Additional information on sustainability preferences according to MiFID 2
1. Introduction
The United Nations have defined 17 goals for sustainable development, the so-called ‘Global Goals’. To achieve these goals, the European Union also wants to engage the financial services industry.
The development towards more sustainability is referred to as ESG. Economic activities should also serve these goals of ecology, social justice, and the principles of good governance. Companies are considered sustainable if they try to achieve these goals through their economic activities.
The EU obliges institutions to ask their customers for their preferences on sustainability issues. The sustainability preference is your decision whether and to what extent you want to consider financial instruments that take sustainability aspects into account in your investment. Article 2 No. 7 of Regulation (EU) 2017/565 provides for several alternatives. We would like to explain the sustainability preferences available to you below.
2. Sustainability preferences
The EU would like to offer you the following sustainability preferences to choose from:
2.1 Sustainability according to the Taxonomy Regulation
The strictest sustainability preference is the one according to Art. 2 No. 7 a) IR 2017/565. This allows you to determine whether a minimum share should be invested in environmentally sustainable investments within the meaning of Article 2 No. 1 of Regulation (EU) 2020/852. These are financial instruments that comply with the Taxonomy Regulation, i.e. the set of EU rules defining ecological investments. These are economic activities that make a significant contribution to achieving one of the environmental objectives according to Art. 9 of the Taxonomy Regulation and do not significantly harm any of the other environmental objectives.
The so-called Taxonomy is intended to determine which economic activity may be classified as sustainable/ecological. Six environmental objectives are defined:
- Climate protection
- Adaptation to climate change
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Avoidance and reduction of environmental pollution
- Protection and restoration of biodiversity and ecosystems
According to the Taxonomy Regulation, an economic activity by a company is classified as sustainable if it significantly promotes at least one of the above six environmental objectives and does not significantly harm the other environmental objectives.
The technical details are defined by so-called delegated acts. These delegated acts have not yet been finally adopted and are still under political discussion. However, drafts are already available. For example, passenger transport by bus is considered ecological if the vehicles used for this purpose do not cause direct CO2 exhaust emissions. Such definitions also apply to production processes, e.g. for the production of liquid pig iron, no more than 1.331112 t CO2 eq per tonne may be emitted.
In order to meet the Taxonomy requirements, companies must ensure that the OECD Guidelines for Multinational Enterprises and the United Nations Guiding Principles on Business and Human Rights, including the fundamental principles and rights from the 8 core conventions set out in the International Labour Organisation’s Declaration on Fundamental Principles and Rights at Work and from the International Bill of Human Rights, are followed.
According to MiFID II, the standards from the Taxonomy would ensure the highest possible level of sustainability for you. The problem with the Taxonomy as it stands in the summer of 2022 is that fundamental political decisions have not yet been made. This applies, for example, to the question of the classification of nuclear energy or the gas industry. You can follow this discussion in the media. In addition, regulations are pending that oblige companies to report on the extent to which their economic activities comply with the Taxonomy. The first steps in this direction are currently being taken, but have not yet been completed. As things stand in the summer of 2022, we have to assume that the proportion of companies that operate in accordance with the Taxonomy will be well below 10%.
It is therefore not yet possible for Inyova to compile a risk-adjusted and diversified portfolio of financial instruments from issuers that contribute solutions according to the EU Taxonomy.
2.2 Sustainability according to the Disclosure Regulation
The second sustainability preference you can choose is financial instruments where you specify that a minimum proportion should be invested in sustainable investments as defined in Article 2(17) of Regulation (EU) 2019/2088, the so-called Disclosure Regulation or SFDR.
These are economic activities that contribute to the achievement of an environmental objective, measured, for example, by key indicators of resource efficiency in the use of energy, renewable energy, raw materials, water and soil, waste generation and greenhouse gas emissions, or impact on biodiversity and the circular economy, or an investment in an economic activity, that contributes to the achievement of a social objective, in particular an investment that contributes to the fight against inequalities or promotes social cohesion, social inclusion and labour relations, or an investment in human capital or in favour of economically or socially disadvantaged groups, provided that principles of good corporate governance are also applied.
