Institutional investors as environmental activists

ABSTRACT

Climate change mitigation has presented a serious problem for global regulators. An area that is emerging from a collection of legislative initiatives of the European Commission is the role of institutional investors in holding companies accountable for decisions that have a climate change impact. These legislative initiatives are the Revised Shareholder Rights Directive, Disclosures Regulation, Taxonomy Regulation and Revised Benchmarks Regulation. The article analyses each piece of legislation critically and seeks to describe their cumulative effect in terms of what is required of institutional investors. This article argues that these legislative initiatives will, together, create a normative expectation that institutional investors adopt, to a greater extent than has been previously observed, the role of activist with respect to the climate change impacts of investee companies. The article then describes the possibility of enforcement of this normative expectation by non-State actors.

KEYWORDS:

• Institutional investors
• climate change
• corporate governance
• engagement

1. Introduction

The impact that climate change could potentially have on global economic developments, poverty and general welfare is well understood to be enormous. Regulatory authorities and governmental initiatives around the world have sought to mitigate the consequences of climate change. This article will argue that recent EU legislation seeks to place an onus on institutional investors to advocate for climate change mitigation in their dealings with investee companies in the form of engagement. This engagement can take the form of both monitoring and discipline, the former involving the assessment of sustainability risks of companies prior to investment and the latter involving more direct activism in the form of voting and dialogue. According to the European Commission (‘EC’), institutional investors should perform the function of holding companies in which they are invested accountable for the environmental impact of their actions. This article will argue that a normative expectation is created by a suite of EU legislation that institutional investors adopt the role of environmental activist with respect to investee companies. The article's primary focus will be on climate change activism but the legislation that is described is broader, seeking ‘long term engagement’ and consideration of a wide range of environmental and sustainability issues and therefore some broadening of the analysis will be necessary at certain points.

Climate change mitigation can come in many forms, it can be directly spearheaded by Government or indirectly through the emphasis of the role of companies in mitigating their own carbon impact.¹ This Article is concerned with legislative efforts, at an EU level, to enhance the role of institutional investors of EU public listed companies in climate change mitigation of such companies. While there are many other EU legislative projects dealing with climate change that do not involve institutional investors,² enhancing the responsibility of institutional investors is arguably a necessary element of a wider plan to address climate change. Institutional investors are the dominant form of shareholder of companies across OECD countries³ and they have the potential to profoundly influence such companies, through voting and engagement. They can encourage management to take a short term view, with potentially devastating long term effects,⁴ or they can use their influence to orient companies towards the mitigation of long term risks, of which climate change is arguably the most important globally.

This Article is organised in the following way: Part 1 analyses the Revised Shareholder Rights Directive, Part 2 analyses the Disclosures Regulation, Part 3 analyses the Taxonomy Regulation, Part 4 analyses the Revised Benchmarks Regulation, all of which, it is argued, seek to place institutional investors into the position of environmental activist. These Regulations, it is argued, create a normative expectation of such activism, without making such actions mandatory. This soft law based approach, whereby many institutional investors can opt out from the desired actions of environmental activism (without opting out from the disclosure obligations of these various pieces of legislation) creates uncertainty as to whether institutional investors will, to a greater extent than presently, adopt this role in corporate governance. Part 5 explores the possibilities of enforcing the normative expectation, describing the reputational forces at play in the context of climate change activism by institutional investors.

2. The revised shareholder rights directive

In response to the global financial crisis of 2008, the EC sought to identify some of the causes of crisis in order to ground legislative fixes. One contributing factor identified was institutional investor passivity in the face of excessive risk taking by company management in the lead up to the crisis. In the Recitals of the Revised Shareholder Rights Directive, it is stated:

 … there is clear evidence that the current level of ‘monitoring’ of investee companies and engagement by institutional investors and asset managers is often inadequate and focuses too much on short term returns, which may lead to suboptimal corporate governance and performance.⁵

Engagement and monitoring are expressly considered by the EC to be activities that are undertaken necessarily for long term benefits. Shareholder engagement is also considered to be a vital accountability mechanism and to promote good governance by management.⁶ According to the EC, where shareholders choose to be passive and fail to monitor investee companies and instead sell their shares when unhappy with the company's short term financial performance, this indirectly pressures management to make decisions for the benefit of the short term only, in order to raise the share price in the short term. A finalised text of the revised Shareholder Rights Directive was published in May 2017. A distinction between ‘institutional investors’ and ‘asset managers’ is maintained in the Directive and different disclosure obligations attach to each. In the Directive, ‘institutional investors’ are defined as being certain undertakings involving insurance and pension funds⁷ and ‘asset managers’ are defined as investment firms that provides portfolio management services.⁸ The Recitals of the Directive explain its goals and, in particular, set out:

Effective and sustainable shareholder engagement is one of the cornerstones of the corporate governance model of listed companies, which depends on checks and balances between the different organs and different stakeholders. Greater involvement of shareholders in corporate governance is one of the levers that can help improve the financial and non-financial performance of companies, including as regards environmental, social and governance factors, in particular as referred to in the Principles for Responsible Investment, supported by the United Nations.⁹

The Principles for Responsible Investment (‘PRI’), mentioned in the above Recital, are an investor led initiative, to which institutional investors voluntarily can sign up and which is promoted by the United Nations.¹⁰ There are six principles, the first three of which are focused on environmental, social and governance (‘ESG’) issues and the latter three on the promotion, effectiveness and reporting on the first three principles. The 2019 PRI Annual Report states that ‘[c]limate change continues to be the number one issue of concern for signatories, and the number of signatories reporting that they take specific climate-related actions in their work is growing’.¹¹ Engagement on climate change is clearly an important aspect of the obligations the Directive imposes on institutional investors and asset managers.

Of these obligations, the one which most directly seeks to engage institutional investors and asset managers is Article 3g, which requires institutional investors and asset managers subject to it to either create and disclose an engagement policy or give a clear and reasoned explanation why they have chosen not to do so.¹² More precisely, this provision requires institutional investors to develop and publicly disclose an engagement policy that describes how they integrate shareholder engagement into their investment strategy (again, or provide an explanation for not doing so). It goes on to elaborate that such a policy must describe how they monitor investee companies on relevant matters, including ‘social and environmental impact’, as well as how they conduct dialogues with investee companies, exercise voting rights, cooperate with other shareholders and other relevant stakeholders and manage actual and potential conflicts of interests in relation to their engagement.

