2016) might be somewhat smoothed out, but they will persist. It should be noted that certain pieces of recent EU legislation that integrate ESG dimensions could alleviate some of the behavioural biases. Putting things into a larger perspective, insufficient ESG integration and lack of clarity as to what constitutes a sustainable economic activity is also a hurdle for directing capital flows towards sustainable investments: too high search costs, and a lack of awareness regarding ESG will result in an untapped pool of money that is not directed towards sustainable investment. Improvements in this area are likely to result in additional flows to such investments through: (i) the attraction of new sustainable investments; and by means of (ii) the rebalancing of existing portfolios towards sustainable investments. Although the exact impact is difficult to quantify, even small changes will be economically significant. Given the important role of the asset management industry in financing the economy, the industry will also play an important function in contributing to the EU sustainable objectives. Based on EFAMA estimates, the asset management industry in Europe had EUR 22.8 trillion of total assets under management in 2016 and attracted EUR 300 billion in new investments (EFAMA 2017). Hence a 0.5% shift towards sustainable investments due to the rebalancing of existing portfolios and the attraction of new flows would increase the amount of sustainable assets by EUR 115.5 billion. Similarly, the insurance sector in Europe in 2016 had approximately EUR 10 trillion of total assets invested. A shift of only 0.5% in the allocation of its investments towards sustainable investments, either through rebalancing or through directing new premiums towards these investments would increase these investments by EUR 50 billion. III. Why should the EU act? 3.1. Legal bases Article 114 of the Treaty on the Functioning of the European Union (TFEU) confers the European Parliament and the Council the competence to adopt measures for the approximation of the provisions laid down by law, regulation or administrative action in Member States which have as their object the establishment and functioning of the internal market. Article 114 TFEU allows the EU to take measures not only to eliminate current obstacles to the exercise of the fundamental freedoms, but also to prevent the emergence of such obstacles, including those that make it difficult for economic operators, including investors, to take full advantage of the benefits of the internal market. Thus, Article 114 of the TFEU gives the EU the right to act since, in line with the problem definition outlined in section 2, the options that will be assessed by this impact assessment will aim at (i) ensuring a more uniform approach in the way relevant entities consider ESG factors in the investment and advisory process, and (ii) reducing the search costs of end-investors regarding what are sustainable economic activities and the extent to which ESG factors are integrated in investment decisions. More specifically, the lack of clarity and coherence in EU legislation regarding the consideration of ESG factors in the investment and advisory process as part of the duties towards investors/beneficiaries (driver 1) results in a heterogeneous implementation of these duties across the EU. At EU level, the duties towards investors and the obligations in the advisory process are set out in the AIFMD Directive 2011/61/EU, the UCITS Directive 2009/65/EC, the MiFID II Directive 2014/65/EU, the Solvency II Directive 2009/138/EC, and the Directive on Insurance Distribution 2016/97/EU. The legal bases for the EU to act are provided and delineated by these directives, which require delegated acts to be adopted in specified areas to ensure that the obligations set out in the directives are implemented in a consistent way across the EU. As the IORPs II Directive 2016/2341, based on Articles 53, 62 and 114(1) TFEU, currently does not require adoption of delegated acts in these specified areas, it will have to be amended. This impact assessment, when analysing concrete options to provide more uniform conditions on the integration of ESG factors in the investment and advisory process, considers the extent to which harmonisation is necessary, always with the principles of subsidiarity and proportionality in mind and with the objective of ensuring cross-sectoral consistency. The lack of ESG disclosure requirements on institutional investors, asset managers and investment advisors on the integration of ESG factors (driver 2) and the lack of disclosures on exposures to sustainability objectives as well as the lack of coherence in the prevailing national legal obligations in these regards result in insufficient and inconsistent information – and therefore not comparable – information for end-investors. This is detrimental to the functioning of the single market. Several EU financial services Directives would therefore require amendments. In consequence, the legal bases for the EU to act are: (i) Article 53(1) TFEU for amendments to the UCITS Directive 2009/65/EC, the AIFMD Directive 