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I started writing about EU Directives on investment back in 1998, when I covered the introduction of cross-border pension rights, and I’ve covered quite a few sizeable, complex, acronym-rich stories since: IORPs I & II and, another double act, the MIFIDs.
But I’ve never seen a story plot as big and complicated as that of the EU Green Deal, the Action Plan on Sustainable Finance and the Corporate Sustainability Reporting Directive (CSRD) … OK, maybe MIFID II 😉
Before I start, a quick thank you to the-powers-that-be that renamed the misnomer of the ‘Non-Financial Reporting Directive’ to the CSRD. Last year, ‘non-financial’ was voted the second most unpopular phrase in sustainable finance by RI readers, with good reason!
Good to get that off my chest.
We’ve dedicated most of our forthcoming RI Europe flagship conference next month to unpacking the most important aspects of the various EU regulations, and we’ve set up an ‘Any Questions’ forum where you can write what’s puzzling you about the proposals and we’ll try and get an answer.
And RI’s journalists have been doing a fantastic job looking at all the angles – and importantly, detail – on the EU regulatory developments. I’ll include their coverage here as deeper reference points to jump into.
But here’s my personal overview of what’s happening, which, like the RI Europe conference, is designed to simplify and support understanding, and give colour where I think it’s interesting. I should add that it’s not in chronological order, nor is it comprehensive. It’s more in ‘influence’ order, and very much as I see it…
Company reporting gets wider, deeper and more important
The EU’s new CSRD obliges the number of companies reporting sustainability data to quadruple to almost 50,000, covering three quarters of all EU-based companies – all large companies and almost all listed companies. That’s massive. An assurance mechanism will be applied for rigour, and the actual standards for disclosure are being developed by the European Financial Reporting Advisory Group. It’s hard to say how all this will fit with the global corporate reporting standards being developed by the IFRS Foundation’s Sustainability Standards Board. But something big will likely happen. Sometime. Soon. I think. Hopefully a smart amalgam of the best parts of each into a global sustainability reporting depot that can underpin clear, mandatory reporting regulation. But first, there has to be international agreement on whether reporting should focus on climate, or broader sustainability issues; and whether they should consider, on top of financial ESG risks, the impact of business activities on people and the planet. The US will have a big influence on the direction of travel on these two issues, as it wades into the debate for the first time this year.
I believe properly accounting for climate in corporate P&Ls is on its way, as I discussed in a must-watch RI webinar on the subject recently. What does all this mean for ESG data providers? In all likelihood, some form of tighter regulation on their services following the calls recently by a range of powerful organisations including national financial regulators and industry groups.
Taxi for the green taxonomy?
I’ll admit I wasn’t exactly bowled over by the idea of a taxonomy (is there a less sexy word?) to underpin EU efforts to address greenwashing and shift capital towards sustainable investments when the European Commission first proposed it. Don’t get me wrong, I have a deep respect for Linnaeus and science, but us journalists like something a bit juicier for headlines than ‘taxonomy’.
But, I am a convert. I was impressed with the taxonomy’s scientific credentials, pragmatism, progress and policy influence (and for a while it seemed to slip blissfully under the lobby radar). I was coming around to the power of ‘taxonomy’ thinking, when suddenly, WHAM, some climate laggard EU Member States realised the EU’s Covid recovery money was pegged to improved environmental standards and uproar ensued. And then, true to national energy policy form, France wanted nuclear in the taxonomy, Germany wanted it out. Then came the (ongoing) ruckus over looser rules on inclusion for gas, forestry and bioenergy. My new-best-friend taxonomy was in trouble!
The Franco-German spat had been public since December 2019 when the Level 1 part of the taxonomy was blocked because of it. The possible addition of gas and nuclear into the Level 2 part later this year is down to these tetchy negotiations. Add to that volatile energy mix the hordes of Brussels-based corporate lobbyists that have realised that Taxonomy + Net-Zero Commitments + Timeframe = Genuine Business and Investment Transformation and now we’re talking hardball. I can imagine European Commission staff are taking a lot of inbound flak at the moment, and I suspect we haven’t seen the last of this debate. Either way, we will clearly need to see higher carbon prices and related taxes/incentives to underpin the green taxonomy and pump-prime more related investment.
SFDR…another acronym arrives
Are you an Article 8 or 9, or maybe even a 3?