As noted, institutional investors and asset managers can choose not to comply, provided they disclose a ‘clear and reasoned explanation’ for this choice.¹³ Notwithstanding this, as Therese Strand argues, Article 3g ‘to some extent … [imposes] requirements on certain investor categories that, in practice, remove their option to abstain from active engagement’.¹⁴ According to her, this is because some institutional investors may be unable to provide a ‘clear and reasoned explanation’ for such abstinence.¹⁵ It is submitted that there is no reason to believe that ‘clear and reasoned’ explanations based on economic efficiency and the relative costs of active engagement would not suffice for the purposes of Article 3g. Iris Chiu argues that despite the availability of an explanation in lieu of compliance in Article 3g, ‘such an approach is likely to be regarded as the outlier and not the norm’ since the provision ‘could be regarded as presuming in favour of the optimality of shareholder engagement’.¹⁶ Chiu develops this argument with Dionysia Katelouzou, opining that while an institutional investor or asset manager can elect to explain non-compliance and ignore engagement altogether, ‘the proposed [as it then was] Directive is not far short of imposing a duty to demonstrate engagement, as there is a duty to publicly disclose the implementation and achievement of such engagement under Article 3g’.¹⁷ While other regulatory initiatives that seek to encourage greater institutional investor engagement, such as the Stewardship Code in the UK, are entirely voluntary,¹⁸ Article 3g requires a disclosure of either compliance or an explanation for non-compliance. For this reason, Chiu and Katelouzou suggest that, because it is a disclosure-based regulation, a certain degree of engagement may be required ‘in order for there to be sufficient matters to report’ and that the Revised Directive therefore represents ‘a step towards hardening stewardship norms into an engagement behaviour that is transparent and accountable, balancing a range of interests which are long-termist in nature’.¹⁹

The cost–benefit calculus that, at least partially, decides whether or not an institutional investor will engage with investee companies may be affected by Article 3g.²⁰ It is true that, in order to spur more engagement, either the ‘cost’ side of engagement must be reduced or the ‘benefit’ side must be enhanced. Commentators have doubted whether the disclosure-based approach in the Directive creates sufficient incentives for institutional investors to undertake greater levels of engagement.²¹ Article 3g neither reduces the costs of engagement nor increases the perceived benefit of engagement. On this metric alone, it is likely that the Directive will fail to transform institutional investors into activists of any sort, let alone activists for environmental issues. It is possible that this analysis undervalues the reputational costs of non-compliance, as institutional investors may want to signal their seriousness about sustainability risks and awareness of their own environmental impact to the market and wider society.²²

Other provisions of the Directive seek to engage asset managers indirectly, such as Article 3h. Where an institutional investor hires an asset manager to invest assets on their behalf, they must disclose how the arrangement incentivises the asset manager ‘to make investment decisions based on assessments about medium to long-term financial and non-financial performance of the investee company and to engage with investee companies in order to improve their performance in the medium to long-term’.²³ If institutional investors embed incentives into asset management mandates, it will encourage asset managers to engage more with investee companies. It is difficult to envisage what form such an incentive would take, given the costs that engagement entails. An institutional investor could make clear to asset managers that they expect a certain kind of engagement on certain issues and could insert these expectations in investment mandates. A group of pension funds in the UK are already signalling such expectations in the form of a collective initiative. This initiative is ‘red line voting’ and involves this group setting ‘red lines’ that should guide the asset managers of this group in how they vote the shares at general meetings of investee companies.²⁴ One such ‘red line’ relates to climate change. It states:

If the company does not have an Environmental Sustainability Committee chaired by a board director, or if the company is outside the FTSE 350 and does not have a named board member with responsibility for this area as evidence of appropriate concern, vote against the chair of the board.²⁵

Conflict has arisen surrounding the red lines between the pension funds who created it and asset managers, as the former experienced resistance from the latter who refused to be bound by such voting instructions.²⁶ In pooled accounts with asset managers, splitting votes between different asset owner clients can be logistically very difficult, if not practically impossible and some asset managers have refused to attempt to do so.²⁷ This may be an ominous sign for the operation of Article 3h.

Hanne Birkmose argues that the provisions of the Revised Directive may indicate a paradigm shift.²⁸ This shift is from a corporate governance framework that assumes shareholder monitoring where such monitoring benefits the shareholder as residual claimant, with indirect benefits for society as companies maximise their profits, to a framework that places engagement duties on shareholders.²⁹ The original 2007 Directive simply facilitated shareholder engagement by enumerating specific rights of access at the company's annual general meeting. Its approach was facilitative, in that it allowed shareholders to decline to monitor companies or engage with them if they so chose.³⁰ The Revised Directive, however, goes further by creating a normative expectation of engagement as a starting point for institutional investors. Choosing to be passive is therefore a deviation from this normative expectation. Implied within this expected norm is engagement not just for the private interests of the engaging shareholder. The Directive emphasises the role of disclosures for the accountability of institutional investors to ‘civil society’ and requires engagement on ‘non-financial performance and risk’ as part of an engagement policy, arguably implying an expectation of engagement on behalf of wider society's interests.³¹

An engagement norm alone does not imply engagement by shareholders on non-financial issues such as environmental or social concerns. Engagement could also take place on the basis of entirely financial concerns, such as encouraging financial distributions in the form of dividends or share buybacks. Yet, there are reasons to believe that engagement on non-financial matters will have an enhanced status within the normative expectation of engagement. As is noted, non-financial engagement on ESG issues is mentioned specifically in Article 3g. The next three sections will detail a suite of Regulations that have recently been introduced that seek to encourage institutional investors, again mainly through disclosures, to consider environmental issues, and particularly the risks associated with climate change, to a greater extent in how they carry out investment strategies. As will be seen, these Regulations are primarily focused on the orientation of institutional investors’ assets towards more ‘environmentally sustainable economic activities’,³² including the activities that seek to address and mitigate the impacts of climate change.³³ Arguably, these Regulations will incorporate environmental consciousness and climate change awareness into the normative expectation of engagement. In other words, the normative expectation of institutional investor engagement on climate issues will take on a greater importance than engagement simpliciter.

3. Disclosures regulation

Beyond the Revised Directive, which seeks to engage institutional investors with respect to investee companies, a large scale sustainable finance initiative from the EC seeks to integrate sustainability risks, of which climate change is arguably the most pressing, into investment decisions of institutional investors and orient their capital towards sustainable investment. This initiative grew initially from the appointment of a High Level Expert Group on sustainable finance (‘HLEG’) at the end of 2016 by the EC, which launched a ‘domino effect’ of EU policies in this area.³⁴ The HLEG published its Final Report in January 2018.³⁵ This was quickly followed by an EC Action Plan on ‘financing sustainable growth’ which was primarily focused on the risks that climate change posed to the EU economy.³⁶ The major Regulations that were the product of this Action Plan are on sustainability disclosures by financial market participants (the ‘Disclosures Regulation’),³⁷ on a taxonomy of sustainable finance (the ‘Taxonomy Regulation’)³⁸ and on a revision of the 2016 Benchmarks Regulation to include low carbon benchmarks (the ‘Revised Benchmarks Regulation’).³⁹