2011/61/EU and the MiFID II Directive 2014/65/EU; (ii) Articles 53(1) and 62 TFEU for amendments to the Solvency II Directive 2009/138/EC; (iii) Articles 53, 62 and 114(1) TFEU for amendments to the IORP II Directive 2016/2341; and (iv) Article 114 TFEU for amendments to Regulations 345/2013 on European venture capital funds and 346/2013 on European social entrepreneurship funds. The lack of clarity on what constitutes a sustainable economic activity (driver 3) is explained by current divergences at national level in the classification systems and criteria used to define sustainable economic activities. This fragmentation hampers the proper functioning of the internal market in the context of sustainable investments. Article 3(3) of the TFEU says: “The Union shall establish an internal market. It shall work for the sustainable development of Europe […] and a high level of protection and improvement of the quality of the environment.” Article 114 of the TFEU gives the EU the legal basis to address this fragmentation, adding that proposals that concern environmental protection and consumer protection have to take as a base a high level of protection. Taxonomies put forward by private initiatives do not offer a suitable and uniform basis for measures aimed at incentivising sustainable investment. This is visible in the French example, with the TEEC label employing a taxonomy that diverges from existing market-led classifications. Different categories of low-carbon indices with various degrees of ambition have emerged in the marketplace. While some benchmarks are content with lowering the carbon footprint of a standard investment portfolio (the 'decarbonised benchmarks'), others aim to select only components that make a contribution to the attainment of the 2° objective set out in the Paris Agreement (the 'positive carbon impact benchmarks'). Despite the differences in objective and strategy, all these benchmarks are commonly promoted under the uniform denomination of low-carbon benchmarks. The lack of minimum standards for low-carbon benchmarks and the use of a uniform denomination of low-carbon benchmarks result in inappropriate tools for institutional investors and asset managers to reflect their low-carbon investment strategies. In order to ensure the proper functioning of the internal market and ensure a high level of consumer and investor protection, it is appropriate to lay down a regulatory framework for low-carbon benchmarks at Union level. Article 114 of the TFEU gives the EU the legal basis to address the fragmentation of the methodologies of low-carbon benchmarks by modifying the Benchmark Regulation. In addition, the lack of publicly available information on the extent to which the methodology of those benchmarks administrators takes into account ESG objectives prevents end-investors from assessing the consistency in terms of sustainability between the benchmark and the portfolio. In consequence, the legal basis for the EU to act is Article 53(1) TFEU for amendments to the UCITS Directive 2009/65/EC and the MiFID II Directive 2014/65/EU. 3.2. Subsidiarity: Necessity of EU action The problems and their drivers, as identified in section 2, could possibly be addressed through individual action by Member States. Nevertheless, individual action by Member States is likely to only partially address the identified issues (notably because some Member States may legislate, while others would not) and create additional fragmentation due to diverging regulatory approaches. Asset managers, insurance companies, pension funds, portfolio managers and investment advisers are largely working across borders in the EU. Therefore legislation applying to those market players is largely harmonised at EU level. Action at EU level as regards investors' duties and transparency towards end-investors is thus warranted in order to ensure coherence and to further improve the functioning of the single market. More specifically, while EU legislation already defines 'fiduciary obligations' of asset managers, institutional investors and investment advisors and disclosure requirements at EU level, the interpretation of these requirements as regards sustainability factors leaves large flexibility in terms of implementation. Specification of these requirements is warranted to avoid fragmentation, inconsistency and unpredictability in the functioning of the internal market. It would also help prevent an uneven playing field and multiplying compliance costs for an industry, which is largely working across borders. Responses to the public consultation on investors' duties largely support an intervention at EU level. The exact interpretation of 'duty' or 'duties' differs among EU jurisdictions for various reasons, including different legal traditions, cultural understanding and approaches taken in this area. Therefore, several stakeholders called for legislation at EU level, which embeds this duty in law and provides clarity to relevant entities. They recommended that the EU introduces legislation which requires integration and disclosure of sustainability factors in the investment and advisory process.