If you, as a customer, choose this sustainability preference, you would be choosing a medium level of sustainability according to MiFID II. The problem with this sustainability preference is unfortunately very similar to the one described above regarding the financial instruments that are supposed to comply with the Taxonomy Regulation. Regulatory definitions are lacking and it is difficult to make a precise delineation of the respective economic activities that are supposed to comply with this requirement. The key indicators mentioned in the regulation are not defined by law and have yet to be developed in practice. As things stand today in summer 2022, this standardisation has hardly been developed. In addition, as of summer 2022, companies are not yet obliged to report in accordance with the key indicators mentioned, and their non-financial reporting still largely lacks statements on the key indicators.
For Inyova, it is therefore not yet possible at this stage in summer 2022 to clearly assign the economic activity of issuers to this sustainability preference.
However, we believe that our assessment of companies in the Handprint largely corresponds to this definition. Furthermore, with regard to Green Bonds, we use an ETF that classifies itself as Article 9 and thus also states that it fully corresponds to this category.
2.3 Sustainability preference through consideration of Principle Adverse Impact (PAI) indicators.
The third sustainability preference is the decision by you to consider financial instruments that take into account the PAI indicators, whereby the qualitative or quantitative elements used to demonstrate this consideration are determined by the (potential) clients. Definitions can be found in Art. 4, 6 and 7 of the Disclosure Regulation.
The PAI indicators are determined on the basis of sustainability indicators. These are:
- greenhouse gas emissions,
- carbon footprint,
- the general greenhouse gas emission intensity of a company,
- the company’s commitment to fossil fuels,
- share of energy consumption and generation from non-renewable energy sources,
- intensity of energy consumption by climate-intensive sectors,
- impact on areas of biodiversity in need of protection,
- water consumption of a company,
- proportion of hazardous and radioactive waste,
- violations of the UNGC Principles and the OECD Guidelines for Multinational Enterprises,
- lack of compliance processes and mechanisms to comply with the UNGC Principles and the OECD Guidelines for Multinational Enterprises,
- gender pay gap,
- gender diversity in governance and oversight bodies,
- engagement in controversial weapons (anti-personnel mines, cluster munitions, chemical and biological weapons)
The German banking industry, the German Derivatives Association and the German Association of Investment Companies have presented an association concept to cluster financial instruments based on these indicators. Companies that take into account material PAI indicators are defined as companies that pursue a dedicated ESG strategy with consideration of the standard PAI indicators on environmental and/or social topics. In addition, these companies must take into account minimum exclusions. These minimum exclusions mean:
For companies:
- Arms production above 10% (outlawed weapons above 0%)
- Tobacco production over 5%
- Coal over 30%
- Severe violations of UN Global Compact (without adequate remediation):
- Protection of international human rights
- No complicity in human rights violations
- Upholding freedom of association and the right to collective bargaining
- Elimination of forced labour
- Elimination of child labour
- Elimination of discrimination in respect of employment and occupation
- Precautionary principle in dealing with environmental problems
- Promotion of greater environmental awareness
- Development and dissemination of environmentally friendly technologies
- To work against corruption in all its forms
For government bond issuers, no serious violations of democracy and human rights.
In addition, in order to implement good corporate governance practices, issuers must accept a recognised industry standard for themselves, in Germany, for example, the German Corporate Governance Code.
3. Your decision
You are not obliged to choose one of the above sustainability preferences. As a provider, we aim to make you an offer that takes sustainability preferences into account. Please bear in mind that we are not yet able to draw on a sufficient database of companies. Only in the future will companies be obliged to provide detailed information on the share of their investment and turnover in economic activities in their non-financial reporting, e.g. in accordance with the Taxonomy Regulation. These obligations will only affect larger companies, but not smaller and medium-sized companies. These will probably only be obliged to report in a limited way. The same applies to governmental or supranational issuers.
Inyova can currently therefore not guarantee the achievement of your sustainability goals.