The new lexicon of reporting and information that financial product sellers need to produce on ESG has taken it away from the pastime of ‘those ESG people in the corner of the office’ to a must-know for compliance, reporting, product development, change management, RFP teams, and on up into the C-suite. This is a very good thing. Sustainability is now rightly on the agenda across entire financial service organisations. Finally, we can come out of hiding and openly talk about how serious and relevant all of this is to investment with our colleagues!
But, it’s complicated.
The 10 March deadline for Sustainable Finance Disclosure Regulation (SFDR) reporting was one of the earliest reporting milestones of all the initiatives under the EU’s sustainable finance strategy. However, the groundwork is far from over. The first deadline only required ‘principles-based’ disclosure while more detailed and stricter rules are being worked out. The detailed Regulatory Technical Standards (RTS) were due to come into force before March this year but will be delayed until 2022, partly because the original proposals were deemed too challenging due to a lack of data. The number of indicators investors and service providers must report against has been slashed from the original proposals. The European Supervisory Authorities (ESAs) – who have advised the EC on what the RTS should entail – recently warned that January 2022 may also be unfeasible unless the standards are finalised by July this year.
My colleague, RI Editor Sophie Robinson-Tillett, moderated a brilliant panel on how Dutch investors and the country regulator is approaching SFDR implementation at present at our recent RI Netherlands conference. It can be watched on playback here.
A major element of how the SFDR will really drive investment behaviour and client choices will be how the rules relating to investment product sellers and advisors require them to present (or not) ESG-related products to customers.
My colleague, RI Deputy Editor, Elza Holmstedt Pell, is tracking what the Delegated Acts for so-called ‘suitability preferences’ on advisory business mean. Once the Commission finalises a Delegated Act, European Parliament and the European Council generally have a two-month window to veto it (a rare occurrence). If they don’t, it enters into force across the EU.
Before I end on SFDR, I’ll admit to a growing concern that financial product sellers that steer clear of any mention of sustainability or ESG in their products could get off lightly; an unintended consequence perhaps? We’ll see.
What about green bonds?
A legislative proposal for a taxonomy-based EU green bonds standard (GBS) is expected this year. While most of the EU’s sustainable finance strategy is aimed at investors and companies, the green bond standard is expected to have implications for governments too. This is because 30% of bonds the European Commission plans to issue under its NextGeneration EU Covid-19 recovery package will be issued in the form of green bonds. However, it has recently emerged that the EU is unlikely to apply the EU GBS to its green bond programme and member states will not be required to disclose how they use proceeds from sovereign green bonds. While it wasn’t a complete surprise, it will send a message to some that public and private finance will not be subject to the same scrutiny on climate and sustainability.
Could S&G have their EU regulatory day?
E may be getting all the attention, but S&G have more recently risen up the agenda of policymakers, with a Social Taxonomy being considered and a Sustainable Corporate Governance Directive expected to be adopted in coming weeks.
The experts advising the Commission on what a social taxonomy could look like will present their initial thinking this month, but RI covered what some of that thinking looks like, based on internal documents.
The social taxonomy is expected to dovetail with the Sustainable Corporate Governance Directive, which looks set to require companies to measure any adverse sustainability impacts of their activities and take into account broader stakeholder interests relevant to the long-term sustainability of the firm or those impacted by its operations.
EU Member State efforts: is Denmark’s EU sustainable finance enforcement unit a sign of things to come?
The raft of new EU sustainable finance regulation will need to trickle down to national level guidance and policy. Examples of how various member states are going about this are starting to emerge. Denmark’s Financial Supervisory Authority, Finanstilsynet, for example, has created a new unit to monitor SFDR disclosures and will have powers to issue warning notices, injunctions and police reports to organisations that do not comply with the SFDR. Expect similar enforcement units to spring up across jurisdictions.
All this, and not a moment too soon
The timeline for making the EU Action Plan and sustainable finance strategy a reality is, and has always been, ambitious. Some deadlines have slipped in order to allow more time to address data gaps. But with the policy heft of the EU Green Deal behind it, and the ‘translation’ effects of EU policy starting to really pick up globally, this is the regulatory paradigm shift we have all been working for. As I’ve said before, responsible investment professionals are at the heart of these game-changing regulations, and we should back the changes vigorously, despite some of their flaws, and work these through to resolution as we go. To prevent climate destruction, restore invaluable ecosystems and biodiversity, make our societies more just and equitable and ensure that capitalism is accountable and mobilised for change, this policy revolution can’t take effect a moment too soon.
The RI Europe flagship conference runs from June 14-18 and will unpack the most important aspects of the various EU regulations on sustainable finance. It is free to attend for RI subscribers.