The first part of July 2021 marks an important step at the level of the EU in its road towards the European Green Deal objectives. On July 14, 2021, the European Commission (EC) announced the rather complex set of reforms under the Fit for 55 package. Only a week before, the EC issued the Renewed Sustainable Finance Strategy setting forth the main steps going forward towards placing ESG-disclosures and sustainability matters at the heart of financing system and economy in the EU.
The focus on ESG and sustainability-related matters has constantly increased in the past years, both at the level of EU, but mostly when it comes to market practice, with the importance attached to such matters by investors and financiers growing at a rhythm exceeding by far the corresponding legal developments. The need to ensure a similarly high level of transparency regarding ESG matters provided by undertakings across Member States in order to eliminate potential barriers to free movement of investment and financing was flagged by the EC ever since 2011. Today, channeling of funds towards sustainable business and activities appears to be at the core of EU priorities, in line with the European Green Deal and, in line with the recent Renewed Sustainable Finance Strategy, it can only be expected to continue as a central piece of the EU policies.
In this context, the purpose of this material is to briefly go through the main ESG-pieces of legislation applicable to date at the level of the EU, as well as the ongoing amendment and development processes, highlighting the importance of such matters not only for listed companies and other entities currently subject to ESG disclosure requirements under the NFRD Directive, but also for investors and financing institutions subject to the Sustainable Finance Disclosure Regulation (SFDR) and more generally, for any other entities in the context of attracting funds from the market. These recent developments in various stages of completion will require a close monitoring with the ultimate aim of integration of such matters in the strategy of undertakings acting on the common market.
- The EU Taxonomy Regulation
Amidst the multitude of relevant initiatives and sets of regulations designed to help achieve these objectives, a central place is undoubtedly occupied by the Taxonomy Regulation. The regulation aims at establishing a unique reference system when it comes to what is “environmentally sustainable” in the EU, in other words determining “how good is good enough”.
1.1 Scope and criteria
The purpose of the Taxonomy Regulation is to establish the criteria for determining whether an economic activity is environmentally sustainable, in order to further determine whether an investment is environmentally sustainable. In essence, an activity is considered environmentally sustainable if it substantially contributes to one of the 6 objectives announced in the Taxonomy Regulation and does not harm any of the other objectives. The Taxonomy Regulation expressly regulates in its Article 17 the cases where an activity will be deemed as significantly harming the environmental objectives, in respect of each of the six objectives.
In June 2021 the EC published the EU Taxonomy Compass, including a visual representation of the contents of the EU Taxonomy, with the aim to allow users to check which activities are included in the EU Taxonomy (taxonomy-eligible activities), to which objectives they substantially contribute and what criteria they have to meet.
Assessment of whether an activity substantially contributes to one of the 6 objectives under the Taxonomy Regulation is to be done against the relevant set of technical screening criteria (TSCs) to be issued by the European Commission in respect of each of the objectives. The process of TSCs issuance by the Commission is so far following the timeline announced and, according to the Renewed Sustainable Finance Strategy, it should continue as per the below:
- on 21 April 2021, the Commission has issued a delegated act approving the TSCs in respect of the first 2 objectives under the Taxonomy Regulation (i.e. climate change mitigation and climate change adaptation) and formally adopted it on 4 June 2021 for scrutiny by the co-legislators. The act is currently under review by the European Parliament and the Council.
- the TSCs under the remaining 4 objectives should be adopted in the first half of 2022.
The TSCs under the Taxonomy Regulation are expected to set the environmental sustainability standards inter alia as regards (i) qualifying financial products and bonds as environmentally sustainable and (ii) making disclosures by entities subject to the NFRD Directive. Thus, the mandatory use of TSCs and compliance with the other requirements under the Taxonomy Regulation appear to be currently limited to entities subject to NFRD Directive and issuers of financial products and bonds qualified as environmentally sustainable.
However, reference to such criteria and applicability thereof have a wider impact to the extent that even smaller companies, not subject to NFRD Directive, may find themselves impacted by environmental sustainability requirements, in the context where they seek access to financing. Also, the “do no significant harm” principle set out under the Taxonomy Regulation has been taken over as one of the major criteria to be used in the process of assessing the national recovery and resilience plans presented by Member States seeking financing under the European Recovery and Resilience Facility. Only measures respecting this principle will benefit from support under these facilities.
1.2 The “double-materiality” standard and information to be provided
Under the Taxonomy Regulation system, such assessment is based on disclosure requirements meeting the “double materiality” standard explaining: i.e. impact of a company’s activities on the environment and society (“inside-out”) and the business and financial risks faced by a company due to its sustainability exposures (“outside-in”).
Guidance in terms of information to be provided by both financial and non-financial entities subject to the Taxonomy Regulation would be given by a Delegated Act adopted by the Commission under the Article 8 of the Taxonomy Regulation on 6 July 2021, and currently under scrutiny by the co-legislators. This Delegated Act details the information that undertakings subject to the NFRD Directive must include in their (consolidated) non-financial statements on how and to what extent the undertaking’s activities are associated with economic activities that qualify as environmentally sustainable.