The Disclosures Regulation will come into force across the EU on 10 March 2021.⁴⁰ The disclosure obligations under this Regulation apply to ‘financial market participants’, which are defined as including a range of different kinds of institutional investor and asset manager, including insurance firms, pension funds, venture capital funds and credit institutions that also provide investment portfolio management.⁴¹ Disclosure obligations also fall upon ‘financial advisers’, which is defined as including institutions that provide investment advice.⁴² Under Article 3 of this Regulation, financial market participants must disclose information about their policies on the integration of sustainability risks in their investment decision-making process.⁴³ Financial advisers must disclose information about their policies on the integration of sustainability risks in their investment advice or insurance advice.⁴⁴ The purpose behind these disclosure obligations appears to be two-fold. First, it allows the end-user investors and clients of financial advisers to have information about how sustainability risk is integrated into their investments and advice in order to make decisions about how they invest their assets. In theory, enhanced disclosures about the integration of sustainability risks could direct the assets of end users towards institutional investors who are most conscious and active on the risks that climate change poses. Second, and relatedly, by requiring these disclosures, institutional investors and financial advisers may be encouraged to consider environmental sustainability risks to a greater extent in each investment decision and act of engagement with investee companies. If end user investors demonstrate a desire to direct their assets towards institutional investors that better consider sustainability risks, this will provide a financial incentive for institutional investors. Certain kinds of institutional investor may feel inclined to survey beneficiaries to discover their sustainability preferences in order to guide their disclosures.⁴⁵

Financial market participants must disclose on their websites the principal adverse impact of their investments on ‘sustainability factors’ and if they take the view their investments have no adverse impacts, they must give ‘clear reasons’ why they have taken this view.⁴⁶ ‘Sustainability factors’ in this context is defined in the Regulation as meaning environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.⁴⁷ Article 5 requires that both financial market participants and financial advisers disclose how their remuneration policies are consistent with the integration of sustainability risks.⁴⁸ Article 6 requires financial market participants to disclose how sustainability risks are integrated into their investment decisions.⁴⁹ It also requires them to make an assessment of likely impacts of sustainability risks on the returns of the financial products they make available and disclose the results of this assessment.⁵⁰

The Regulation enhances the transparency requirements for financial market participants that promote environmental consciousness. These requirements correspond with Article 4 of the Taxonomy Regulation, discussed below, requiring disclosure of the same information as in Article 6, as well as information about how the relevant environmental or social characteristics sought to be promoted are met and, if an investment product follows an index benchmark, how this benchmark is consistent with such characteristics.⁵¹ Article 9 focuses on financial products that have ‘sustainable investment’ as their objective and distinguishes between the necessary disclosures for such products that follow or do not follow a reference index benchmark.⁵² In cases where a product with ‘sustainable investment’ as its objective follows a benchmark index, disclosure requirements relating to the characteristics of the benchmark are required.⁵³ Where there is no benchmark index, an explanation must be provided by the financial market participant of how the objective is to be obtained.⁵⁴ ‘Sustainable investment’ is defined in the Regulation as being an investment in an economic activity that contributes to either an environmental or social objective.⁵⁵ With respect to environmental objectives, the economic activity must be measured ‘by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy’.⁵⁶

With regard to financial products that have ‘sustainable investment’ as their objective or promote environmental or social characteristics, the Regulation specifies how disclosures by financial market participants must be made. For such financial products, disclosures must be made and maintained on the financial market participant's website, with a description of the environmental or social characteristics or the sustainable investment objective.⁵⁷ Information on the methodologies used to assess, measure and monitor the environmental or social characteristics or the impact of the sustainable investments selected for the financial product must also be disclosed.⁵⁸ Outcomes must also be disclosed as the extent to which environmental or social characteristics have been met or the overall sustainability-related impact of the financial product in relation to a sustainable investment by reference to the relevant sustainability indicators.⁵⁹

The Disclosures Regulation is designed to encourage institutional investors to integrate sustainability risks into investment decisions. This could lead to a greater awareness of sustainability risks within an investment portfolio, which, in turn, could lead to greater activism in relation to the mitigation of sustainability risks. The very act of ‘monitoring’ the sustainability risks that investee companies pose is itself an act of engagement, though certainly not an intense one. A problem that may defeat the aims of the Disclosures Regulation is that it is not clear how the required disclosures are to be enforced. Article 14 states that ‘Member States shall ensure that the competent authorities designated in accordance with sectoral legislation … monitor the compliance of financial market participants and financial advisers with the requirements of this Regulation’.⁶⁰ However, it is not clear how competent authorities can penalise non-compliance once identified. Member States may enact supplementary legislation that provides for such penalties but, even in the event that some Members States do this, there is no guarantee such penalties will be consistent across Member States. Even if the disclosure requirements are not ignored by financial market participants, it is not clear how the quality of ongoing disclosures are enforced either.

4. The taxonomy regulation

According to the EC, reorienting capital flows should be underpinned by a taxonomy in order to provide clarity on which activities can be considered ‘sustainable’.⁶¹ The EC acknowledged that developing a classification would be time-consuming and therefore proposed a ‘step-by-step approach’.⁶² The taxonomy of climate change mitigation would be prioritised as a first step, with a taxonomy of other environmental and social activities following as a second step.

The text of the Taxonomy Regulation was agreed by the European Parliament and Council in March 2020 and was published in June 2020. It establishes a taxonomy for the remaining sustainable finance initiatives. In this Regulation, Article 3 identifies four criteria for an ‘environmentally sustainable economic activity’:

1. the economic activity contributes substantially to one or more of the specified environmental objectives;

2. the economic activity does not significantly harm any of these environmental objectives;

3. the economic activity is carried out in compliance with certain minimum safeguards;

4. the economic activity complies with technical screening criteria.⁶³

In order to be designated environmentally sustainable, an economic activity must comply with all four of these criteria. Setting out these criteria helps to avoid different standards across different member states.⁶⁴ Article 5 of the proposed Regulation imposes disclosure obligations on asset managers and institutional investors that offer financial products that are marketed as environmentally sustainable in some form.⁶⁵ These disclosure obligations apply if the financial product promotes environmental characteristics or has sustainable investment as its objective.⁶⁶ Institutional investors and asset managers selling such financial products must disclose to which environmental objective or objectives the product contributes⁶⁷ and ‘how and to what extent the investments underlying the financial product are invested in environmentally sustainable economic activities’ as listed in Article 3.⁶⁸ It is not clear how these disclosure requirements are to be enforced, if at all. A failure to properly penalise or discourage inadequate disclosures may provide an incentive for institutional investors and asset managers to market ‘environmentally sustainable’ financial products without ensuring that the products meet the necessary minimum criteria.

The first criterion involves contributing substantially to a specified environmental objective. Specified environmental objectives are listed in Article 9 of the Regulation as being climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, waste prevention and recycling, pollution prevention and control and protection of healthy ecosystems. Each of these objectives is given elaboration in subsequent provisions. An economic activity can be said to contribute substantially to climate change mitigation, for example, where it contributes substantially to the stabilisation of greenhouse gases in the atmosphere. This can involve the reduction of greenhouse gases through various means listed in the Regulation, including generating, transmitting, storing, distributing or using renewable energy, the improvement of energy efficiency and the increase of carbon capture and storage use.⁶⁹ This level of specificity in the Regulation is to be welcomed, allowing focus to remain on the causes of climate change and encouraging capital flows toward focused solutions to these causes. The Regulation also recognises ‘enabling activities’ that do not themselves directly substantially contribute to one or more of the Article 9 objectives but directly enable another activity to make a substantial contribution and does not, in turn, undermine long-term environmental goals and has a substantial positive environmental impact on the basis of lifecycle considerations.⁷⁰ The inclusion of enabling activities within the taxonomy is a development from the original 2018 proposal.

