About the Sustainable Finance Action Plan
Scope of the Sustainable Finance Action Plan
Corporate Sustainability Reporting Directive (CSRD)
Corporate Sustainability Due Diligence (CSDD)
Sustainable Finance Disclosure Regulation (SFDR)
Low-carbon benchmark regulation
Industry implications of the European Commission’s Sustainable Finance Action Plan
Context
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.
The Sustainable Finance Action Plan has led to the creation of a regulatory framework that aims at increasing the transparency of financial markets and issuers regarding sustainability matters.
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 small and medium enterprises (SMEs) and individuals to access sustainable finance
On 13 June 2023, the European Commission published measures to complete its sustainable finance regulatory framework. Those measures aim at helping finance the transition of the economy towards an environmentally sustainable economy. As part of this package of measures, the European Commission has:
- Adopted delegated acts to complete the EU taxonomy of sustainable economic activities across the six EU environmental objectives
- Proposed new rules for Environmental, Social, and Governance (ESG) rating providers, which will increase transparency of sustainable investments
- Published the “Recommendation on facilitating finance for the transition to a sustainable economy,” which provides information and examples on how the EU taxonomy, EU climate benchmarks and EU green bond standards can be used to establish credible transition plans
About the Sustainable Finance Action Plan
The Sustainable Finance Action Plan has mainly resulted in the following key regulatory initiatives:
- The EU taxonomy regulation defines environmentally sustainable economic activities that significantly contribute to the six EU environmental objectives and introduces transparency requirements for financial products and companies
- The Sustainable Finance Disclosure Regulation and the Corporate Sustainability Reporting Directive introduce transparency requirements respectively for financial products and for companies on whether and how they consider sustainability risks and main adverse impacts on environmental and social matters
- The Corporate Sustainability Due Diligence directive requires large EU companies to perform due diligence on their value chain to ensure their suppliers and clients comply with human rights and environmental standards
Scope of the Sustainable Finance Action Plan
EU taxonomy Regulation
The EU taxonomy regulation establishes a taxonomy of sustainable economic activities for each EU 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 degree of alignment of financial products and companies with those objectives. Those transparency requirements apply to:
- The proportion of investments in environmentally sustainable economic activities for financial products in the scope of SFDR that have environmental characteristics or sustainable investment as an objective
- Key performance indicators that show the alignment of activities carried out by companies currently subject to the Non-Financial Reporting Directive (NFRD) and by companies subject to the Corporate Sustainability Reporting Directive
The EU taxonomy regulation entered into a phased-in application in January 2022, starting with the transparency requirement to disclose the alignment of financial products with the objectives of climate change mitigation and adaptation for non-financial companies. This transparency requirement will apply to financial companies from January 2024.
Transparency requirements regarding alignment with the other environmental objectives will start to apply from January 2024 for financial products, from January 2025 for non-financial companies, and from January 2026 for financial companies.
Regarding a potential social taxonomy (i.e., a classification tool for economic activities that contribute to the EU’s social goals, such as improved living standards, decent wages, and tackling bribery and corruption), the EU Platform on Sustainable Finance, an expert group advising the European Commission on taxonomies and related policy projects, published its final report on February 2022. The next steps are not yet known.
Corporate Sustainability Reporting Directive (CSRD)
The Corporate Sustainability Reporting Directive (CSRD):
- Extends the scope of the Non-Financial Reporting Directive (NFRD) to all large companies and all EU or non-EU companies listed on regulated markets (except listed micro-enterprises)
- Requires the audit (assurance) of reported information
- Introduces more detailed reporting requirements and a requirement to report according to mandatory EU Sustainability Reporting Standards (ESRS)
- Requires companies to digitally ‘tag’ the reported information so that they may be machine readable and feed into the European single access point (ESAP)
To complement this directive, the European Commission adopted on 31 July 2023 the delegated act on the first set of twelve European Sustainability Reporting Standards (ESRS), which apply regardless of the company’s sector of activity.
Other standards need to be adopted by the Commission to complete the CSRD regulatory framework:
- Standards applying to listed SMEs and for other SMEs, the latter being for voluntary use
- Sector standards
- Standards for non-EU companies in the scope of CSRD
Corporate Sustainability
Due Diligence (CSDD)
On 23 February 2022, the European 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.
The trilogue negotiations have started. The EU Parliament and the Council have divergent views on the scope of financial services and on the value chain for financial institutions.
The entry into force for large companies is expected in 2025, and in 2027 for high social and environmental risk sectors companies.
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 (institutions for occupational retirement provision – IORPs – and private pensions, managed portfolios, undertakings for the collective investment in transferable securities – UCITS, – alternative investment funds – 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
- On the description of ESG characteristics or sustainable investments as objective in pre-contractual documents and on their attainment in periodic reports
In April 2023, the European Supervisory Authorities (ESAs) consulted stakeholders on a review of the Regulatory Technical Standards to improve social disclosures and product information about greenhouse gas emissions reduction targets. ESAs are expected to publish their advice in Q3/Q4 2023.
A comprehensive assessment of SFDR started in September 2023 with a public consultation launched by the Commission. If this consultation is followed by a legislative proposal, this proposal will only be introduced by the new elected European Commission in late 2024 at the earliest.
Regulation on the transparency and integrity of Environmental, Social, and Governance rating activities
On 13 June 2023, the European Commission published a proposal for a regulation that aims at improving the reliability and transparency of ESG rating activities from ESG rating providers.
