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Regulation is being used to spur sustainable finance

Many see sustainable finance as the growth opportunity of the century. Led by the EU, governments are using financial regulations to encourage sustainability in businesses. What are the implications for intermediaries?




Impact on Swiss financial services providers

The regulatory agenda around sustainable finance has gained momentum around the world in recent years, as many states and regions have made regulation a key driver for shaping sustainable economic systems. 

They have recognised that the financial sector has great potential as a catalyst for reallocating capital to sustainable economic activities. At stake are the ambitious goals of the Paris Climate Agreement and the implementation of the United Nations’ Agenda 2030 (Sustainable Development Goals).

By incentivising the integration of environmental, social and governance (ESG) criteria into business and investment decisions, regulation can help to direct financial flows towards sustainable economic activities and, thus, contribute to addressing social and environmental challenges.

EU regulation leads the way

The European Union is pioneering sustainable finance regulation, with the European Commission’s Action Plan on Sustainable Finance providing decisive impetus. The Action Plan sets out a comprehensive strategy to connect sustainability and finance, inter alia based on four regulatory aspects: 

(i) Taxonomy
Establish the conditions and the framework to create a single classification of what is a sustainable economic activity. 
(ii) Disclosure
Foster transparency and strengthen sustainability disclosure by introducing comprehensive harmonized disclosure rules.
(iii) Benchmarks
Introduce a new category of benchmarks on (low and positive) carbon impact. 
(iv) Sustainability preferences
Amend existing regulations (including MiFID II) by implementing ESG factors e.g. in the suitability process. 

The Action Plan will be implemented in stages over the coming years. Key aspects that have already been adopted include the disclosure regulation requiring financial service providers, among others, to provide transparency into the ESG factors they consider when servicing clients.   

Even without extra-territorial effects, the EU sustainable finance regulation will impact Swiss and other non-EU financial service providers. On the one hand, firms distributing financial instruments into the EU must comply with the regulation. Non-EU financial service providers with a relevant or significant share of clients domiciled in the EU will, as part of a risk assessment, have to evaluate to what extent the regulation should be implemented autonomously, as is already the case with MiFID II. On the other hand, increasing client demand for sustainable investments, especially from the ESG-enthusiastic so-called ‘next generation’, will further accelerate the implementation.

Switzerland’s approach

Positioning the country as a leading sustainable finance market is part of Switzerland’s strategy for promoting competitiveness. However, no laws or regulations have been passed yet. The Swiss government typically prefers to be a mediator and facilitator, supporting the creation of an optimal regulatory framework. While the Federal Council has adopted a report and high-level guidelines on sustainability in the financial sector, it leaves the implementation of concrete measures to the financial industry. The Council will only assess a few aspects – including transparency, reporting and pricing of risks.
Against this background, key financial industry associations have published their own guidelines and recommendations on sustainable finance, including SFAMA (the Swiss asset management association), SSF (Swiss Sustainable Finance), SIA (Swiss Society of Engineers and Architects) and SwissBanking. SwissBanking’s guideline, for example, introduced six principles for the integration of ESG considerations into financial services processes:

  1. Assess and document client expectations with respect to ESG investing;
  2. Provide an adequate overview on ESG considerations through relationship managers;
  3. Outline the spectrum of ESG investment solutions as part of the advisory process;
  4. Match characteristics of ESG investment solutions with client expectations as part of the suitability testing process;
  5. Build ESG investment solutions aligned with client expectations;
  6. Ensure diligent and transparent provision of services.

Although the guideline is not legally binding, the principles serve as best practice rules. The courts, FINMA and auditors will use them for interpretative guidance when assessing a financial service provider’s diligence or policies and processes. FINMA’s increasing efforts in the area of sustainability emphasize this point; in particular, FINMA’s curiosity to understand ESG processes and compliance of supervised entities. Consequently, it is very likely that ESG considerations will soon constitute part of the suitability obligations under FinSA – similar to the EU’s efforts under MiFID II.

Against this background, it is important for financial service providers to address the challenges associated with sustainable finance at an early stage. Notably, they should ensure that relationship managers are adequately trained and that there is an efficient process for matching clients’ ESG preferences with the ESG characteristics of financial instruments and financial services.