Market Transparency and Efficiency: How the Omnibus Proposal heightens Systemic Risks for Financial Stability
Introduction
The EU’s proposed changes to due diligence and sustainability reporting requirements under the Omnibus Proposal are more than just a regulatory adjustment - they have implications for how markets function. While policymakers emphasize the importance of efficient markets, limiting disclosure requirements removes information that investors rely on to allocate capital effectively.
This is not just about ESG; it is about ensuring that financial markets have access to all relevant data to make informed decisions. Without proper transparency, markets may misprice risks, leading to inefficient capital allocation and potential instability over time.
1. The Contradiction: Market Efficiency and the Role of Information
The Efficient Market Hypothesis (EMH) suggests that asset prices reflect all available information, but the degree to which this holds depends on the form of EMH in question:
Weak form: Prices incorporate all past trading information (e.g., historical prices and volumes).
Semi-strong form: Prices reflect all publicly available information, including financial and non-financial disclosures.
Strong form: Prices incorporate all information, including insider knowledge.
By reducing disclosure requirements, these changes particularly impact the semi-strong form of the EMH – the assumed form of how financial markets are operating. Here publicly available sustainability data would allowe investors to better assess long-term risks. If transparency is reduced, markets may struggle to accurately price climate and sustainability risks, potentially leading to misallocation of capital.
A historical parallel can be drawn to the 2008 financial crisis, where risks in mortgage-backed securities were not fully understood or disclosed, leading to mispricing. A similar challenge arises if climate-related risks are not adequately reflected in financial markets.
2. Asset Pricing Distortions and Systemic Risks
In asset pricing models, investors assess risks and expected returns based on available information. If companies are not required to disclose sustainability-related risks, these models may not fully account for transition risks associated with regulatory shifts, physical climate impacts, or changing consumer preferences.
Without clear data, investors might unknowingly overvalue firms with significant exposure to sustainability risks while undervaluing companies that are better positioned for long-term resilience. This could contribute to asset mispricing and potential corrections in the future, similar to how unpriced risks have led to market volatility in the past.
3. The Bigger Picture: Market Functionality and Capital Allocation
Efficient markets rely on complete and reliable information. If sustainability disclosures become voluntary, an adverse selection problem may emerge—companies with greater transition risks may opt not to disclose them, while those with lower risks might still provide transparency. This creates an uneven playing field, where investors cannot accurately differentiate between firms.
If financial markets fail to account for transition risks, capital may continue flowing into industries that are not aligned with long-term economic and environmental stability. Over time, this could result in inefficient investment patterns and financial corrections that impact both investors and broader economic systems.
Conclusion
The EU’s proposed regulatory adjustments have implications beyond ESG—they affect how financial markets process information. Market efficiency depends on transparency, and without adequate disclosures, investors may struggle to price risks effectively.
Ensuring that all relevant financial and sustainability-related information is available supports better decision-making and long-term market stability. Ultimately, well-functioning markets depend on clarity, and reducing transparency may create unintended inefficiencies in capital allocation.