ESG in the board room – a multi-layered challenge for directors of insurance and reinsurance undertakings

1. Over the past few years, the European legislator has been crafting an extensive and intricate regulatory framework to encourage insurance sector actors to integrate economic, social and governance (ESG) aspects into their business strategies and operations. 
The legal requirements deriving from this framework are vast and complex. In particular, they range from disclosure obligations to rules on risk management, product governance and suitability, as well as conflicts of interest.
2. The board of directors – as the body ultimately responsible for the sound and prudent management of insurance and reinsurance undertakings and their compliance with applicable laws, regulations and administrative guidelines  – is tasked with ensuring that all relevant ESG requirements are properly implemented. The challenges inherent to this feat were highlighted by Luxembourg’s supervisory authority for the insurance sector, the Commissariat aux assurances (CAA), in an information note published on 25 August 2022.  
3. This article provides a brief overview of the main practical impacts of today’s ESG rules on the boards of insurance and reinsurance undertakings (Undertakings), in terms of duties (II.), composition (III.) and liabilities (IV.).
4. Since, as mentioned above, the board is ultimately liable for the sound and prudent management of its Undertaking, it is also ultimately liable for ensuring compliance with today’s ESG requirements. 
5. Broadly, these requirements fall into three main categories:

Boards are expected to ensure that Undertakings comply with any relevant disclosure obligations, deriving notably from the amended Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector (SFDR), Regulation 2020/852 on the establishment of a framework to facilitate sustainable investment (EU Taxonomy) and Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups (NFRD). 
Boards are also expected to anticipate future changes in applicable disclosure requirements, such as those to be imposed under the proposal for a Corporate Sustainability Reporting Directive (CSRD), intended to amend the existing reporting requirements of the NFRD.

The legal framework deriving from the amended Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) has been amended to take into account the impact that sustainability risks may have on Undertakings’ risk profiles.
These amendments require boards to ensure that Undertakings integrate sustainability risks and considerations into their overall systems of governance and their implementation of the prudent person principle.

Similar to the Solvency II framework, the legal framework deriving from the amended Directive 2016/97 of the European Parliament and of the Council of 20 January 2016 on insurance distribution (IDD) has also been updated to integrate sustainability considerations into Undertakings’ product governance processes, suitability assessments and conflicts of interest arrangements.
6. In practice, therefore, it will fall to the board to oversee whether the updates needed to account for all applicable ESG requirements are made to an Undertaking’s internal processes, policies and procedures, as well as contractual documents and external publications.
Boards will also be in charge of ensuring that relevant staff are properly trained.
A. Competences 
7. In a general sense, Undertakings are required to ensure that the professional qualifications, knowledge and experience of all persons who effectively run the Undertaking or perform other key functions are adequate to enable sound and prudent management.  
8. The board of directors of any Undertaking must effectively possess competences pertaining to the insurance and financial markets, the system of governance, financial analysis, risk management and the regulatory framework and requirements. 
9. Since the ESG obligations deriving from the current legislative framework impact all these areas of competence, meeting these obligations requires a review of the competences present at the Board, both at a collective and individual level.
Indeed, board members must understand the key ESG requirements applicable to the Undertaking, so as to be in a position to supervise and evaluate their integration into its overall management.
10. The board is, however, not only required to ensure its own adequate composition in terms of competences. More generally, as the board of directors is, according to the applicable regulatory rules, ultimately responsible for evaluating the Undertaking’s overall system of governance, including its daily management and key functions , the board is ultimately also responsible for ensuring that the management and the other key functions of the Undertaking embed the knowledge, skills and experience necessary to understand the impact of ESG risks and factors on the Undertaking’s activities, strategy and economic model, as well as the concrete obligations that the complex and extensive ESG legal framework imposes upon the Undertaking.
11. From a practical perspective, this requires the board of directors:

B. Diversity
12. Beyond their impact in terms of professional competences, ESG requirements influence the personal qualities expected of board members, notably promoting greater diversity among them.
13. This is not entirely new; diversity in the board room has been considered a key component of good governance for regulated entities for a number of years now.
14. The Guidelines on system of governance published by EIOPA back in 2014  provide in this respect that Undertakings “should ensure that persons who effectively run the undertaking or have other key functions are ‘fit’ and take account of the respective duties allocated to individual persons to ensure appropriate diversity of qualifications, knowledge and relevant experience so that the undertaking is managed and overseen in a professional manner”
The foregoing is echoed by ESMA and the EBA in their 2021 Joint Guidelines on the assessment of the suitability of members of the management body and key function holders.  In particular, these specify that diversity, in terms of “age, gender, geographical provenance and educational and professional background” should be taken into account when recruiting members to the management body “to achieve a variety of views and experiences and to facilitate independent opinions and sound decision-making within the management body”.
15. Similarly, the recent CAA Circular Letter 22/15 on the board of directors of insurance and reinsurance undertakings  explicitly refers to the “principle of diversity of qualities and competences”.
16. Accordingly, boards of Undertakings must ensure, when recruiting members, that, as far as possible, they accumulate a broad set of qualities and competences in their members, in order to foster constructive criticism and discussion based on different points of view.
17. Whilst good governance in general is an eligibility criterion for classification as a sustainable investment, board gender diversity in investee companies in particular is now among the mandatory social principal adverse impact indicators imposed under the SFDR. 
As a result, diversity within the board room of Undertakings will arguably become subject to increasing scrutiny, both from regulators and from other stakeholders.
18. ESG requirements have indisputably become part of the board’s duties and responsibilities.
By the same token, they are now also part of the board’s liability exposures, be it from a regulatory or general corporate and civil law perspective.
19. Adequate training and active board involvement will thus be key to mitigating the associated liability risks.
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20. In implementing today’s ESG requirements, Undertakings face significant challenges; challenges that regulators at both the EU and the national level have clearly acknowledged. Nevertheless, Undertakings are expected – not just by regulators, but by all stakeholders – to ensure concrete compliance with all applicable rules and to monitor and anticipate regulatory changes.
Boards are destined to play a pivotal role in this process, and will also have to shoulder much of the burden of any shortcomings.
For board members, therefore, it is imperative to stay ahead of the ESG game.

By Emmanuelle Mousel, Partner specialised in Insurance & Reinsurance and Banking & Financial Services & Clara Bourgi, Senior Associate specialised in Banking & Financial Services and Insurance & Reinsurance.

[1] Article 70 of the amended law of 7 December 2015 on the insurance sector (the 2015 Law).

[2] Information Note 22/9 of 10 August 2022 regarding regulatory issues linked to sustainable finance.

[3] Article 72 of the 2015 Law.

[4] Point 8 of CAA Circular Letter 22/15 of 26 July 2022 on the board of directors of insurance and reinsurance undertakings.

[5] Point 21 of the CAA Circular Letter 22/15 of 26 July 2022 on the board of directors of insurance and reinsurance undertakings; Points 19 and 20 of the CAA Circular Letter 21/12 of 3 August 2021 on the key functions defined under Solvency II.

[6] Guideline 11 (point 1.42) of the EIOPA Guidelines on System of Governance, 1 January 2014, EIOPA_BoS_14/253 EN.

[7] Point 16 (Definitions, Diversity) and Title V (Diversity within the Management body) of the Final report on the Joint ESMA and EBA Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU, 2 July 2021, ESMA35-36-2319, EBA/GL/2021/06.

[8] Point 23 of CAA Circular Letter 22/15 of 26 July 2022 on the board of directors of insurance and reinsurance undertakings.

[9] ESMA Final Report on draft Regulatory Technical Standards with regard to the content, methodologies and presentation of disclosures pursuant to Article 2a(3), Article 4(6) and (7), Article 8(3), Article 9(5), Article 10(2) and Article 11(4) of Regulation (EU) 2019/2088, 2 February 2021 (JC 2021 03).

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Clara Bourgi

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