The existing lack of clarity on what constitutes a sustainable economic activity could be exacerbated by parallel and uncoordinated attempts by Member States in that field. Given the commitments to environmental and climate policy goals, both at international (e.g. Paris Agreement) and at Union level, it is very likely that in the future more Member States will explore the option of setting up labels for sustainable financial products, for which they would use self-tailored, divergent taxonomies. This means that in the future, the cross-border barriers to the functioning of capital markets for the purpose of raising funds for sustainable projects will grow further: The multiplication of classification systems would increase market fragmentation and raise competition issues, making it more difficult and costly for investors to understand what is considered a sustainable investment. The criteria or classification of what constitutes a sustainable activity for the purposes of investment should therefore be harmonised at Union level. This would make it easier for economic operators to attract capital across the Union for sustainable investments. It would also constitute a first step towards addressing greenwashing and help investors identify more easily which criteria were used to deem a financial product 'green' or sustainable. The vast majority of stakeholders consulted on the introduction of an EU classification system for the purposes of identifying sustainable economic activities saw the need for regulatory intervention at EU level as opposed to letting national or market-led initiatives shape these classification systems. These respondents also considered that a sustainable classification system at EU level would be helpful to fulfil their investors' duties and take into account ESG factors in their investment decision process. A common classification system is thus needed not only to empower the EU to accurately measure and track progress towards the achievement of its policy objectives, but also to allow market participants to reap the benefits offered by a single market for sustainable investment, and increase capital flows towards sustainable investments, when addressing barriers to cross-border investment in sustainable economic activities. In a similar manner, the lack of minimum standards and requirements regarding methodologies for designing sustainable (and in particular low-carbon) benchmarks results in confusion among benchmark users and end-investors, preventing them from fully benefiting from the single market. In order to address potential instances of greenwashing, Member States are likely to adopt different rules that would help avoid ambiguity regarding the aims and targeted impact underpinning different categories of low-carbon indices. In the absence of a framework providing minimum standards that ensure the accuracy and integrity of the main categories of low-carbon benchmarks, it is likely that differences in Member States' approaches would create obstacles to the smooth functioning of the internal market (for the provision of low-carbon indices that serve as low-carbon performance benchmarks). The majority of respondents to a targeted consultation on benchmarks thought that some harmonisation of the methodology for correctly assessing carbon emissions is needed at European level as it would support the development of reliable low-carbon indices to assess/track the performance of European low-carbon financial products. Half of them also believe that a harmonised EU approach would increase the use of low-carbon indices and, as a result, the supply of low-carbon investment strategies. 3.3. Subsidiarity: Added value of EU action Several Member States already require in their legislation on duties towards investors/beneficiaries that ESG factors are integrated/considered (see section 2.3). However, most Member States have still not taken action. Legislation at EU level would therefore create a level playing field and help prevent divergence between Member States. As regards a classification system to define what constitutes sustainable economic activities, it will be more effective for the EU to adapt its legislative framework at an earlier stage, before other Member States start to develop national legislation in this area. It would also limit greenwashing risks, assist consumers in identifying sustainable economic activities for the purposes of investment, and facilitate cross-border sustainable investments. The variety of potential uses of a sustainability classification system developed at EU level further demonstrates the added value of EU level intervention (see also Box 5 in section 5.6.1.). Due to the fact that many asset managers, insurance companies, pension funds, portfolio managers and investment advisors already work at an EU if not global level, action at EU level will provide economies of scale, compared to a scenario where investors would face: (i) different interpretations of duties towards investors/beneficiaries, and disclosure obligations as regards ESG throughout the Member States, (ii) different classification systems, and (iii) inconsistent methodologies for building low-carbon benchmarks. IV. Objectives: What is to be achieved? 4.1. General objectives The general objectives of the initiatives supported by this impact assessment correspond to the three overarching goals of the Commission Action Plan on Financing Sustainable Growth. In particular, these initiatives aim to directly contribute to the Action Plan's goals of (i) managing financial risks stemming from climate change, resource depletion, environmental degradation and social issues; and (ii) fostering transparency. They are to do so by addressing the two main problems identified in section 2: (a) high search costs for end-investors to identify what are sustainable economic activities and to which extent ESG factors are integrated in investment decisions, and (b) the lack of incentives for relevant entities to consider ESG factors in the investment and advisory process. Increased transparency and reduced search costs will create a more favourable investment environment, where investors can make sustainable investment decisions more easily. As a result, once additional building blocks will be put in place, the proposed initiatives will also help reorient capital flows towards achieving sustainable growth. The magnitude of the reoriented capital flows will depend on the actual demand for sustainable products among investors operating in this more favourable environment, and on the implementation of the various initiatives supported by this impact assessment. Therefore, the impact on investment flows will be assessed at a later stage, as explained in Section 5 below. 