Documents considered by the Committee on 16 January 2019 Contents

7Green Finance: Low Carbon Benchmarks

Committee’s assessment

Politically important

Committee’s decision

Cleared from scrutiny; drawn to the attention of the Environmental Audit Committee

Document details

Proposal for a Regulation amending Regulation (EU) 2016/1011 on low carbon benchmarks and positive carbon impact benchmarks

Legal base

Article 114 TFEU; ordinary legislative procedure; QMV



Document Number

(39798), 9348/18 + ADDs 1–3, COM(18) 355

Summary and Committee’s conclusions

7.1In May 2018, the European Commission introduced draft EU legislation with the aim of ensuring that the financial services industry plays its part in the fight against climate change. The Commission argues this would benefit the environment and lead to more sustainable economic growth (as well as being in the industry’s own interest by reducing insurance claims related to environmental damage and ensuring the viability of long-term investments). The overall aim of the proposals is to channel more investment into sustainable activities by incorporating ‘Environmental, Social and Governance’ (ESG) considerations into investment industry practices.

7.2Concretely, the European Commission tabled three legislative proposals as part of its ‘Green Finance‘ package. The first two of these would create a ‘Sustainability Taxonomy‘, to aid the assessment of how environmentally-friendly a given investment is, and introduce new mandatory Environmental, Social and Governance (ESG) disclosure requirements for asset managers, institutional investors and investment advisors, requiring them to be transparent with their customers about the environmental footprint of their investment decision-making or advisory process. We cleared the latter from scrutiny at our meeting on 9 January 2019.

7.3The third proposal, on which this chapter focuses, would establish statutory EU-wide requirements for financial benchmarks. These purport to show whether the carbon footprint of a specific investment is greater or smaller than a baseline—the benchmark—of a hypothetical portfolio of ‘low carbon’ or even ‘carbon positive’ investments (i.e. the activities of a set of companies deemed to have a relatively small carbon footprint). More specifically, the draft legislation would amend the 2016 Benchmarks Regulation:72 a key piece of post-crisis financial law adopted following the LIBOR and EURIBOR benchmark manipulation scandals, intended to govern the accuracy and integrity of indices used in financial contracts throughout the EU.

The Benchmarks Regulation

7.4As it stands, the 2016 Regulation sets harmonised rules for their production and governance, such as management of conflicts of interest—a key failure in the LIBOR and EURIBOR scandals, which were manipulated by banks for their own gain at the expense of other parties—and the standards of supervisory oversight by national and European regulators of individual benchmarks offered by EU-based companies. Moreover, supervised entities such as banks, investment firms and insurance companies in the EU can normally only use a benchmark in their contracts or other operations if its administrator is authorised in the EU. For non-EU benchmarks, use is permitted only if its home country has been given ‘equivalence’ decision, or if its specific administrator has been granted ‘recognition’ by the financial regulator of a Member State.73 (This system of ‘recognition’, which to some extent removes the need for an overall determination of equivalence, is currently subject to negotiations, after the Commission proposed it should be abolished as part of the review of the European System of Financial Supervision.)

The Commission proposal on ‘low carbon’ and ‘carbon positive’ benchmarks

7.5Where investors want to make environmentally sustainable investments, their asset managers can compare their investments against low carbon or sustainability benchmarks to ascertain whether that objective is being achieved. The Treasury has explained that, at present, those benchmarks typically consist of a standard benchmark (such as the S&P 500 or NASDAQ 100) within which companies with relatively high carbon footprints are removed or under-weighted. In that way, the climate impact of specific investments can be compared to the performance of low-carbon economic activities more broadly.

7.6However, the European Commission argued that specific legislation is necessary to ensure that benchmarks used to measure the sustainability performance of investments are accurate and sound.74 It therefore proposed a new Regulation to define two new categories benchmarks (namely ‘low carbon’ and ‘positive carbon impact’), and introduce specific transparency requirements for their administrators, obliging hem to disclose the methodology underpinning those benchmarks.75 The Regulation as originally proposed would empower the European Commission to establish—by means of Delegated Acts—the minimum criteria for the actual calculation of sustainability benchmarks.76 These would cover the choice of the underlying assets against which an investment would be benchmarked; the method for the weighting of the underlying assets relative to each other; and the method for the calculation of carbon emissions and carbon savings associated with the underlying assets.77

7.7Based on an Explanatory Memorandum submitted by the Treasury in summer 2018, the European Scrutiny Committee considered the proposed Low Carbon Benchmarks proposal in some detail in its Report of 18 July 2018. The Government’s position was that it was “not opposed to the introduction of specific [rules] for sustainability benchmarks if it helps investors to make more informed decisions”, but that the new Regulation should not be “overly prescriptive” in determining how such benchmarks should be calculated because it could “hinder innovation and competition” and “discourage firms from providing these benchmarks”.