The Regulation defines ‘significant harm’ to any of the above objectives as involving six outcomes which align with the environmental objectives listed in Article 9. For example, ‘significant harm’ to the objective of climate change mitigation will occur ‘where that activity leads to significant greenhouse gas emissions’.⁷¹ Minimum safeguards with which the economic activity must be in compliance in order to be considered environmentally sustainable are defined in Article 18 as corresponding with the eight fundamental conventions identified in the International Labour Organisation's declaration on Fundamental Rights and Principles at Work.⁷² In other words, the undertaking carrying out the economic activity in question must do so in compliance with the right not to be subjected to forced labour, the freedom of association, workers’ right to organise, the right to collective bargaining, equal remuneration for men and women workers for work of equal value, non-discrimination in opportunity and treatment with respect to employment and occupation and the right not to be subjected to child labour.

The final criteria for an economic activity to be considered environmentally sustainable is that it complies with technical screening. The EC have sought to develop technical screening criteria which will inform, in a more detailed and evolving manner, how different economic sectors can undertake their activities in a way that can be considered, under the Regulation, environmentally sustainable. To this end, the EU Technical Group on Sustainable Finance published its Taxonomy Technical Report in June 2019, which set out technical screening criteria for activities across a range of economic sectors.⁷³ In March 2020 the Group published its Final Report, containing its final recommendations to the EC regarding the technical screening criteria that apply to the Taxonomy Regulation.⁷⁴ These include design issues that the Group identify, such as the recommendation that companies performing activities not covered by the taxonomy should nonetheless be encouraged to make taxonomy-related disclosures.⁷⁵ This could occur where an activity is not covered by existing technical screening criteria.

The Taxonomy Regulation is a vital initial step in the process of developing a unified approach across different legislation to the reorientation of capital towards sustainable ends. Without a common understanding of what can be considered ‘sustainable’ in the context of regulatory intervention to encourage ‘sustainable finance’, little progress can be expected, as each institutional investor and market participant can broaden the meaning of sustainability in a manner that pays lip service to environmental issues but leaves the status quo unaffected. A uniform understanding of sustainability in financial regulations such as the Disclosures Regulation helps to guide incentives of financial market participants and avoid ‘greenwashing’ whereby financial products are misleadingly portrayed as environmentally friendly.⁷⁶

5. Revised benchmark regulation

Financial benchmarks are essential in capital markets around the world. ‘Benchmark’ is a broad term and there is a great deal of overlap with the term ‘index’. Strictly speaking, an ‘index’ is an aggregate of value of a basket of financial products, such as stocks or other financial instruments, determined by some formula. A benchmark is a standard against which performance can be measured. An index can be used as a benchmark and often is. As noted by Rauterberg and Verstein, ‘[t]he number and variety of indices is daunting, and it may seem that it is impossible to organise them or even define their boundaries’.⁷⁷ Indices used as benchmarks include interest rate indices such as the London Interbank Offered Rate (‘LIBOR’) and stock market indices such as the S&P 500. The 2016 Benchmark Regulation defines ‘benchmark’ as being an index by reference to which an amount under a financial instrument or contract is payable or which is used to measure the performance of an investment fund.⁷⁸ In other words, a benchmark is an index that is used as a standard against which a financial contract or instrument or investment fund is measured. An ‘index’ is defined as any figure that is published, regularly determined by some method of calculation, including the application of a formula on the basis of the value of one or more underlying assets or price.⁷⁹ The 2016 Benchmark Regulation was introduced in response to manipulation of previously self-regulated benchmarks, the most notorious being the LIBOR rigging scandal, to oversee and set minimum standards regarding the operation of benchmarks and controlling conflicts of interest.

As part of the sustainable finance initiative, the EC proposed amending the 2016 Benchmark Regulation to encompass the regulation of low carbon benchmarks. The HLEG, in its Final Report, noted that ‘[m]any investors rely on indices and benchmarks for the creation of investment products, for measuring the performance of markets or investment funds, and for guiding asset allocation’.⁸⁰ The HLEG also note that demand for ESG based indices is growing and that index providers are developing new financial products in response that build factor in ESG elements. It recommended that index providers should disclose their exposure of widely used and referenced benchmarks to climate and sustainability parameters. These recommendations are guided by the enormous growth in popularity of passive investing relative to active investing in the previous decades, mentioned above. Passive investing, whereby a benchmark index is set and followed passively by investors, has resulted in a massive reorientation of asset flows towards index benchmark financial products. Disclosures of exposure of benchmarks to sustainability risks is therefore aimed at the orientation of capital toward sustainable economic activities.

The Revised Benchmark Regulation inserts a number of provisions into the 2016 Regulation.⁸¹ The main revision is the introduction of ‘EU Climate Transition Benchmarks’ and ‘EU Paris-aligned Benchmarks’. The administrators of EU Climate Transition Benchmarks are required to formalise, document and make public any methodology used for the calculation of the benchmark, including the criteria applied to exclude assets or companies that are associated with a level of carbon footprint or a level of fossil fuel reserves that are incompatible with inclusion in the benchmark and the total carbon emissions of the index portfolio.⁸² The administrators of EU Paris-aligned Benchmarks must disclose similar information and also the formula or calculation that is used to determine whether the emissions of constituent companies are in line with the objectives of the Paris Agreement. The selection and weighting of companies within an EU Climate Transition Benchmark must be done in accordance with the requirement that the constituent companies of the benchmark disclose measurable carbon emission reduction targets, a reduction in carbon emissions which is disaggregated down to the level of relevant operating subsidiaries and annual information on progress made towards those targets.⁸³ This may have the indirect effect of institutional investors who provide these benchmark products encouraging companies to take concrete actions to reduce their carbon impact. The lower cost of capital for companies included in an EU Climate Transition Benchmark may outweigh the costs of disclosures and the reduction in carbon emissions that is required.

Obligations fall on providers of Benchmarks that are not specifically designated EU Climate Transition Benchmarks or EU Paris-aligned Benchmarks. Indeed, endeavouring to provide one or more EU Climate Transition Benchmarks is itself a requirement of the Revised Regulation for all ‘significant benchmark’ providers located in the EU.⁸⁴ Here, ‘significant benchmark’ is defined as one that is used as a reference for financial instruments or contract or measuring the value investment funds of a total average value of at least €50 billion.⁸⁵ For all regulated benchmarks in the EU, a benchmark statement is required, setting out, inter alia, its methodology, criteria and procedures used to determine the benchmark and the controls and rules used to govern the discretion of a benchmark administrator.⁸⁶ The Revised Regulation adds that a benchmark statement must also include an explanation of how ESG factors are reflected in each benchmark or family of benchmarks provided and published.⁸⁷ It is sufficient for a benchmark statement to clearly state, as an alternative, that it does not pursue ESG objectives.