4.2. Specific objectives These general objectives translate into three specific objectives, which address the problem drivers described above, as reflected in the table below: 1.ensure clarity and a coherent approach across sectors and Member States as regards the integration of ESG factors by the relevant entities in their investment/advisory process; 2.increase transparency towards end-investors by improving ESG-related disclosure requirements; 3.provide clarity at EU level on what are sustainable economic activities. Table 2: Objectives and underlying problem drivers Problems Objectives Lack of incentives for relevant entities to consider ESG factors and high search costs for end-investors leading to: 1. Non-financial material risks not being mainstreamed into investment decisions; 2. Transparency in financial activity on sustainability remaining limited; and 3. Capital flows towards sustainable investments remaining limited, leaving the investment gap to achieve EU sustainability objectives not to be closed. General Objectives: 1. Mainstreaming financial risks stemming from sustainability issues; 2. Fostering transparency in financial and economic activity on sustainability. 3. Reorienting capital flows towards sustainable investments. Problem driver 1: Lack of clarity and coherence regarding the consideration of ESG factors in the investment and advisory process. Specific objective 1: Ensure clarity and a coherent approach across sectors and Member States as regards the integration of ESG factors by relevant entities in their investment/advisory process. Problem driver 2: Lack of ESG disclosure requirements for institutional investors, asset managers and investment advisors. Specific objective 2: Increase transparency towards end-investors by improving ESG-related disclosure requirements. Problem driver 3: Lack of clarity on what are sustainable economic activities. Specific objective 3: Provide clarity at EU level on what are sustainable economic activities.

V. What are the available policy options, what is their impact and how do they compare? 5.1. What is the baseline from which options are assessed? As explained in Section 1, in its Action Plan on Financing Sustainable Growth, the Commission has put forward ten actions, some of which are supported by this impact assessment. As indicated in the Action Plan, the preferred approach to develop those actions will draw on the outcome of the present assessment. Hence, the baseline scenario takes as a starting point the possibility of not acting at EU level. The potential initiatives described in the Action Plan are part of a comprehensive EU package of measures to carry out the EU's climate and sustainable development agenda, in line with the UN 2030 Sustainable Development Goals and the Paris Climate Agreement. Other measures — such as EU energy and climate policy under the Energy Union Strategy or the environmental policy acquis — do not explicitly focus on the financing aspect. Finance as a catalyst for progress towards a greener economy is currently under-exploited, and limited progress is normally expected within this area in the short-term, even though access to finance is widely considered a key pre-requisite to ensure compliance with environmental and climate objectives. This situation was also acknowledged by the explicit call for targeted action from the High-Level Expert Group. Under the baseline scenario, no policy action would be taken to encourage the consideration of ESG factors by institutional investors, asset managers and investment advisors in their investment decision-making process and investment advice. Additionally, disclosure on how these actors consider those factors would continue to depend on existing rules and voluntary disclosure. Furthermore, classification of what are sustainable economic activities would remain predominantly market driven and not harmonised across the EU. Relevant market entities could make use of the following ESG information disclosed by issuers. This additional information would —at least with regard to large issuers— facilitate the integration by asset managers and institutional investors of ESG factors into their investment decision-making process and the disclosure of this information. As explained in Box 2, the number of financial market participants considering environmental factors is estimated to have increased by 8% over the period 2015-2018 – which corresponds to a compound annual growth rate of 3.9%. Given the rate of progress and divergences observed within the market, the baseline scenario would imply that the current problem drivers as discussed in section 2.2 would not be addressed. We refer to section 2.3 for a discussion of the consequences of the problems and how they would evolve. In summary: 1.EU rules would remain insufficiently clear and not fully aligned across sectors on how the relevant entities need to consider ESG factors as part of their duties toward investors/beneficiaries. 2.Disclosure on how institutional investors, asset managers and investment advisors consider ESG factors in their investment decisions and recommendations would continue to be insufficient. 