7.8When we last considered the proposal, there was a large degree of ambiguity around the implications of the amendments to the Benchmarks Regulation, as it was unclear to who they would apply and what their practical impact on the market would be. Moreover, noted that the new requirements for ‘green’ benchmarks might apply to the UK industry directly and indirectly even after its formal withdrawal from the EU in March 2019. We have made a fuller assessment of the potential implications of the Low Carbon Benchmarks proposal for the UK in paragraphs 14 to 17 below in light of the most recent developments in the Brexit process.

Developments in the legislative process since July 2018

7.9On 9 January 2019, the Economic Secretary to the Treasury (John Glen MP) provided us with an update on the negotiations among EU Member States on the Low Carbon Benchmarks proposal.78 The Minister’s letter noted that the “proposals have not changed a great deal from the original text” following discussions among national officials. However, significantly, the Commission has clarified that the ‘low carbon’ and ‘positive carbon impact’ benchmarks are intended to be optional product labels, applicable only to benchmark providers “who wish to market their benchmark using these accredited labels”. As a consequence, the revised legal text would make it explicit that providers would only be bound by the calculating methodology for the ‘green’ benchmarks set out under the Regulation if they actively choose to use those appellations. The Minister explained that this clarification enabled the UK to “achieve [its] key objective in the file”, namely to “ensure that the Regulation does not prescribe a methodology or framework for all environmental impact investing benchmarks, thereby allowing room for innovation in this rapidly developing market”.

7.10The Minister’s letter also explains the Member States want to use the legislative process to introduce a further amendment to the Benchmarks Regulation, which is unrelated to the broader sustainability question. This concerns an extension of the existing transitional period—which ends on 1 January 2020—during which benchmarks in use before the Regulation took effect in June 2016 would not need to be fully in line with its requirements. Because two ‘critical’ benchmarks79—EONIA and EURIBOR, both administered from Belgium—are unlikely to meet the January 2020 deadline, the Member States are looking to extend the transition until the end of 2021.80

7.11The Minister has signalled the Government’s acceptance of this new proposal, because the “cessation of these benchmarks”—which would occur automatically if they are not compliant by the deadlines set out in the Regulation—“could cause disruption to both investors and consumers, with potentially severe repercussions on financial stability”. He adds that LIBOR, which is administered in the UK, is the only other critical benchmark in use in the EU, but it is already authorised under the Regulation by the Financial Conduct Authority.

Next steps

7.12The Economic Secretary’s letter also explained that the EU Finance Ministers are expected to formally adopt a ‘general approach’—a mandate for negotiations with the European Parliament on the final text of the Low Carbon Benchmarks Regulation—in January 2019 to reflect their suggestions and concerns as described above.81 He therefore asks the European Scrutiny Committee for scrutiny clearance, to enable the Government to support the Member States’ common position on the proposal.

7.13The Parliament’s Economic & Monetary Affairs Committee adopted its position on the proposal on 13 December 2018. Following the Council vote, final negotiations on the text of the Regulation will begin between the Romanian Presidency of the Council and MEPs, with a view to reaching agreement before the dissolution of the European Parliament in April 2019.

Our conclusions

7.14We thank the Minister for his letter informing us of the state of play on the amendment to the Benchmarks Regulation, and the potential impact it could have on the UK financial services industry. We note that the Commission’s clarification of the scope of its proposal, namely that it is an optional label whose rules are applicable only where a financial benchmark provider explicitly chooses to market a product as ‘low carbon’ or ‘carbon positive’. This means the overall impact of the new Regulation is likely to be fairly limited. We have also taken note of the new amendments relating to the extension of the transitional period for the EURIBOR and EONIA benchmarks to be brought in line with the requirements of the Regulation.