Finally, a note should be made on passive investors and activism generally. There are different perspectives on whether passive investors have the incentives to be active or passive in corporate governance.⁸⁸ According to some, passive investors are incentivised to take a passive approach and decline to engage with investee companies, while others take the opposite view that passive investors have unique incentives among asset managers to engage in activism. According to the first view, providers of index funds will usually have investment portfolios that are much more diversified than their active counterparts. This will also necessarily be the case with providers of EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks. The high diversification of passive investors has been pointed to as presenting an obstacle to engagement as a greater number of companies in an investment portfolio may mean asset managers are less willing to expend resources on engagement in any one company.⁸⁹ Passive index investors may put indirect market pressure on index providers who form indices by investing in those formed under desirable criteria from a climate perspective. Index providers in turn provide an encouragement for companies to fit themselves with criteria for index selection and, as a result, have access to the capital that passive investors provide. This is perhaps a stretch of the concept of ‘activism’, which is typically understood to encompass positive acts undertaken to persuade company management or other shareholders of a position that the activist believes will benefit the company.⁹⁰

On the other hand, it has been argued that, because passive investors are ‘locked in’ once the index is set, they cannot sell their shares when displeased with an investee company's performance and so can only seek to enhance performance of their investment, and compete with other mutual funds for the assets of investors, through active engagement.⁹¹ Providers of passive investment products themselves have made this argument. Larry Fink, the CEO of BlackRock said in his 2018 letter to CEOs, ‘[i]n managing our index funds, however, BlackRock cannot express its disapproval by selling the company's securities as long as that company remains in the relevant index. As a result, our responsibility to engage and vote is more important than ever’.⁹² A greater orientation towards environmentally conscious benchmarks could have the effect of excluding certain high carbon companies from index benchmarks but also, once the index is set, could spur passive investors to engage with companies in the index to ensure their environmental credentials remain satisfactory. A company included in an EU Climate Transition Benchmark must disclose measurable carbon reduction targets to be achieved with a specific timeframe and progress made toward these targets.⁹³ The Regulation is silent on how the benchmark provider must act if those targets are not met within the specified timeframe or if the disclosures relating to the ‘progress’ towards targets become more vague. Passive investors who are locked into their index investment may be more likely to engage on such issues and encourage companies to improve performance by reference to specified targets or improvement of disclosures.

6. Enforcement of norms

The obligations under the Revised Shareholder Rights Directive, the Disclosures Regulation, the Taxonomy Regulation and the Revised Benchmarks Regulation provide a legal context that creates normative expectations that institutional investors will play a greater role in encouraging companies to mitigate their environmental impact, including their impact upon climate change. The provisions of these pieces of legislation do not require engagement, however, and they do not require that climate change risks are appropriately integrated into investment strategies or that capital is allocated appropriately toward economic projects that are aimed at mitigating climate change. Each of the above described pieces of legislation uses disclosures as a tool to encourage these outcomes. They seek to designate these outcomes as a normative expectation, from which any deviation should be given some form of explanation. In order for institutional investors to effectively adopt the role of climate change activist, however, enforcement of the normative expectation is necessary. For example, an institutional investor may give a ‘clear and reasoned’ explanation of why they have chosen not to create an engagement policy under Article 3g under the Revised Shareholder Rights Directive. They may disclose information on how limited their integration of sustainability risks in investment decisions is under Articles 3 and 6 of the Disclosures Regulation. For many institutional investors, all that is required is transparency, not necessarily compliance with the underlying aim of improved behaviour regarding environmental activism.

The use of disclosures as a tool to guide behaviour is premised on the hope that disclosure may lead end-user investors, ‘civil society’ and other stakeholders of both companies and of institutional investors to privately and publicly apply pressure, where institutional investors disclose deviations from the expected norm.⁹⁴ This is enforcement of the norms, not enforcement of disclosure requirements under the Directive and Regulations described above, which will fall upon competent authorities of Member States.⁹⁵ Institutional investors have powerful disincentives to playing the role of climate change activist with respect to investee companies. These disincentives come in the form of costs that are inherent in any shareholder engagement. ‘Rational apathy’ and the free rider problem are well known phenomena that describe the difficulties of engaging shareholders, where the anticipated costs of engagement outweigh the anticipated benefits in circumstances where such benefits are shared by all shareholders, including those who do not engage.⁹⁶ Engagement with respect to the risks posed by climate change will require incurring costs in the short term with uncertain, long-term benefits that are spread out throughout society. The question that is raised in this Article is whether the various disclosure requirements described above will give rise to incentives for environmental activism that overcomes the existing financial disincentives. Commentators have argued that disclosures alone do not provide incentives to engage but that this argument may not take reputational costs associated with disclosures into account.⁹⁷ Reputational costs can drive shareholder engagement with investee companies since institutional investors prize their reputation among investors, regulators and the wider public.⁹⁸ Climate change is a divisive issue and so arguably the reputational costs could be incurred by an institutional investor that is an activist for climate change mitigation but also by an institutional investor that remains passive in the face of climate change risks.

Institutional investors that are activists or seek change within investee companies with regard to climate change impact may face backlash for such actions. This may come from groups that are sceptical of the influence of companies on climate change and do not wish to see investment assets being directed toward climate change mitigation. A backlash may take the form of public advocacy against the power of asset managers on the basis of excessive power, the misdirection of investment assets or regulatory intervention. Any public reaction to the actions (or inactions) of institutional investors will be magnified by the size of the institutional investor in terms of assets under management because this will correlate with increased influence. For this reason, the biggest asset managers, BlackRock, Vanguard and State Street have taken up much of the attention of commentators considering the influence of institutional investors in corporate governance around the world.⁹⁹ These so called ‘Big Three’ are US asset managers but have significant holdings in EU companies. As such, the disclosure obligations in the legislation described above will fall upon the Big Three, insofar as their various subsidiaries with registered offices across the EU offer financial products and investment management in EU markets.¹⁰⁰ Bebchuk and Hirst have identified what they believe to be ‘an especially strong factor inducing the Big Three to be excessively deferential to corporate managers’,¹⁰¹ namely the fear of a public and political backlash against their growing power. According to Bebchuk and Hirst, management interests can be expected to receive substantial public support by making the argument that powerful asset managers such as the Big Three are ‘micromanaging or second guessing’ their companies.¹⁰² According to them, ‘pursuing any such strategy whereby the Big Three used their power in ways that adversely affect corporate managers would have a significant risk of backlash’.¹⁰³

Of course, the normative expectation created by the above described legislation is itself a reason to doubt that a backlash might arise that would impede institutional investor engagement on climate change in EU companies. However, as noted, the costs of engagement and monitoring will act as a disincentive to full compliance with the desired outcomes of such legislation. What is required is pressure to comply not only with the disclosure requirements in the legislation but to comply with the desired outcomes. Sergakis identifies ‘social enforcement’, that is, enforcement outside the State apparatus by end-user investors and civil society as a potential source of pressure on the reputation of institutional investors.¹⁰⁴ Social enforcement may involve financial incentives, such as when end-user investors choose only to invest with institutional investors whose environmental disclosures under the above described legislation provide convincing evidence of greater activism. There are examples of civil society groups seeking to put pressure on the Big Three to take greater steps to addressing their climate change impact. A collective of environmental NGOs, including Greenpeace, Friends of the Earth USA and the Rainforest Action Project, sent a public letter to Larry Fink in May 2018. In this letter, the NGOs asked Fink to consider BlackRock's ‘social purpose and contribution to society’ and asserted that ‘[a]s a result of the sheer size of your holdings, BlackRock is responsible for more greenhouse pollution than almost any other company in the world’.¹⁰⁵ If BlackRock declines to engage on environmental issues, the public pressure from groups will inevitably increase.