3.The lack of clarity on what are sustainable economic activities in the EU would persist. As regards point 1, institutional investors, asset managers and investment advisors will still lack regulatory incentives to integrate ESG factors in their investment decision/advisory process (governance arrangements, risk management, investment strategy, asset allocation, suitability assessment and product selection process). This notably means that there will not be regulatory incentives to assess the risks related to ESG factors and, where relevant, take them into account in the investment decision/advisory process, with potentially economic, legal and reputational consequences. In addition, investment advisors and insurance distributors will also lack regulatory incentives to discuss and take into account their clients' preferences as regards ESG, with the result that end-investors' preferences in this field will continue not to be systematically discussed. Fragmentation in market practices on ESG integration in investment/advisory processes will thus persist. Overall, this will lead to distortions in investment decisions and reduced opportunities for ESG investments. In addition, investors who would like to invest with impact through the selection of assets that contribute to the 2°C trajectory objective, will still not have the appropriate tools (benchmarks) to assess the performance of their low-carbon funds/portfolio. The lack of minimum standards for the methodologies to develop low-carbon indices would continue to affect their comparability and relevance. In addition, it will not incentivise companies to align their corporate strategies with climate goals. With regard to point 2, relevant entities will still lack regulatory incentives to disclose to their clients in a transparent way how they integrate ESG factors in their investment decision/advisory process, making it more difficult and costly for end-investors to make informed decisions. Even though the reputational benefits of external communication on ESG integration may create incentives for more voluntary disclosures, such disclosures will not be systematic, coherent nor harmonised. Transparency on ESG factor integration will thus remain limited. A related issue that is likely to persist is greenwashing of products/services that pursue ESG objectives. Eurosif (2016) for example, finds that roughly half of surveyed assets under management are said to subject to an ESG investment strategy. However, the strategy used to make these products/services environmental-friendly is mostly based on exclusionary screening policies, which are easy to implement, but may not always contribute to sustainability in the way that is advertised. There is a risk that investors and beneficiaries will continue to perceive a certain level of sustainability and environmental impact in their investment, whilst that often may not be the case. Finally, as regards point 3, most Member States would likely remain without any classification in place or adopt a selected international classification by tailoring it to national policy priorities. As a result, divergence of definitions as to what constitutes a sustainable economic activity, for the purposes of investment, is likely to further increase. Market-led or market-driven classifications of sustainable economic activities and those provided by international bodies (that serve as baselines for Member States) would likely expand their scope, but progress would likely remain limited to subsets of environmental factors. Given the slow pace of development that has been observed over the last decade, it is likely that no substantial improvement in the coherence of different classifications would be achieved within the medium to long term. In the absence of a common framework to understand what constitutes a sustainable economic activity, for the purposes of investment, the greenwashing issue would become even more sensitive. Due to an increasing variety of labels and standards available on the market, it would be difficult as well as costly for investors and beneficiaries to know whether the products they invest in meet their expectations. This would hamper not only demand for sustainable investments, but also trust in financial institutions. 5.2. Methodology To identify the policy options for each of the three problem drivers identified in section 2 (and the corresponding specific objectives in section 4), three options were considered: (i) a non-legislative approach, (ii) a "light" regulatory approach, and (iii) a more comprehensive regulatory approach. For each of the problem drivers, the most realistic policy options were assessed. An overview is provided in the table below.

Table 3: Methodology table Non-legislative approach Light regulatory approach Comprehensive regulatory approach Problem driver 1: Lack of clarity and coherence regarding the consideration of ESG factors in the investment and advisory process. ✓ ✓ X Problem driver 2: Lack of ESG disclosure requirements for institutional investors, asset managers and investment advisors. X ✓ ✓ Problem driver 3: Lack of clarity on what are sustainable economic activities. X ✓ ✓ X = discarded; ✓= assessed. 5.3. What is the scope of the various initiatives? Before describing in detail the possible different options for each of the four initiatives considered in this impact assessment, and without pre-empting the choice of a preferred option, it is worth underlining that the four initiatives being assessed - because they are addressing different problem drivers - will not apply to the same universes of investments, and thus will have different scopes in terms of financial entities, financial products/services and economic sectors impacted. (Section 6.1. describes in more detail the exact scope of the preferred option for each of the four initiatives in terms of financial entities, financial products and economic sectors impacted). The initiatives related to Drivers 1 and 2 (namely the requirement to integrate ESG factors in the investment decision and advisory process and to disclose this information) would be expected to have an impact on all types of investment, whether sustainable or not. Therefore, these initiatives would have an impact on all financial products offered and services provided to end-investors by the relevant financial entities. They would make consideration of ESG integration mainstream in all investment decisions and advisory processes of these