"EU lawmakers are playing favourites with financial institutions — but this could backfire"

MEPs are set to decide how to include the financial sector in the corporate due diligence directive on 1 June. Their decision could either strengthen or distort the European financial market and enable corporate abuses of people and the planet, Uku Lilleväli writes. [...]

The Corporate Sustainability Due Diligence Directive can provide the financial sector with a clear legal framework to address these issues and pave the way for a more robust and resilient economy. [...]

The European Commission and the European Council are proposing to exempt asset managers and investors and limit mandatory due diligence obligations to financial services only, giving a free pass to investments and financial products. 

The European Parliament is edging closer to the final plenary vote that could change the course and ensure that investee companies and funds are not overlooked. 

But for this, MEPs can’t deviate from the compromise deal that has been carefully crafted with wide support from all key EU groups, considering the thorough discussions in the parliamentary committees.

Exceptions for some make it unjust to others

Making an exception for investments and asset managers makes it unjust for other financial services and institutions. 

What’s more, it also fails to incentivise them to identify and address sustainability risks. 

Businesses in economies with underdeveloped capital markets that struggle to secure equity investments and rely on credit would be disproportionately more affected than their peers.

Although SMEs are exempt, businesses in economies with underdeveloped capital markets that struggle to secure equity investments and rely on credit would be disproportionately more affected than their peers.

To add more insult to injury, the European Commission and the European Council have also created blind spots for the financial sector as they have asked financial firms to conduct sustainability due diligence only once before the financing decision. 

This allows them to overlook grave financial, physical and reputational risks that can arise throughout the financing cycle. 

Similarly to how banks need to know of any substantial changes in the credit profile of the mortgage holder or credited company, effective risk management requires an understanding of the relevant sustainability risks and harms that occur in the portfolios.

Full financial sector inclusion is proportionate, workable and necessary

Many investor groups like Eurosif, Principles for Responsible Investment and Institutional Investors Group on Climate Change have emphasised that requiring the entire financial sector, including asset managers and institutional investors, to conduct sustainability due diligence is proportionate, workable and necessary to manage sustainability risks, impacts and opportunities. 

Following a risk-based approach, all financial institutions would have to prioritise risks and impacts most relevant to their business model, mandate and portfolios, thus not putting a disproportionate burden on financial firms or omitting others.

It is crucial that MEPs support the entire compromise deal, which includes due diligence obligations for the entire financial sector.

Mandatory sustainability due diligence for all financial institutions, services and instruments would not only signal the need to address sustainability issues in the wider economy but also allow financial institutions to be more resilient and safeguard their long-term financial stability.