Green finance: Regulation of financial market participants


In November 2019, the European Commission published Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector.

All financial market participants are subject to this regulation. Nevertheless, UCITS and AIFs that do not wish to comply and continue offering investments not eligible for green taxonomy, are required to clearly state this in their documentation (website, annual financial reports, prospectuses and other commercial documents). If “brown” sectors making the transition to green such as steel, cement, nuclear power and gas, and “red” sectors such as coal and diesel are included in their investment strategy, they need to be clearly mentioned.

Companies that make the choice to manufacture and distribute green products shall also explain their sustainable investment strategy and justify the sustainable risk. It is not enough to mention the sectors eligible for green finance, such as wind power for example. They also need to take counterparty risk into account and classify financial assets by economic sector and investment type. Accordingly, environmental, social and governance (ESG) criteria must be justified.

Data required for ESG classification

The “sustainability” of an investment product calls for a focused effort on all three criteria, each observed equally. Observation of the environmental criterion, which is the easiest to measure, shall not prevail over observation of social or governance criteria.

In order to classify an investment product as “sustainable”, a large quantity of data must be collected. We are currently seeing a mad dash for data, in an attempt to obtain the information needed to classify a product as “ESG”.

Data providers relying on the most currently recognised indices, such as the MSCI, are working non-stop to cover the criteria required by the green taxonomy in their data bases. Unfortunately, compiling data is one thing, but knowing how to use it is something else entirely.

From the data made available, it is necessary to draw the information required by Articles 3 to 11 of Regulation (EU) 2019/2088 (amended by Regulation (EU) 2020/852 of 18 June 2020), which addresses the establishment of a transparent framework to facilitate sustainable investment.

Are market participants ready?

Some participants already active in the Socially Responsible Investment (SRI) sectorand offering their clients environmentally-friendly products are ahead of the game. Their products are “SRI”-certified, but is that enough?

The financial market does not have reliable data that can be used to confirm that an asset or product complies with all three ESG criteria. Of the three, the environmental criterion is often the easiest to observe and check. It is more complicated for the other two criteria.

The social criterion is difficult to assess insofar as most indices do not guarantee that a given company ensures diversity or gender equality, for example. Nor do they guarantee that a company does not rely on child labour.

More often than not, the only way to perform a control is to go on-site and audit companies to make sure they meet the social criterion. That is a costly challenge, especially in emerging countries where data or transparency tend to be lacking.

Firms responsible for verifying the financial products offered to their clients will be required to invest in technologies and/or human resources to ensure that the ESG criteria are met. The road to obtaining the necessary proof promises to be long and expensive.

What solutions are available to establish this information?

An International Platform on Sustainable Finance (IPSF) was founded in October 2019. Its members are government authorities of Argentina, Canada, Chile, China, India, Indonesia, Kenya, Morocco, New Zealand, Norway, Senegal, Singapore, Switzerland and the European Union (EU), representing nearly half of the world’s greenhouse gas emissions.

Its first report, published in October 2020, indicated that more and more jurisdictions are developing sustainable development standards and labels. The IPSF plans to supervise the creation of such standards and form a working group to monitor them.

Distribution of environmental data is improving: most of the platform’s member countries have already established a framework ensuring at least a minimum level of transparency. However, there is still a clear lack of consistency in terms of quality and comparability of information provided to investors. The IPSF will thus be launching a working group to harmonise these standards.

The report also covers developments in the sustainable finance field. It stresses that the IPSF’s purpose is not to recommend tools for sustainable finance, but merely to highlight the difference between the tools and initiatives launched by the member states. The IPSF hopes that this will promote the convergence of standards proposed by national authorities. The three main tools considered are taxonomy, standards and labels, and transparency.

Challenges facing the Commission and its green regulation

The regulation established by the European Commission is aimed at encouraging sustainable finance. Another objective is to help international investors identify investments that actually meet the environmental goals of saving the planet.

Even though taxonomy, via Regulation (EU) 2020/852, creates a classification system to help investors more easily recognise “sustainable” products, there is still no universal definition of green investments.

To comply with Regulation (EU) 2019/2088, asset managers and companies that manufacture/sell financial products also have to be able to meet investor needs clearly, which is why a universal definition is needed.

What about Luxembourg?

In the EU, Luxembourg is still the leader in terms of domiciliation, distribution and services offered to investment funds1. This growing sector will continue to grow with the determination to expand responsible and sustainable investment. The longstanding tradition of asset management means that Luxembourg captures a substantial portion of European capital invested in mutual funds (nearly 40% of net assets in UCITS and over 25% of net assets in mutual funds (UCITS +AIFs)) in the European Union. This in addition to the more than 300 products currently certified by the LuxFLAG association and approximately 225 mutual funds2 that have obtained ESG certification have cemented Luxembourg’s status as a European platform for green and sustainable finance.

To advance even further, the country must be able to legitimately impose its certification labels through LuxFLAG. In doing so, they will guarantee the quality of mutual funds meeting the necessary specifications, as well as other financial products such as green bonds. LuxFLAG labels could be legitimised even faster if, like other European labels, they obtain a European certification guaranteeing that their analysis criteria comply with European regulations. Luxembourg has already succeeded in exporting LuxFLAG labels to ten EU countries, which attests to its credibility and represents opportunities for the Luxembourg financial industry as a whole.

What’s next

The green taxonomy may only be just beginning, yet it already boasts huge potential as the subject of multiple publications, studies, analyses and surveys aimed at better understanding and selling green finance.

On the downside, many clarifications still need to be made to provide financial market participants with better guidance and encourage them to offer more green products.

As for Regulation (EU) 2019/2088, the European Commission will not be publishing the regulatory technical standards (a.k.a. “Level 2 measures”) this autumn as initially expected. To comply with the regulation, asset managers and other financial market participants will therefore have to do their best to interpret it by 10 March 2021, when most of the Level 1 measures will be applicable.

It is worth noting, however, that working too quickly to produce data without any standardisation of assessment processes and/or other methodologies for sustainable investment and risk management may prove to be a waste of time and energy. Countless interpretations are possible, making supervision and compliance checks no easy task. Not to mention the lack of reliable data or tested, recognised and uniform methodologies to assess criteria that are still way too incomparable at this point.


1 Source: ALFI (Association Luxembourgeoise des Fonds d’Investissement – Luxembourg Investment Fund Association)

2 Source: LuxFLAG


UCITS: Undertaking for Collective Investment in Transferable Securities

AIF: Alternative Investment Fund

Article published in Agefi Lux on Wednesday November 11, 2020.