entities - without however 'forcing' investment into sustainable economic activities. As a result, all economic sectors could be impacted. Note that ESG integration as commonly interpreted by market participants in the context of duties towards investors/beneficiaries, refers to the environmental/social/governance risks that could affect the financial returns of the product/services offered/provided by the relevant entities. The initiative's proposal to address Driver 3 (to provide clarity on what constitutes a sustainable economic activity by setting out a framework for developing an EU taxonomy) could, by definition, have a direct impact on investments and financial products deemed sustainable. The universe of investments, financial products and thus financial entities affected by this specific initiative would therefore be much more limited than those affected through the initiatives addressing problem drivers 1 and 2. Only economic activities considered or marketed as 'sustainable' would be impacted by this initiative. Thus, it would not correspond to the broad set of ESG factors that could affect an investment’s financial performance as is the case under the initiative aiming at clarifying the duties towards investors. The initiative aimed at setting minimum standards for the methodologies used to develop low carbon indices would have an indirect impact on those investments and financial products deemed to be and identifying themselves as ones that contribute to the lowering of carbon emissions (including the financial entities that offer them). The universe of investments, financial products and thus financial entities affected by this specific initiative would therefore be even more limited. 5.4. Duties toward investors/beneficiaries with regards to ESG factors 5.4.1. Description of the policy options Option 1: do nothing. See baseline scenario in section 5.1. Option 2: clarification of existing EU rules on duties towards investors/beneficiaries (non-legislative approach) This option would provide clarification that the existing duties of relevant entities towards investors/beneficiaries do not prevent, but even support the integration of material ESG factors in the investment decision-making process and in the advisory process, even though this is not explicitly mentioned in most existing EU rules. More specifically, it would clarify, via a Commission communication or recommendation, how existing EU rules are to be interpreted vis-à-vis the integration of ESG factors in the investment process and advisory process as part of the duties towards investors/beneficiaries. Under this option, relevant entities would be encouraged to follow (on a voluntary basis) the interpretation or recommendation of the Commission. This option would also provide further encouragement to Member States and industry bodies to align their rules and principles/practices with the interpretation provided by the Commission. The use of non-binding tools and self-regulation grants relevant entities a high level of flexibility with regard to the integration of ESG factors in existing processes/procedures in the areas of risk management, investment strategy, asset allocation, governance and suitability assessment. This option could build on or refer to existing work by international bodies (e.g. OECD) and current (best) market practices. As compliance with the communication or recommendation would be voluntary, public authorities would have no power to enforce them. Option 3: explicitly require the integration of ESG factors in the investment process and the advisors' recommendation process as part of duties towards investors/beneficiaries (light regulatory approach) The current applicable rules do not explicitly refer to ESG factors and this leads to different interpretation of duties towards investors/beneficiaries with respect to ESG factors integration and creates legal uncertainty on whether and how these should be considered.

ESG integration is increasingly performed but it is not a widespread practice as it is hampered by the existing legal uncertainty. Some entities, in fact, do not analyse these factors, either because they do not have the tools and the ESG-related knowledge to do it or because they confuse ESG integration with ethical investing, which implies accepting lower risk-adjusted returns, which would not be in the best interest of their clients/beneficiaries. This option would clarify that relevant entities, in order to act in the best interest of clients and coherently with the mandate, need to consider also ESG factors within the processes and procedures they have already in place to assess all relevant financial risks. This option would specify that relevant entities are required to consider ESG risks as drivers of value in their investment process or investment advice as part of their duties towards investors/beneficiaries. More specifically, it would detail how and where material ESG risks are to be integrated within the procedures in the areas of investment strategy, risk management, asset allocation and governance, as they do for financial risks. This option would not prescribe how and where relevant entities need to invest, while performing their duties to investors/beneficiaries. If, as a result of their assessment, they find out that ESG factors have no material impact on the financial performance, they will not take them into account in their investment decisions/advisory recommendations. However, where asset managers and institutional investors pursue a low carbon emission objective, they will be required to designate an appropriate benchmark, such as the EU low carbon or the positive carbon impact index as a reference benchmark. For investment advisors, individual portfolio managers and insurance distributors, this option would also detail how and where ESG preferences are to be integrated within the suitability assessment and the product selection. The sectoral EU frameworks (i.e. the AIFMD Directive 2011/61/EU, the UCITS Directive 2009/65/EC, the MiFID II Directive 2014/65/EU, the Solvency II Directive 2009/138/EC, Directive IDD 2016/97/EU) with