It is clear that there are forces of social enforcement that operate in relation to climate change mitigation and that, on balance, these forces operate on the side of encouraging institutional investors to take up the role of climate change activist within investee companies. The Big Three appear to be integrating sustainability and climate change considerations into their recent actions to a greater extent. BlackRock, the world's largest asset manager by assets under management announced in early 2020 that it would divest from companies presenting a high environmental risk.¹⁰⁶ More precisely, it announced it would remove companies that generate more than 25% of their revenues from thermal coal production from its discretionary active fund portfolios.¹⁰⁷ In his 2020 letter to CEOs, Larry Fink, explained that these investment changes are rooted in economic considerations, saying ‘[i]nvestors are increasingly reckoning with these questions and recognising that climate risk is investment risk’.¹⁰⁸ In July 2020, BlackRock publicly threatened adverse voting action against different named companies that it said were too slow in their progress in dealing with climate change impact.¹⁰⁹ This appears to have occurred due to social enforcement, whereby several groups, including pension fund clients and other asset managers, publicly criticised BlackRock for its inaction in the face of the accelerating climate change risks.¹¹⁰ The Big Three play an important role in leading the compliance among asset managers with the normative expectation created by the above described legislation and this may force compliance by smaller asset managers who are not directly targeted by social enforcement. Indeed, the Big Three are subject, to a certain extent, to the disclosure obligations contained in this legislation.¹¹¹ As reported by the Financial Times, ‘2020 has proved to be a landmark year for investor action on climate change, with significant resolutions being passed and investment pouring into sustainable funds’.¹¹²

7. Conclusion

The progress that large companies are making toward mitigating their contribution to climate change may be occurring at a pace that is unacceptably slow but institutional investors have the power to accelerate this progress. In order to do so, they must adopt the role of climate change activist and hold company management to account for decisions and strategies that are responsible for exacerbating climate change risks or that allow these companies to ignore climate change risks. This article has argued that a suite of EU legislation has created a norm of environmental activism that may have the effect of pushing institutional investors of EU companies into the role of climate change activist. Though there remain formidable barriers for institutional investors to adopting this role on a widespread basis, in the form of the costs of engagement and the uncertain and shared benefits that would result from climate change activism, this article has argued there are reasons to be optimistic. Social enforcement is an uncertain tool but the disclosures of institutional investors provide social enforcers, whether they are non-profit environmental groups, investors in institutional investors or some other actor, with a basis upon which enforcement can occur. It is hoped then that these EU legislative initiative will prove to be a necessary first step in a long process by which the largest EU companies begin to properly consider the contribution they making to climate change and to its ongoing mitigation.

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Additional information

Notes on contributors

Tom Giles Kelly

Tom Giles Kelly is a Barrister based in Dublin, Ireland and holds a PhD from the University of Dublin, Trinity College.

Notes

1 Dirk Schoenmaker, ‘The Impact Economy: Balancing Profit and Impact’ Working Paper, Issue 4, 7 July 2020, available SSRN: https://ssrn.com/abstract=3567026 at 1.

2 See, for example, the ‘European Green Deal Investment Plan’, involving an array of different actions, including the ‘Just Transition Mechanism’, which will be a fund to support businesses transitioning toward a ‘green economy’ and a ‘European Climate Law’, which is a proposal for a Regulation establishing the framework for achieving climate neutrality. See European Commission, ‘Communication from the Commission to the European Parliament, the European Council, the Council, the European Economic and Social Committee and the Committee of the Regions: The European Green Deal’ 11 December 2019, available at https://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1588580774040&uri=CELEX:52019DC0640; European Commission, ‘Proposal for a Regulation of the European Parliament and of the Council establishing the framework for achieving climate neutrality and amending Regulation (EU) 2018/1999 (European Climate Law)’ 4 March 2020.

3 Serdar Çelik and Mats Isaksson, ‘Institutional Investors as Owners: Who Are They and What Do They Do?’ (2013) 11 OECD Corporate Governance Working Papers.

4 In a corporate sustainability context, see Beate Sjåfjell, ‘Achieving Corporate Sustainability: What Is the Role of the Shareholder?’ in Hanne S Birkmose (ed), Shareholders’ Duties (Wolters Kluwer 2017), chapter 18, at 394 at 382–385. In the context of institutional investor short termism potentially leading to the global financial crisis of 2008, see Lynne L Dallas, ‘Short-Termism, the Financial Crisis, and Corporate Governance’ (2011) 37 The Journal of Corporation Law 264. Short termism among institutional investors and its negative effects upon investee companies is also given considerable analysis in a UK context by John Kay, ‘The Kay Review of UK Equity Markets and Long-Term Decision Making: Final Report’ July 2012.

5 Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement, Recital 2.

6 Rafael Savva, ‘Shareholder Power as an Accountability Mechanism: The 2017 Shareholder Rights Directive and the Challenges Towards Enhancing Shareholder Rights’ (2018) 5 InterEULawEast: Journal of International & European Law, Economics & Market Integrations 277.

7 See Directive (EU) 2017/828, Article 1(2)(b) which provides that ‘institutional investor’ means: ‘(i) an undertaking carrying out activities of life assurance within the meaning of points (a), (b) and (c) of Article 2(3) of Directive 2009/138/EC of the European Parliament and of the Council, and of reinsurance as defined in point (7) of Article 13 of that Directive provided that those activities cover life-insurance obligations, and which is not excluded pursuant to that Directive; (ii) an institution for occupational retirement provision falling within the scope of Directive (EU) 2016/2341 of the European Parliament and of the Council in accordance with Article 2 thereof, unless a Member State has chosen not to apply that Directive in whole or in parts to that institution in accordance with Article 5 of that Directive’.

8 See ibid, ‘asset manager’ means ‘an investment firm as defined in point (1) of Article 4(1) of Directive 2014/65/EU that provides portfolio management services to investors, an AIFM (alternative investment fund manager) as defined in point (b) of Article 4(1) of Directive 2011/61/EU that does not fulfil the conditions for an exemption in accordance with Article 3 of that Directive or a management company as defined in point (b) of Article 2(1) of Directive 2009/65/EC, or an investment company that is authorised in accordance with Directive 2009/65/EC provided that it has not designated a management company authorised under that Directive for its management’.

9 Ibid, Recital 14.

10 Principles for Responsible Investment: An investor initiative in partnership with UNEP Finance initiative and the UN Global Compact, 2016.

