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In our latest report, we promised to come back with further details on the latest Sustainable Finance Package disclosed by the European Commission on June 13.
As a reminder, the package contains:
In the meantime, the European Commission released a Q&A on the European Sustainability Reporting Standards (ESRS) as well, with the objective of providing background regarding links between SFDR and Taxonomy.
The ESRS are technical standards which enable linking different pieces of legislation in the implementation of the Green Deal, namely CSRD and SFDR. They have been developed to help companies subject to the Accounting Directive fulfil their legal sustainability reporting obligations. The non-financial reporting obligations are detailed under the Corporate Sustainability Reporting Directive, which amends and completes the Accounting Directive and will replace the Non-Financial Reporting Directive (NFRD). Companies’ disclosures in the form prescribed by the ESRS will help, in turn, investors to get the information they require to fulfil their own disclosure obligations under SFDR.
These common standards, inspired by the Global Reporting Initiative (GRI) standards, are based on technical advice from EFRAG, an independent, multistakeholder advisory body, majority funded by the EU. They take into account the double materiality perspective.
What does the concept of “double materiality” mean?
By double materiality, we mean that companies, through their activities and operations, have an impact on people and the environment, on the Society/Environment in the broad sense. At the same time, the environmental, social, and governance issues, (i.e. the previously-mentioned Society/Environment), also have an impact on corporations by creating financial risks and opportunities. The double materiality perspective refers to the fact that, under ESRS, companies have to report on impact from both perspectives, subject to a certain materiality threshold.
The sustainability reporting standards are highly aligned with the International Sustainability Standards Board (ISSB) rules. The EU regulation has therefore implemented the ISSB as much as possible in its own legal framework. It is the first regulation worldwide with such a high level of adoption of the rules.
In terms of timeline, the European Parliament and the Council have in total four months to object to the proposal. If the proposal is adopted as such, the companies in the scope of the NFRD will report on the 2024 financial year from 2025 according to the ESRS and from 2026 for other large companies on their 2025 financial year. Listed SMEs will follow from 2027 at the earliest.
It is interesting to focus on the consultation for reviewing the CSRD criteria, with a focus on materiality assessment.
The text of the ESRS adopted by the European Commission differs from the proposal of EFRAG in that the European Commission decided to subject the entire reporting requirement to a materiality assessment by the reporting company, with a limited exception. By giving a key role to materiality assessment, the European Commission has substantially relaxed the reporting requirements for companies. While we can welcome the argument of materiality for sustainable requirement disclosures for companies, we still deplore the lack of consistency between what is requested from companies under CSRD compared to what is requested from financial market participants (FMP) under SFDR. Indeed, CSRD should provide the data needed by FMP to comply with SFDR disclosure requirements – notably the statement related to Principal Adverse Impact (PAI) indicators. By allowing companies not to report on key PAI if self-declared as non-material, the European Commission has created a data gap between corporations and FMP.
On the positive side, we can applaud the long-awaited Delegated Acts on the four remaining objectives of the EU Taxonomy, namely:
The draft Delegated Acts foresee 1 January 2024 as the proposed date of entry into force, meaning the European Parliament and the Council have 6 months in total for scrutiny. If they have no objection, the texts should increase the number of activities and investment opportunities entitled to EU Taxonomy alignment from that date. Indeed, 35 economic activities in 8 economic sectors are added to the EU Taxonomy opportunities universe.
The enlargement of the green activities according to the Taxonomy will present interesting opportunities for different sectors, in particular:
The green bonds market will also benefit from greater diversification beyond the usual renewable energy, green buildings, and clean transportation projects.
It can be noticed that some activities can be covered by two different taxonomy objectives, whilst the Q&A session from ESA dated 17.11.2022 has strictly forbidden any double counting in terms of SDFR reporting requirements. Therefore, as soon as one activity is counted as aligned with one taxonomy objective, it cannot be considered for another potential taxonomy objective.
The new Delegated Acts suffer from the same challenges as the existing Taxonomy, namely applying the eligibility technical screening criteria, notably the implementation of the “do not significantly harm principle”. These complexities are also tangible for debt issuance, notably when issuers would like to issue green bonds; it remains challenging in practice to align the taxonomy criteria with the upcoming European Green Bond Standard.
The European Commission has disclosed an EC Staff working document to enhance the usability of the EU Taxonomy and the overall EU Sustainable Finance framework.
The European Parliament and the Council now have 6 months in total to scrutinise the proposal, notably the controversial addition of aviation to the list of green activities or the offsetting programme regarding biodiversity. Regarding the latter, the European Commission already agreed on the exclusion of the offsetting programme from the activities aligned with Taxonomy on biodiversity. Concerning aviation, several NGOs and institutional investors have strongly reacted, arguing that if the sector needs transition and adaptation, it cannot be considered as transition activities for climate change adaptation or mitigation.
Lastly, a note on the proposed ESG Ratings Regulation disclosed on June 13. We welcome that the European Commission has decided to regulate this market, given its increasing importance, the reliance on data providers by the management industry, and the need for transparency and understanding of the ESG profile assessment.
In parallel with SFDR, this would be a transparency regulation, i.e., allowing the data providers to use their own methodology, as long as this is transparent and consistent. The expectations are greater transparency, more integrity with clearer objectives and methodologies, and better clarity on data sources. This new proposed regulation does not affect the obligation of financial market participants to perform quality due diligence on data providers and their methodology.
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