the only exception of the IORPs II Directive 2016/2341, already foresee empowerments to specify the details of the relevant entities' duties in the area of governance, asset allocation, investment strategy, risk management, the suitability assessment and the product selection. Under this option, the current duties laid down by the above mentioned sectoral EU frameworks would be further specified through level 2 measures either (i) making use of the existing empowerments or (ii) introducing new empowerments (under Directive 2016/2341) having regard to the following areas: ·Corporate governance: the integration of specific ESG considerations within governance arrangements and policies of relevant entities (e.g.: board responsibility, including a ESG specific committee and/or board member(s) in charge of approving ESG risk limits and overseeing their implementation; internal control functions responsible also for checking the effectiveness and adequacy of procedures, measures and policies specifically considering ESG factors integration; skill, expertise and knowledge on ESG factors, remuneration; ESG financial expertise). ·Investment strategy: the integration of specific ESG considerations in the product investment strategy. ·Risk management: the identification, measurement, management and monitoring of the risks stemming from ESG factors within the overall risk management process. The risk assessment should not only be limited to financial risks. The quality and depth of the assessment of ESG factors depends on the investment policy (it varies according to asset classes: currency, for example, would be more difficult to assess than equity), the investment strategy (volatility-based strategies are more difficult to assess then equity long-short), and the available information. ·Asset allocation: the integration of material ESG risks into the asset allocation and ongoing monitoring of the portfolio. ·Suitability assessment: the integration of ESG factors into the suitability assessment process with the client. Firms providing investment advice would introduce ESG–related questions as part of client preferences, objectives and risk appetite. Based on the client’s profile, they would offer or recommend products (for example, collective investment funds, insurance-based investment products) and/or services that reflect ESG considerations. ·Product selection process: investment advisors should take into account ESG factors when assessing the range of financial instruments to be recommended to a client - in line with client's investment objectives - in order to ensure that ESG risks are adequately taken into account in the assessment of the target market. Asset owners and investment intermediaries should ensure that they have a sound understanding of the broad range of long-term interests and preferences of their clients and/or beneficiaries. This understanding should lead to an investment policy that is compliant with prudent person and incorporates the possible preferences stated by beneficiaries on ESG. This option would either amend current Level 2 measures on general organisational and operating conditions or, where such measures do not yet exist as is the case under IORP II, introduce them in a consistent way. The Delegated Acts will be based on advice by the ESAs. As regards the suitability assessment, ESMA guidelines would be modified pursuant to Level 2 amendments. All these amendments would require public consultations of market participants. Table 4: Discarded option for duties towards investors/beneficiaries Discarded option Reasons for discarding it Option 4: Harmonisation of models/methodologies on the integration of ESG factors in the investment decisions/advisory recommendations (e.g. the way to measure ESG risks within the overall risk assessment would be harmonised for all relevant entities, irrespective of their size and sector). ·The harmonization of models/methodologies to measure ESG risks is perceived as premature as there is no consensus in the industry, among practitioners and in academia, on how to best integrate ESG factors. In addition, the issue of the quality, consistency and depth of existing data on issuers is challenging. ·Given the heterogeneous approaches developed internally by relevant entities, this option would imply high compliance costs (at least for small entities), as they would have to adapt their existing processes to a single approach that does not necessarily fit with their characteristics. They would have to adapt their processes also under the preferred option 3, but they would retain the freedom to do so in a way that is compatible and proportionate to their organisation, business model, and cost function. ·This option is not supported by industry stakeholders (EC2017b), as it would curb the discretionary power of the relevant entities in adapting models/methodologies to their needs. 5.4.2. Pros and cons Table 5: Pros and Cons of options on duties towards investors/beneficiaries Pros Cons Option 2 ·It provides clarity on the fact that existing duties of relevant entities towards investors/beneficiaries do not prevent but even support assessing ESG factors and taking them into account in the investment/advisory process, whenever they are deemed to be a source of risks impacting on the financial performance. ·It allows for the flexible integration of ESG factors. ·The recommendations provided by the Commission would provide encouragement for relevant entities and Member States to align with the existing best practices, but no specific guidance would be provided on how and where these factors should be considered in the investment/advisory process. Hence, diverging market practices on the integration of ESG factors would persist, given the uncertainty on the approach that Member States and/or relevant entities would adopt to implement the Commission recommendation (lack of coherence). ·Relevant entities are likely to continue their current practices, lacking incentives to assess and take ESG factors into account in their investment process. ·Similarly, entities providing financial advice and portfolio man