Five Key Focus Areas of BaFin’s Sustainable Finance Strategy

On 5 July 2023, BaFin, Germany's financial supervisory authority, outlined its sustainable finance strategy (the Strategy).¹ The Strategy focuses on five areas that BaFin views as key to supporting the transition to a more sustainable economy and to protect investors from misleading information.

BaFin's Role as a Supervisory Authority

As a financial supervisory authority, BaFin's primary responsibility is to ensure a stable and functional financial system and, as is noted in the Strategy, BaFin has a limited role in the area of sustainable finance. It does not pursue its own environmental, social or economic policy goals nor direct financial flows, as these are the responsibilities of policymakers. BaFin's role is to supervise market participants and ensure they manage all risks, including those related to sustainability. The Strategy is intended to provide information as to the framework within which it operates and the expectations it has of itself regarding its own role with respect to sustainable finance, emphasizing BaFin’s risk-oriented approach to regulation, the need for reliable data and appropriate management of environmental risks.

According to the Strategy, taking sustainability aspects into account in supervision is a medium-term goal for BaFin, and is one of ten priorities the authority has set for the coming years. BaFin’s sustainability-related activities are based on the following understanding of its role:

•  ‘Sustainability’ is fundamentally understood to refer to Environmental, Social and Governance (ESG).
  
  
• In line with the current focus of regulation and available data, BaFin’s supervision is primarily based on the “E” of ESG – particularly climate change – rather than the “S” or “G”.
  
  
• BaFin treats supervision of ESG risks as part of its regular supervision of market participants.
  
  
• BaFin does not independently establish evaluation criteria for the ESG effectiveness of investment strategies or financial products. 
  
  
• Within its mandate, BaFin supervises the implementation of ESG transparency obligations by market participants and financial products, as determined by legislators.

Five Key Focus Areas of BaFin’s Strategy

1. Risk-oriented and practical regulation: In general, BaFin contributes to legislative initiatives, advocating for consistency across financial market sectors, appropriate proportionality and practicality. Supervisory law should serve exclusively the objectives of solvency, conduct and market supervision. BaFin notes in the strategy that green loans and green investments do not inherently carry lower risk, and the particular risk should always be the key consideration. Consequently, BaFin opposes the introduction of green supporting factors or brown penalizing factors that result in non-risk-consistent requirements.
   
   
2. More reliable data on financial climate risks: BaFin recognizes that market participants need access to reliable data from businesses across all economic sectors to effectively manage (i) transition to a more sustainable economy and (ii) physical risks. The availability of meaningful information is expected to improve in the next few years due to more comprehensive disclosure requirements at the EU corporate level, such as the Corporate Sustainability Reporting Directive (CSRD)² and the European Sustainability Reporting Standards (ESRS). BaFin will carefully monitor market participants' disclosure of sustainability risks and environmental risks and build enforcement capacities for CSRD compliance.
   
   
3. Appropriate management of environmental financial risks: In view of the increasing availability and quality of relevant data, BaFin encourages market participants to continuously improve their recognition, measurement and management of environmental risks. In the Strategy, BaFin addresses the appropriate management of transition to a more sustainable economy and physical risks as well as their transparent disclosure.
   
   
4. Preventing and combating greenwashing: BaFin emphasizes the importance of market participants considering the sustainability-related characteristics of their products and the sustainability goals of their target market during product development. It also stresses that during product development, market participants must consider sustainability features and target market goals. When market participants provide investment advice, investors’ sustainability preferences should be factored into such advice.
   
   BaFin highlighted that while there is no universally agreed definition of greenwashing, it undoubtedly involves market participants failing to clearly and honestly disclose their sustainability profile when distributing products, potentially misleading investors about the ESG impact of their investments. In some cases, greenwashing can also refer to market participants underestimating transition and physical risks or not transparently managing those risks. BaFin plays a role in both situations.
   
   To prevent greenwashing, BaFin uses its regulatory tools to ensure compliance with the transparency and disclosure obligations related to ESG impact (e.g., Sustainable Finance Disclosure Regulation (SFDR)³ and Articles 5 to 7 of the Taxonomy Regulation).⁴ BaFin is focused on the implementation of distribution requirements under the delegated regulations for the Insurance Distribution Directive (IDD)⁵ and MiFID II,⁶ and will monitor compliance with CSRD transparency obligations when they start to apply. BaFin also advocates for clearer and more meaningful information to be made available to investors with regards to ESG-related regulatory developments.
   
   
5. Generating and sharing knowledge in open dialogue: BaFin values open exchange with experts and stakeholders, and actively participates in European and international institutions, as well as engaging in bilateral exchanges with other supervisory authorities. In the Strategy, BaFin explains its mandate and the limits on its mandate, but it recognizes the importance of maintaining an intensive and open dialogue with all stakeholders. BaFin has an observer role in the German government's Sustainable Finance Advisory Board and participates in ESG discussions with the Federal Ministry of Finance and other leading agencies.

Conclusion

BaFin’s Strategy highlights the importance of risk-oriented and practical regulation, but also the need for reliable data on financial climate risks, appropriate management of financial environmental risks, prevention and combating of greenwashing, and generating and sharing knowledge in open dialogue. At the same time, the Strategy makes clear that BaFin does not pursue its own environmental, social or economic policy goals or direct financial flows, which are the responsibilities of policymakers.

Continuing to focus on ESG, on 11 July 2023, BaFin published a set of Questions and Answers on the application of the pre-contractual and periodic disclosure templates set out in the annexes to the regulatory technical standards supplementing SFDR (the Q&A).⁷ We will publish an OnPoint on the Q&A in due course.

Footnotes

1) The Strategy is available here (original language only).
2) Directive (EU) 2022/2464.
3) Regulation (EU) 2019/2088, as amended.
4) Regulation (EU) 2020/852.
5) Directive (EU) 2016/97, as amended.
6) Commission Delegated Regulation (EU) 2017/565, as amended.
7) The Q&A is available here (original language only).