In 2015, the adoption of the United Nations 2030 Agenda for Sustainable Development and the Paris agreement marked a significant shift in global attitudes towards climate change and sustainability.
On 8 March 2018, the European Commission published a first Sustainable Finance Action Plan to channel more funding to environmentally sustainable economic activities, particularly towards activities that can play a critical role in reaching a carbon-neutral and climate-resilient economy by 2050.
Sustainable finance: a renewed strategy for the European Commission
In July 2021, the Commission published its renewed sustainable finance strategy, which particularly focuses on:
Financing economic activities that further the transition to sustainable objectives
Improving the financial sector’s resilience to sustainable risks
Examining the desirability of a social taxonomy and improving opportunities for SMEs and individuals to access sustainable finance
About the Sustainable Finance Action Plan
The first action plan on sustainable finance has so far mainly resulted in regulatory initiatives, which:
Define what environmentally sustainable economic activities are, in particular economic activities that contribute significantly to mitigate climate change or adapt to climate change
Introduce transparency obligations for financial products and companies on whether and how they consider sustainability risks borne by investments or resulting from the economic activity carried out as well as on whether and how they consider and mitigate adverse impacts on environmental and social matters resulting from investments or from the exercise of an economic activity
Scope of the Sustainable Finance Action Plan
EU Taxonomy Regulation
The EU Taxonomy Regulation entered into a phased-in application as of January 2022.
The EU Taxonomy Regulation establishes a taxonomyof sustainable economic activitiesfor eachEU environmental objective– namely, climate change mitigation, climate change adaptation, pollution prevention, circular economy, protection of marine resources, healthy ecosystems – which (i) contribute significantly to reach at least one of the objectives (ii) without harming significantly any of the 5 other objectives (iii) while meeting minimum social and governance safeguards.
The EU Taxonomy Regulation also introduces transparency requirements:
On the proportion of investments in environmentally sustainable economic activities for financial products in the scope of SFDR with environmental characteristics or sustainable investment as an objective and,
On KPIs showing the alignment of activities carried out by companies subject to the Non-Financial Reporting Directive (NFRD) (EU public interest companies with staff over 500 people, covering approximately 11 700 companies and groups) with economic activities listed in the EU taxonomy.
On 21 April 2021, the European Commission published a proposal for a Corporate Sustainability Reporting Directive (CSRD) that amends the Non-Financial Reporting Directive in order to:
Extend the scope of NFRD to all large companies and all EU or non-EU companies listed on regulated markets (except listed micro-enterprises)
Require the audit (assurance) of reported information
Introduce more detailed reporting requirements, and a requirement to report according to mandatory EU sustainability reporting standards
Require companies to digitally ‘tag’ the reported information so that they may be machine readable and feed into the European single access point (ESPA) that will be implemented as of 2024
On 23 February 2022, the Commission published a proposal for a Directive on corporate sustainability due diligence.
Large EU companies and Non EU-companies active in the EU that have a turnover above a certain threshold would have to identify, bring to an end, prevent, mitigate and account for negative human rights and environmental impacts in the company’s own operations, their subsidiaries and their value chains.
In addition, certain large companies would need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5 °C in line with the Paris Agreement.
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Sustainable Finance Disclosure Regulation
The Sustainable Finance Disclosure Regulation – SFDR – entered into a phased-in application on 10 March 2021. SFDR applies to financial products (IORPs and private pensions, managed portfolios, UCITS, AIFs, insurance-based products) marketed in the EU, and to their manufacturers and financial advisers, by introducing transparency requirements:
On consideration of sustainability risks borne by financial products
On policies considering adverse impacts on environmental and social matters and associated indicators for manufacturers of financial products in the scope of application of NFRD, financial products manufactured by them and for financial products with environmentally sustainable investments as objectives
SFDR aims to provide greater transparency on the degree of sustainability of financial products.
Low-carbon benchmark regulation
The low-carbon benchmark regulation:
Defines two new EU voluntary standards, namely the EU climate transition benchmark and the Paris-aligned benchmark, for EU low-carbon benchmarks that are on a decarbonisation trajectory;
Introduces new transparency requirements on consideration of sustainability factors by benchmarks (with the exception of interest and currency rate benchmarks).
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Amendments to other regulations
Amendments to the UCITS Directive, AIFMD, MiFID II, Solvency II align the risk management process and due diligences process with new transparency requirements under the sustainability-risk disclosure regulation.
Amendments to MiFID II and the Insurance Distribution Directive (IDD) define which categories of financial products can be advised for clients who express sustainability preferences when asked the question as required by suitability assessment.
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Industry implications of the European Commission’s Sustainable Finance Action Plan
Although institutional investors and banks welcome the Sustainable Finance Action Plan, they are faced with difficulties in collecting granular and reliable data on sustainability to meet their transparency obligations.
The obligation for financial products to disclose the quantitative degree of alignment of their portfolio with the EU taxonomy entered into application in January 2022 under SFDR. The transparency obligation for non-financial undertakings on the alignment of their activities with the EU Taxonomy will only start as of January 2023.
Securities Services’ view
The CSRD proposal, which is proposed by the European Commission to enter into application as of January 2024 but could be delayed in the final text by one year as a result of negotiations with the EU Council and Parliament, will be part of the data gap solution by requiring in-scope companies to disclose standardised sustainability reporting.
The following actions, which are part of the renewed sustainable finance action plan, will also help to solve the data issues:
Enhancing the quality of data providers on ESG research and ratings
Promoting sustainable finance globally
Key dates of the European Commission’s Sustainable Finance Action Plan
1 January 2022
Financial products: periodic reports for financial products with ESG characteristics must comply with SFDR & EU Taxonomy requirements of level 1 texts
EU Taxonomy: companies must comply with simplified disclosure obligations
2 August 2022
Entry into application of AIFMD, UCITS, MiFID II amendments
31 October 2022
CSRD – expected adoption by the European Commission of delegated acts to provide for sustainability reporting standards with the exception of sector-specific standards
Q3- Q4 2022
EU Taxonomy: publication by the European Commission of the list of economic activities and associated screening criteria for pollution prevention, circular economy, protection of marine resources, healthy ecosystems
1 January 2023:
Financial products: periodic reports for financial products with ESG characteristics will have to comply with the SFDR & EU Taxonomy detailed requirements of the Regulatory Technical Standards (RTS)
EU taxonomy: non-financial undertakings will have to comply with the detailed disclosure obligation
SFDR: the European Commission to review SFDR with regards to the disclosure of the principal adverse impacts on social considerations by financial products and their manufacturers
CSRD: expected adoption by the European commission of a delegated act specifying sector-specific standards
SFDR: large product manufacturers must disclose principal adverse impact indicators on sustainability factors
CSRD: expected adoption of the delegated act on the first set of EU sustainability reporting standards
1 January 2024:
EU Taxonomy: Financial undertakings will have to meet the detaileddisclosure obligation
CSRD: large companies would have to disclose standardised sustainability reporting but this could be delayed by one year as a result of negotiations with the EU Council and EU Parliament