1.3 Upcoming extensions of scope envisaged by the EC
While the current form of the Taxonomy Regulation focuses, as mentioned above, on environmentally sustainable finance and activities, the Renewed Sustainable Finance Strategy announces that the EC is considering the issuance of legislation aimed at recognizing intermediary steps towards sustainability and supporting financing of certain activities (mainly in the energy sector) that do not generate greenhouse gas emissions. Further, the EC intends to extend the taxonomy scope to sectors such as agriculture and energy, including nuclear energy and natural gas and related technologies, the latter as transitional activities. Such extension would be achieved by means of a complementary EU Taxonomy Climate Delegated Act, expected to be issued soon after the end of ongoing specific expert review process. Finally, by the end of 2021 the Commission is expected to start a similar road in connection with the social matters by publication of a report on the provisions required for a social taxonomy.
- Other recent legal developments regarding ESG requirements
As mentioned above, the Taxonomy Regulation is by no means the first EU piece of legislation setting forth ESG-related disclosure requirements, and, while the Taxonomy Regulation focuses on environmentally sustainable activities and investments, other sets of regulations concern the broader ESG context, with the same purpose of redirecting capital and investments towards sustainable activities and preventing “greenwashing”.
2.1 The SFDR
Applicable since 10 March 2021, the SFDR sets forth disclosure requirements for financial market participants and financial advisors regarding the integration of sustainability risks and consideration of adverse sustainability impacts in their investment decision-making processes and the provision of sustainability‐related information with respect to financial products.
This legal obligation for financial market participants and financial advisors to consider sustainability risks and adverse impacts in their activity will undoubtedly impact financing on the market, as financing entities can be expected to impose stricter requirements and have, in any case, an increased attention to such matters, in order to comply with the requirements incumbent on themselves under the SFDR.
In terms of reference system to assess risks and impact, the SFDR provides for several sets of technical standards to be issued by the Joint Committee of the European Supervisory Authorities (ESAs), as regards mainly methodology, content and presentation of information required to be disclosed thereunder. In this respect, the ESAs have issued proposals in respect of two sets of standards, a first set now pending adoption by the EC, while the public consultation organized by the ESAs in respect of a second set ended on 12 May 2021.
As per the Renewed Sustainable Finance Strategy, before the end of 2022, the EC intends to engage with the ESAs to review the regulatory technical standards under the SFDR in order to clarify not only indicators related to climate and environmental-related adverse impacts and risks, but also when it comes to social and employee matters, human rights, anti-corruption and anti-bribery matters.
2.2 Proposed amendments to the NFRD Directive
While the NFRD Directive took a first step in 2014 to impose ESG-related disclosure requirements on large listed undertakings (i.e. over 500 employees), banks and insurance companies and other companies to be designated by national authorities as public-interest entities, this was deemed as insufficient, as it resulted in only 11,700 companies being subject to disclosure requirements thereunder.
The NFRD Directive is therefore currently undergoing an amendment process, with the EC having published in April 2021 a draft Corporate Sustainability Reporting Directive (CSRD). Such proposal aims to remedy difficulties identified under the current NFRD Directive, in the double direction, as follows:
- extending disclosure obligations in terms of entities subject thereto (to include all large companies and all listed companies); and
- providing for the adoption of EU sustainability reporting standards to be developed by the European Financial Reporting Advisory Group (EFRAG), while the European institutions are expected to reach an agreement on the CSRD text and a first draft of standards expected to be issued by mid-2022.
Additionally, as per the Renewed Sustainable Finance Strategy the EC announces the preparation by EFRAG of a simplified sustainability reporting standard to be implemented voluntarily by SMEs.
Aligning these standards with other EU-level disclosure obligations under the SFDR and the Taxonomy Regulation and with delegated and implementing acts will thus become a key cornerstone as regards the coherent implementation of the disclosure requirements and achieving the ultimate goal of contribution to the EU Green Deal objectives.
2.3 Going beyond disclosure - the European Parliament’s ESG Directive proposal
Irrespective of the matter of applying a unitary set of criteria, all the above legislative acts cover requirements related to disclosure and thus would only indirectly result in imposing a certain behavior on entities subject thereof.
However, the initiative on corporate due diligence and corporate accountability promoted in the draft Directive issued by the European Parliament in the March 2021 Recommendation to the EC takes a step further. While this initiative is at a very early stage of its legislative process, it is noteworthy that it sets forth express requirements regarding due diligence in respect of environmental, human rights and good governance matters, throughout the value chain, and taking steps in order to remedy any breaches. The subsequent developments in respect of this initiative will need to be further monitored for a comprehensive picture of the impact of the ESG matters in the life of undertakings within the Member States.
All the above shows that, from different angles and perspectives - whether in terms of reporting or in the context of obtaining financing on the market or when it comes to benefiting from support under the umbrella of the EU Recovery and Resilience Facility – environmental sustainability and ESG-related matters are a matter of growing focus and concern in the EU. Given the complexity of aspects to look at and the importance of awareness in a context of increasing legislation on the matter, an assessment doubled by close monitoring of legal developments is definitely the recommended approach.
By Simona Petrisor, Partner, and Amalia de Ligenza, Managing Associate, Bondoc si Asociatii