11 PRI, Annual Report, 9 August 2019, at 38.

12 Directive (EU) 2017/828, Article 3g(1).

13 Ibid.

14 Therese Strand, ‘Short-Termism in the European Union’ (2015) 22 Columbia Journal of European Law 15 at 21.

15 Ibid (‘Although the Commission employs a “comply or explain” basis and allows some room for opt outs, the proposed requirements in practice impose significant hindrance to rely on passive ownership strategies unless the investors are able to “give a clear and reasoned explanation”’).

16 Iris H-Y Chiu, ‘European Shareholder Rights Directive Proposals: A Critical Analysis in Mapping with the UK Stewardship Code?’ (2016) 17 ERA Forum 31 at 35.

17 Iris H-Y Chiu and Dionysia Katelouzou, ‘From Shareholder Stewardship to Shareholder Duties: Is the Time Ripe?’ in Hanne S Birkmose (ed), Shareholders’ Duties (Kluwer Law International BV 2017) at 143 (emphasis in original).

18 While asset managers and asset owners can choose whether or not to become signatories to the Stewardship Code, asset managers that are regulated by the Financial Conduct authorities are required, under the FCA Conduct of Business Sourcebook, to disclose the nature of their commitment to the Code or where they do not commit to the Code, their alternative investment strategy. See FCA Conduct of Business Sourcebook, Rule 2.2.3. This does not apply to venture capital firms.

19 Chiu and Katelouzou (n 17).

20 For a greater discussion of costs as a barrier to engagement, see below at pp 19–20.

21 In particular, see Hanne Søndergaard Birkmose, ‘European Challenges for Institutional Investor Engagement – Is Mandatory Disclosure the Way Forward’ (2014) 11 European Company and Financial Law Review 214 at 233–235; Hanne S Birkmose, ‘Shareholder Duties – A Transformation of EU Corporate Governance in a Sustainable Direction’ (2018) 5 InterEULawEast: Journal of International & European Law, Economics & Market Integrations 69 at 85–86; Deirdre Ahern, ‘The Mythical Value of Voice and Stewardship in the EU Directive on Long-term Shareholder Engagement: Rights Do Not an Engaged Shareholder Make’ (2018) 20 Cambridge Yearbook of European Legal Studies 88.

22 See Part 5, below.

23 Directive (EU) 2017/828, Article 3h(2)(b).

24 The group of pension funds is called the Association of Member Nominated Trustees (AMNT). See AMNT, ‘Red Line Voting: A New Approach to Asset Owner Voting in the UK Stock Market by the Association of Member Nominated Trustees’, available at http://redlinevoting.org/wpcontent/uploads/2015/11/Red_Line_Voting_Red_Lines.pdf.

25 Ibid, http://redlinevoting.org/environment/.

26 Attracta Mooney, ‘Asset managers push back against activist pension funds’, Financial Times, 31 July 2016.

27 Ibid, quoting Laurent Ramsay, chief executive of Pictet Asset Management as asserting ‘[v]oting is an act of management and it is, therefore, done uniformly for all clients invested in pooled vehicles so far – so, no split votes on pooled funds’.

28 Hanne S Birkmose, ‘Forcing Shareholder Engagement: Theoretical Underpinning and Political Ambitions’ (2018) 29 European Business Law Review 613.

29 This corporate governance framework is agency theory, as described in Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305; Eugene M Fama, ‘Agency Problems and the Theory of the Firm’ (1980) 88 Journal of Political Economy 288; Paul Davies, Klaus Hopt and Wolf-Georg Ringe, in Kraakman, Armour, Davies, Enriques, Hansmann, Hertig, Kopt, Kanda, Pargendler, Ringe and Rock, Anatomy of Corporate Law, (3^rd ed, OUP 2017).

30 See, inter alia, Directive 2007/36/EC, Articles 5 (21 day notice right for general meetings), 6 (right to add items to the general meeting's agenda and to table resolutions), 8 (removal of obstacles to electronic voting), 9 (right to ask questions at the general meeting), 10 (right to appoint proxy holder to vote shares), 12 (right to vote in abstentia).

31 See Directive (EU) 2018/828, Recital 16; Article 3g; Hanne S Birkmose, ‘Shareholder Duties – A Transformation of EU Corporate Governance in a Sustainable Direction’ (2018) 5 InterEULawEast: Journal of International & European Law, Economics & Market Integrations 69 at 82–83.

32 See Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, Article 3, discussed further below in Part 3.

33 See Regulation (EU) 2020/852, Article 10, discussed further below in Part 3.

34 See Elia Trippel, ‘How Green Is Green Enough? The Changing Landscape of Financing a Sustainable European Economy’ ERA Forum, 7 July 2020 at 7.

35 EU High Level Expert Group on Sustainable Finance, ‘Financing a Sustainable European Economy: Final Report’ 31 January 2018 [hereafter ‘HLEG Group Report 2018’].

36 European Commission, ‘Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions: Action Plan: Financing Sustainable Growth’, 8 March 2018 [hereafter ‘2018 EC Action Plan’].

37 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector.

38 Regulation (EU) 2020/852.

39 Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks.

40 Regulation (EU) 2019/2088, Article 20(2).

41 Ibid, Article 2(1).

42 Ibid, Article 2(11).

43 Ibid, Article 3(1).

44 Ibid, Article 3(2).

45 Schoenmaker (n 1) at 13.

46 Regulation (EU) 2019/2088, Article 4(1).

47 Ibid, Article 2(24).

48 Ibid, Article 5(1).

49 Ibid, Article 6(1)(a).

50 Ibid, Article 6(1)(b).

51 Ibid, Article 8(1).

52 Index benchmarks are discussed in more detail below, when discussing the Benchmark Regulation in Part 4.

53 Regulation (EU) 2019/2088, Article 9(1).

54 Ibid, Article 9(2).

55 Ibid, Article 2(17).

56 Ibid.

57 Ibid, Article 10(1)(a).

58 Ibid, Article 10(1)(b).

59 Ibid, Article 11(1).

60 Ibid, Article 14(1).

61 2018 EC Action Plan at 4.

62 2018 EC Action Plan at 4.

63 Regulation (EU) 2020/852, Article 3.

64 See ibid, Recital 14 (‘To avoid market fragmentation as well as harm to consumer interests due to divergent notions of environmentally sustainable economic activities, national requirements that financial market participants or issuers should comply with when they wish to market financial products or corporate bonds as being environmentally sustainable, should build on the uniform criteria for environmentally sustainable economic activities’).

65 Ibid, Article 5.

66 Regulation (EU) 2020/852 refers to the Disclosures Regulation, articles 9(1),(2) and (3) and 8(1), discussed in Part 2.

67 Regulation (EU) 2020/852, Article 5(a). These objectives are listed in Article 9 and discussed in the next paragraph.

68 Regulation (EU) 2020/852, Article 5(b).

69 Ibid, Article 10(1).

70 Ibid, Article 16.

71 Ibid, Article 17(1)(a).

72 Ibid, Article 18.

73 EU Technical Expert Group on Sustainable Finance, ‘Financing a Sustainable European Economy: Taxonomy Technical Report’ June 2019.

74 EU Technical Expert Group on Sustainable Finance, ‘Taxonomy: Final report of the Technical Expert Group on Sustainable Finance’, March 2020.

