To ensure that the capital is truly steered towards sustainable activities, all the relevant stakeholders, including corporates, public interest companies, banks, financial institutions, asset managers, asset owners etc., need to report on their environmental, social and governance (ESG) considerations.
In order to provide an accurate implementation and coordination of the reporting on relevant data, three pieces of legislation will play a key role:
- Sustainable Finance Disclosure Regulation (SFDREU 2019/2088) along with more specific technical standards, which will define what and how, does the financial market participant need to disclose with regards to the sustainability of the financial product it offers – in practice this would mean that you shall be able to check if your private pension fund is investing sustainably or not, if it invests in social or environmental sustainability, is it taxonomy aligned. And if it is not as “green” as you may wish it to be, then free to shift your money and savings towards “greener” and more sustainable investments!
- Draft Delegated Act on art.8 of the EU Taxonomy Regulation, which will define how does the company (either financial or non-financial) need to disclose an alignment of its activities with the Taxonomy regulation. – so again, in practice and thanks to this piece of law, you shall be able to see, how sustainable is a company’s revenue, how about its daily operating expenses, or larger investments, are they “green” or not really? Banks will also need to disclose on how green and sustainable is their portfolio, their financial activities and investments. This information is not only important to you as a curious European citizen or a stakeholder potentially impacted by the company’s operations. This information is very important and will have to be provided to financial market participants, who in turn will need to report back on the very same to you (remember your pension fund exmaple? see above – the sustainable reporting loop is closed!).
- Corporate Sustainability Reporting Directive (CSRD,EU 2021/0104) published on 21st of April 2021 and amending the Non-Financial Reporting Directive (NFRD), introduces more detailed sustainability reporting requirements, defines ESG double materiality term and creaties a mandatory EU sustainability reporting standards – a very important milestone within the wider EU Sustainable Finance framework, which will ensure that all the companies in the scope of this directive (large, listed, financial and non-financial) will have to report on their sustainability strategies, impacts, risks, plans and results. This will be a very powerful tool, because together with the company’s financial annual report you will have access to the company’s annual sustainability report (harmonised and standardized across the EU). And these two reports shall be read together to have a global overarching view on the company ESG risks, impacts and financial results – one is very closely tied to another.
It is also equally important that a common, digital database is created, to ensure equal and transparent access to the disclosed data, enhancing more informative and active participation of the EU citizens in the sustainable financial transformation. The establishment of the ESAP (European Single Access Point) is the first action in the European Commission’s new action plan on the capital market union (CMU) and adoption of the relevant legislation on ESAP is planned for Q3 2021.
T&E works to ensure that the implementation of the Taxonomy Regulation disclosure requirements are impactful, coherent and representative of the taxonomy objectives and that the relevant climate-related data is duly stored in ESAP.
If Europe is to deliver on its ambitious Green Deal commitments and become climate neutral by 2050, creation of harmonised rules and legal oversights for the Environmental, Social and Governance (ESG) rating will be important.
Currently the ESG ratings are developed by a plethora of ESG rating agencies. Far from offering a solid, undisputable, assessment these ratings often diverge considerably. The divergence in methodologies used by such providers means that often companies with disputable environmental credentials can emerge as sustainable. A study done by the Massachusetts Institute of Technology showed how traditional credit ratings from Moody’s and S&P match up about 99% of the time while ESG ratings from different providers link up only about 60% of the time.
Furthermore, there is an important matter of a double materiality which will need to be addressed and clarified. Today, many ESG ratings are based on the financial materiality of sustainable factors (e.g. what is the impact of unsustainable governance on revenue) rather than the social and environmental impact of unsustainable choices (e.g. what impact do operations have on biodiversity).
A unique opportunity exists in the coming twelve months to improve the methodologies of the ESG ratings, to ensure that the newly created mass of information and data points thanks to rigorous and granular environmental criteria and thorough reporting and disclosure standards, can result in an impactful capital allocation.
EU Green Bond Standard
EU President Von der Leyen has announced the creation of an EU Green Bond Standard (EU GBS), and a dedicated €250 billion issuance program. Bonds are expected to be issued in the next two to three years. The sheer size of AAA issuance will make the EU GBS the world’s leading standard by size and credit quality. The new standard will be finalised in 2021 and it is vital that it is fully linked to the Taxonomy’s Technical Screening Criteria.
A number of technical details will determine the success and quality of the new standard, such as: (1) the quality of the underlying economic investments funded – this can be achieved ex ante, through a strict adherence to the taxonomy TSC, and ex post through verification processes and structures and (2) the swift creation of a full yield curve of liquid and actively traded benchmarks.
During the legislative process of the EU GBS, T&E will engage with relevant policymakers to ensure that the standard is finalised and tightly connected to the Taxonomy and the underlying projects are credible and compliant with the TSC.