The proposal introduces:
- The obligation to ensure that fees charged to clients are fair, reasonable, transparent, non-discriminatory and are based on costs. In case of non-compliance, ESMA may take supervisory measures and decide to impose fines
- Disclosure obligations for ESG rating providers to their clients and on their website regarding their methodology models and key assumptions
- Rules on the prevention of conflicts of interest to increase the integrity of the operations of ESG rating providers. Some activities are prohibited, and in particular investment activities, banking, insurance, development of benchmarks, audit, and consulting
- In case of non-compliance, fines that can amount to 10% of the total annual net turnover
The Council and the Parliament must review this proposal before starting trilogue negotiations on a final text.
Low-carbon
benchmark regulation
The low-carbon benchmark regulation:
- Defines two new EU voluntary standards, namely the EU climate transition benchmark (CTB) and the Paris-aligned benchmark (PAB), for EU low-carbon benchmarks that are on a decarbonisation trajectory
- Introduces new transparency requirements on consideration of sustainability factors by benchmarks (except for interest and currency rate benchmarks)
The CTB and PAB represented about 34% of the climate benchmarks at the end of December 2022, according to a report on a study on the feasibility of minimum standards and transparency requirements of an EU ESG benchmark commissioned by the European Commission. This report concludes that a staged approach to the adoption of an EU ESG benchmark could be adopted with the adoption of a voluntary label based on minimum standards for each of the three aspects (E,S and G), the reference point being 2025 when disclosure under CSRD will start.
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.
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 under the EU taxonomy regulation, CSRD, SFDR, and the Capital Requirements Regulation (CRR) (Pilar III).
Institutional investors also face, on the one hand, demand for sustainable financial products from their customers and, on the other hand, the risk of complaints about greenwashing.
SFDR has introduced some concepts such as “sustainable investment” and “consideration of principal adverse impacts (PAI)” on social and environmental matters that have created legal uncertainty for financial market participants. This legal uncertainty has led to a comprehensive assessment of SFDR, which started in September 2023.
Securities Services’ view
The definition of screening criteria covering all six environmental objectives in the EU taxonomy will provide information on the degree of alignment of companies with those environmental objectives and will help companies to define credible transition plans towards environmental sustainability.
The lack of sustainability data to meet reporting obligations under SFDR, the Benchmarks Regulation, or the CRR should gradually reduce between 2025 and 2029 thanks to the phased-in entry into application of the EU taxonomy disclosure obligation for companies as well as the phased-in entry into application of CSRD.
Datapoints under the European Sustainability Reporting Standards adopted on 31 July 2023 with regard to the EU environmental objectives and social and governance issues may be omitted if the information in question is not relevant (“material”) for the business model and activity of the reporting company.
While a Q&A published by the Commission already clarifies that financial market participants may assume that any indicator reported as non-material by an investee company does not contribute to the corresponding indicator of principal adverse impacts in the context of the SFDR disclosures, further clarifications are expected under the frameworks of SFDR, the BMR or the CRR regarding the approach to be taken when a company has assessed a datapoint as being non-material.
Enhancing the quality of data providers on ESG research and ratings and promoting sustainable finance globally are key actions taken by the European Commission to help solve ESG data issues.
Key dates of the European Commission’s Sustainable Finance Action Plan
1 January 2022
- Financial products: pre-contractual documents and periodic reports for financial products with ESG characteristics or objectives 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
1 January 2023:
- Financial products: pre-contractual documents and periodic reports for financial products with ESG characteristics or objectives must comply with SFDR & EU Taxonomy detailed requirements of the Regulatory Technical Standards (RTS)
- EU taxonomy: non-financial undertakings must disclose the degree of alignment of their economic activities with the EU Taxonomy
June 2023:
SFDR: large product manufacturers must disclose principal adverse impact indicators on sustainability factors
Q3 2023
- EU TAXONOMY: EC adoption of the delegated acts to define the list of economic activities for the four remaining environmental objectives
- CSRD: EC adoption of the general set of standards for sustainability reporting
- ESAs’ progress report on greenwashing
Q3-Q4 2023:
- SFDR:
- The European Commission is expected to consult on a review of SFDR with a focus on how it can ensure legal certainty, usability, and prevent greenwashing
- ESMA advice to the EC on the review of PAIs in the RTS
- The European Commission is expected to consult on a review of SFDR with a focus on how it can ensure legal certainty, usability, and prevent greenwashing
- EU Taxonomy: Publication in the Official Journal of delegated acts to define the list of economic activities for the four remaining environmental objectives
- CS3D: adoption of the directive
1 January 2024:
- EU Taxonomy:
- Financial undertakings will have to meet the detailed disclosure obligation
- Entry into application of disclosure obligations regarding the four remaining environmental objectives
- Financial undertakings will have to meet the detailed disclosure obligation
May 2024
- Expected publication of ESAs’ report on greenwashing
1 January 2025
- CSRD: in scope companies must disclose standardised sustainability reporting that is externally audited from:
- January 2025 (for year 2024) for companies already subject to NFRD
- January 2026 (for year 2025) for non-NFRD Companies
- January 2027 (for year 2030) for listed SMEs, small-non complex credit institutions, captive insurance
- January 2030 (for year 2029) – tbc for non-EU companies (with > EUR 150 M turnover in the EU)
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