Political battle lines in the U.S. may have hardened — especially when it comes to applying sustainability standards to public pension investing — but in the EU, things have moved faster. In Europe, climate risk is now accepted as one of the biggest macroeconomic forces impacting economic and business sustainability, and as a result, investment firms are actively grappling with critical decisions on sustainability compliance — including risk measurement, reporting and portfolio composition.

Over the past several years, legislators have written principles-based sustainability risk requirements into pan-European legislation — including for investment firms, mutual fund and ETF managers, banks, insurers, pensions and financial advisers. Virtually all EU financial services firms are under an existing or imminent regulatory obligation to assess, measure, manage and disclose sustainability or ESG risk.

As a result, investors need a deep understanding of their own and their assets’ resilience and exposure across climate and energy price scenarios. To achieve this, they need relevant data to assess sustainability risk exposures in their portfolios and incorporate forward-looking sustainability risk metrics in both their investment decisions and financial products. The idea is that doing so can help reduce the carbon footprint of portfolios and also boost financial performance.

Following the 2008 financial crisis, regulators implemented new risk management and reporting requirements for financial firms and banks. This was intended to enhance oversight of market risk management practices and bolstered requirements across other risk domains, including leverage, liquidity, counterparty, and credit. But the post-financial crisis risk landscape is not fixed.

Globally, the climate crisis is emerging as a new risk driver in the financial system, spurring the development of risk management concepts, tools, data, and disciplines such as climate risk measurement, stress testing, and reporting. In the EU, financial system risk from climate change is included under broader umbrella terms: sustainability risk or ESG risk.

The EU’s new sustainable finance regulations are many. For example, the Sustainable Finance Disclosure Regulation (SFDR) adds sustainability risk requirements for in-scope firms. In parallel, EU legislators and regulators are updating existing financial sector framework laws and technical standards such as: AIFMD (Alternative Investment Fund Managers Directive), IFD/IFR (Investment Firms Directive and Investment Firms Regulation), the UCITS Directive (undertakings for collective investment in transferable securities) and PRIIPs (packaged retail and insurance-based investment products). At the same time, key EU regulatory authorities, such as the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA) have set standards as well.

This multilevel, multi-industry process is ongoing and at varying stages across financial industries, with entities and frameworks filling in the details via regulatory technical standards, guidelines, reports and opinions. EU regulators have published thousands of pages on these topics and will publish thousands more in the coming years.

A deeper dive on EU climate regulation and compliance is available here, in an analysis by Dr. Khosla, who is the Chief Innovation Officer at climate data provider Entelligent, and Nels Ylitalo, Vice President, Director of Product Strategy for Regulatory Solutions at FactSet.

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