7.15For reasons set out more comprehensively in our recent Report on the related EU proposal on sustainability-related disclosures by asset managers and investment advisers, we do still consider that this new EU legislation on low carbon benchmarks—once adopted at EU-level—could still be relevant for the UK:

7.16Given the above, we consider that the new Low Carbon Benchmarks Regulation could impact on the UK financial services industry directly and indirectly for a number of years. We are however content to now clear the proposal from scrutiny, given that the European Commission has clarified the optional nature of using the ‘low carbon’ or ‘carbon positive’ labels for a financial benchmark. We also draw these developments to the attention of the Environmental Audit Committee.

7.17We understand that negotiations on the third proposal in the Green Finance package, relating to Sustainability Taxonomy, are still on-going within the Council. No agreement expected in the short-term, and it therefore remains under scrutiny.

Full details of the documents:

Proposal for a Regulation amending Regulation (EU) 2016/1011 on low carbon benchmarks and positive carbon impact benchmarks: (39798), 9348/18 + ADDs 1–3, COM(18) 355.

Previous Committee Reports

See (39798), 9348/18, COM(18) 355: Thirty-sixth Report HC 301–xxxv (2017–19), chapter 4 (18 July 2018).

73 Moreover, under Article 51 of the Benchmarks Regulation, EU and third country benchmarks already in use in June 2016 can continue to be used until June 2020 as a transitional measure.

74 More specifically, the Commission said EU legislation was needed because Low carbon benchmarks remain relatively insignificant in terms of their use in overall portfolio allocation by asset managers, despite a relatively wide range of them having been developed; there are divergent levels of openness between administrators about the methodologies underpinning their low carbon benchmarks and as a result they are difficult to compare; and in the absence of a common regulatory framework, there is a risk that all low carbon benchmarks are perceived as being equally suitable to measure the sustainability performance of a given investment despite having different characteristics (potentially leading to ‘green washing’ where investments seen more environmentally-friendly than they are).

75 However, under the proposal benchmark administrators would not be required to use the EU Sustainability Taxonomy, to allow them the “necessary degree of flexibility” when designing their products.

76 Delegated Acts are adopted by the European Commission but can be vetoed by either the European Parliament or a qualified majority of Member States in the Council.

77 An earlier draft of the Commission proposal would have introduced a fully harmonized regime for the methodology of calculating the low carbon and carbon positive benchmarks, including the use of the new EU Sustainability Taxonomy (see above). This approach was abandoned after a negative opinion by the Commission’s Regulatory Standards Board.

78 Letter from John Glen to Sir William Cash (9 January 2019).

79 Critical benchmarks under the Regulation are those used as a reference for financial instruments or financial contracts or for measuring the performance of investment funds, having a total value of at least €500 billion.

80 The Member States also want to give the Belgian financial regulator more power to compel the continued contribution to, and administration of, the EURIBOR benchmark (extending existing powers to do so from two to five years). There were concerns that, if the existing two-year mandatory period was triggered in the near future, the reforms to make the benchmark compliant with the Regulation would still not be completed in time.

81 The Council’s position were informally signed off by the Member States’ Permanent Representatives in COREPER before the 2018 Christmas recess.

82 The Member States want the Low Carbon Benchmarks Regulation to apply from April 2020.

83 The relevant provision of the backstop—Article 2 of Annex 4—does not list the specific EU legal acts which would constitute the ‘common standards’ it refers to, and it is also explicitly excluded from the scope of the dispute resolution mechanism created by the Agreement, which can refer questions of EU law to the Court of Justice. It is therefore not clear if the measures in the Green Finance package, which are explicitly linked to the EU’s implementation of the Paris Climate Change Accord, fall within the scope of Article 2 of Annex 4 to the Protocol (although they are based on Article 114 of the EU Treaty, relating to the Single Market, and not Article 192, which governs EU rules on environmental protection).

84 As part of the wider review of the European System of Financial Supervision, the Member States and the European Parliament are also considering strengthening the centralised role of the European Securities & Markets Authority (ESMA) in the oversight of non-EU benchmarks. For example, under a Commission proposal, supervision all benchmarks administered from outside the EU (but used within it) would become the direct responsibility of ESMA. This includes responsibility for granting recognition or endorsement to third country administrators in the absence of an equivalence decision. As a result, national authorities would lose the ability to grant such recognition. It remains unclear what the outcome of the negotiations on this proposal will be, but it could clearly have an impact on the use of UK-administered benchmarks on European financial markets.

85 See for more information the Financial Services (Implementation of Legislation) Bill, and especially Schedule 1. We have discussed the implications of the Bill in more detail in our Report of 9 January 2019 on the EU’s banking reform package.

Published: 22 January 2019