75 Ibid at 13–14.

76 Claudia Kemfert and Sophie Schmalz, ‘Sustainable Finance: Political Challenges of Development and Implementation of Framework Conditions’ (2020) 1 Green Finance 237 at 238 (‘An inaccurate and inconsistent definition [of “sustainable”] can lead to misguided incentives and greenwashing’).

77 Gabriel Rauterberg and Andrew Verstein, ‘Index Theory: The Law, Promise and Failure of Financial Indices’ (2013) 30 Yale Journal on Regulation 101 at 125.

78 Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014, Article 3(1)(3).

79 Ibid, Article 3(1)(1).

80 HLEG, Final Report, 53.

81 Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks.

82 Ibid, Annex III(1).

83 Ibid, Article 19b, as inserted.

84 Ibid, Article 19d, as inserted. This must be done by 1 January 2022. This period may be extended by the competent authority.

85 Regulation (EU) 2016/1011, Article 24(1).

86 Ibid, Article 27(2).

87 Regulation (EU) 2019/2089, Article 27(2a), as inserted.

88 These differing perspectives are well summarised by Giovanni Strampelli, ‘Can BlackRock Save the Planet? The Institutional Investors’ role in Stakeholder Capitalism’ (2020) 11 Harvard Business Law Review (forthcoming) at 15.

89 Ronald J Gilson and Jeffrey N Gordon, ‘The Agency Costs of Agency Capitalism: Activist Investors and the Revaluation of Governance Rights’ (2013) Columbia Law Review 863 at 891–892; Simon CY Wong, ‘Why Stewardship Is Proving Elusive for Institutional Investors’ (2010) Butterworths Journal of International Banking and Financial Law 406 at 407.

90 ‘Shareholder activism’ is often divided into two forms: defensive and offensive, with the former involving the targeting of existing investee companies and engaging in order to protect the investment and the latter involving the targeting a company in which the activist does not have a pre-existing stake. See Andreas Jansson, ‘No Exit!: The Logic of Defensive Shareholder Activism’ (2014) 10 Corporate Board: role, duties and composition 16 at 19–20; Brian R Cheffins and John Armour, ‘The Past, Present, and Future of Shareholder Activism by Hedge Funds’ (2011) 37 Journal of Corporation Law 51 at 56–57; Iris H-Y Chiu, The Foundations and Anatomy of Shareholder Activism (Hart Publishing 2010) at 8–13.

91 See Jill Fisch, Assaf Hamdani and Steven Davidoff Solomon, ‘The New Titans of Wall Street: A Theoretical Framework for Passive Investors’ (2018) 168 University of Pennsylvania Law Review 17.

92 BlackRock, Larry Fink's 2018 Letter to CEOs.

93 Regulation (EU) 2019/2089, Article 19b, as inserted.

94 See Directive (EU) 2018/828, Recital 16; Regulation (EU) 2019/2088, Recitals 9, 19; Regulation (EU) 2019/2089, Recitals 16, 19.

95 See Directive (EU) 2018/828, Article 14b; Regulation (EU) 2019/2088, Article 14; Taxonomy Regulation, Article 15a; Regulation (EU) 2016/1011, Chapter 3.

96 See Jeffrey N Gordon, ‘Ties That Bond: Dual Class Common Stock and the Problem of Shareholder Choice’ (1988) 76 California Law Review 1 at 43; John C Coffee, ‘Liquidity Versus Control: The Institutional Investor as Corporate Monitor’ (1991) 91 Columbia Law Review 1277 at 1281; Bernard S Black, ‘Agents Watching Agents: The Promise of Institutional Investor Voice’ (1992) 39 UCLA Law Review 811 at 821; Stephen M Bainbridge, ‘Director Primacy: The Means and Ends of Corporate Governance’ (2003) 97 Northwestern University Law Review 547 at 558; Sanford J Grossman and Oliver D Hart, ‘Takeover Bids, The Free-Rider Problem, and the Theory of the Corporation’ (1980) 11 The Bell Journal of Economics 42; Edward B Rock, ‘The Logic and (Uncertain) Significance of Institutional Shareholder Activism’ (1991) 79 Georgetown Law Journal 445 at 456.

97 See above, text accompanying footnotes 18–20.

98 Giovanni Strampelli, ‘Are Passive Index Funds Active Owners? Corporate Governance Consequences of Passive Investing’ (2018) 55 San Diego Law Review 803 at 834 (‘“reputational competition” within the investment industry is a factor that can induce most institutional investors to increase their efforts in engagement with investee companies and to bear the related costs’.); Michal Barzuza, Quinn Curtis and David H.Webber, ‘Shareholder Value(s): Index Fund ESG Activism and the New Millennial Corporate Governance’, ECGI Law Working Paper N° 545/2020, October 2020, available at SSRN: https://ssrn.com/abstract=3439516.

99 For example, Jan Fichtner, Eelke M Heemskerk and Javier Garcia-Bernardo, ‘Hidden Power of the Big Three? Passive Index Funds, Re-Concentration of Corporate Ownership, and New Financial Risk’ (2017) 19 Business and Politics 298; Lucian Bebchuk and Scott Hirst, ‘Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy’ (2019) 119 Columbia Law Review 2029.

100 The Revised Shareholder Rights Directive and Disclosures Regulation contain jurisdictional limits on the institutional investors and asset managers that are subject to the provisions therein. These jurisdictional limits, broadly, restrict the application to institutional investors and asset managers that are regulated by other EU legislation, such as the UCITS Directive, MiFID II, AIFM Directive. The Big Three subsidiaries operating in the EU are regulated by these various Directives and so will have to consider how they make disclosures under the Revised Shareholder Rights Directive and Disclosures Regulation. They may also wish to market ‘environmentally sustainable’ financial products, including benchmarks, in the EU and will therefore be covered by the Taxonomy Regulation and Revised Benchmarks Regulation if they seek to do so.

101 Bebchuk and Hirst (n 103) at 2066.

102 Ibid.

103 Ibid.

104 Konstantinos Sergakis, ‘Legal vs Social Enforcement of Shareholder Duties’ in Hanne S Birkmose and Konstantinos Sergakis (eds), Enforcing Shareholders’ Duties (Edward Elgar 2019).

105 NGO Letter to Larry Fink, 4 May 2018, available at https://1bps6437gg8c169i0y1drtgz-wpengine.netdna-ssl.com/wp-content/uploads/2018/05/Larry-Fink-NGO-Letter-May-4-2018-1.pdf

106 See BlackRock, Client Letter, 14 January 2020, available at https://www.blackrock.com/corporate/investor-relations/blackrock-client-letter.

107 Ibid.

108 Larry Fink, Letter to CEOs, 14 January 2020, available at https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter.

109 Attracta Mooney, ‘BlackRock punishes 53 companies over climate inaction’ Financial Times, 14 July 2020.

110 Attracta Mooney, ‘Biggest asset managers attacked over role in climate change’ Financial Times, 11 January 2020.

111 See above, (n 104).

112 Attracta Mooney and Patrick Temple-West, ‘Climate change: asset managers join forces with the eco-warriors’ Financial Times, 26 July 2020.