2024 may be the year of implementation of key wide-ranging legislation in Europe as well as the development of further rules and guidance, with other countries and jurisdictions expected to follow suit. Although the pace of regulatory and policy evolution could be very different across regions.

Issuers and investors across all industries will likely be focusing on applying various sustainability reporting requirements. New rules and reporting standards are being developed to support transparency around climate transition; nature and biodiversity risks; opportunities and impacts; value chain due diligence; and social factors, including in the context of Just Transition. Increasingly, expectations will rise around further integration of ESG factors into traditional financial reporting and analysis and may stretch far beyond 2024. 

Recent UK, EU, US and globally significant policy and regulatory developments and implications for investors, lenders, issuers, and borrowers

• UK Financial Conduct Authority (FCA) publish final Sustainability Disclosure Requirements (SDR) legislation for UK asset managers 
  

Other announcements and publications

Global

• Basel Committee on Banking Supervision launches a consultation on Pillar 3 disclosure framework for climate-related financial risks
• The Partnership for Carbon Accounting Financials (PCAF) publishes its final standard on measuring and accounting for facilitated emissions in capital markets transactions 

UK

• The Transition Plan Taskforce (TPT) launches draft implementation guidance on transition plan disclosures for 7 sectors 

EU 

• EU Lawmakers agree on new Nature Restoration Law
• EU Lawmakers agree on the Critical Raw Materials Act 
• The Commission publishes final EU Taxonomy criteria for non-climate related environmental objectives
• The European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA) propose to amend Sustainable Finance Disclosure Regulation (SFDR) Principal Adverse Impact (PAI) indicators and streamline disclosures
• ESMA publishes a series of “Explanatory notes” to existing legislation
• ESMA publishes a report on climate-related disclosures in financial statements

FCA publish final SDR legislation for UK asset managers

Following the consultation on the Sustainability Disclosure Requirements and investment labels issued in October last year, the FCA has published Policy Statement PS23/16 [1], confirming sustainability disclosure and labelling regime, targeting UK asset managers. Ahead of that, the FCA reviewed [2] current practice on how fund managers have been embedding the FCA’s existing guiding principles in ESG and sustainable investment funds – noting the evidence of some good practice in the design and delivery of ESG and sustainable investments, but also flagging instances where the disclosure principle had not been fully embedded.

The final SDR package includes 3 main components:

• An anti-greenwashing rule for all FCA-authorised firms to make sure sustainability-related claims are fair, clear and not misleading
  
• Product labels to help investors understand what their money is being used for, based on clear sustainability goals and criteria
• Naming and marketing requirements so products cannot be described as having a positive impact on sustainability when they don’t

Originally the FCA had proposed three labels: “Impact”, “Focus” and “Improvers”, but responding to consultation feedback, added a fourth label: “Sustainability Mixed Goals”, essentially for investments with a combination of the three labels. These labels represent different sustainability objectives, and in turn different investment approaches to pursue those objectives. Products without a specific label can still use sustainability-related terms in their names and marketing, but with some conditions. For example, 70% of the portfolio should align with the sustainability claim, and certain terms like “sustainable” or “impact” are restricted.

A 70% threshold for aligned investments applies to all labels, requiring a “robust, evidence-based standard” of environmental or social sustainability (rather than a relative measure), but does allow some flexibility for risk management and liquidity purposes. Crucially, the FCA has noted feedback on the importance of ensuring compatibility with other regimes, including the Sustainable Finance Disclosure Regulation in the EU, and will continue to consider interoperability. 

The timeline for implementation is as follows:

• The anti-greenwashing rule starts to apply from May 2024
  
• Firms can use the investment labels from 31 July 2024; and
• Naming and marketing rules will come into effect from 2 December 2024

Issuers / Borrowers

These rules mostly apply to UK-based asset managers and therefore Sterling and even Euro issuers should be cognisant of the requirements that the fund to which their debt is allocated may have. Investors using these fund labels, or using sustainability terms in marketing, need to provide certain disclosures and can’t invest in anything that conflicts with their sustainability goals. Therefore, issuers should expect engagement on data to support these disclosures regardless of whether it’s a conventional, green, social or sustainability-linked bond. The lack of specificity on what makes an investment sustainable or what impact metrics can be used could lead to reporting / questionnaire / engagement fatigue by issuers. However, the overall improvement in ESG disclosures, as well as expected implementation of the International Sustainability Standards Board (ISSB) standards, should mitigate that concern.

Investors / Lenders

While the new rules currently apply to UK asset managers only, the FCA is considering the scope extension to other market participants, including overseas firms. The new regime will require adjustments in asset managers’ operations, product development, marketing strategies, and reporting processes.

In addition to the investment labelling requirements, the new regime sets rules for detailed pre-contractual, ongoing product-level, and entity-level disclosures. The anti-greenwashing rule mandates that sustainability claims must be fair, clear, and not misleading. Asset managers will need to scrutinise and possibly reconsider their marketing strategies to ensure compliance with the rules and the additional guidance once it has been finalised. The introduction of four sustainability investment labels and the new naming and marketing rules will require asset managers to re-evaluate their product offerings and align them with the new requirements. Additionally, they could see that these requirements or having certain fund labels become a part of the requirements from asset owners.

More generally, investors and asset managers may face a proliferation of sustainability product labelling and disclosure regimes globally once more jurisdictions continue to set their own requirements. Asset managers will need to be able to map the new requirements across jurisdictions – for example, an “Art 9 fund” under EU SFDR may not automatically meet the requirements to qualify for any sustainable investment label under the UK SDR. Page 122 of the Policy Statement provides a helpful summary comparison of the SFDR fund categorisation with the FCA labelling regime. 

Global 

Basel Committee on Banking Supervision launches a consultation on Pillar 3 disclosure framework for climate-related financial risks

The Basel Committee on Banking Supervision has published its consultation paper [3] on a Pillar 3 disclosure framework for climate-related financial risks. 

The proposal focuses on climate-related risks and not the whole spectrum of ESG risks – in contrast to disclosure requirements set out in the ESG risk Pillar 3 disclosures framework adopted by the EBA in the EU. The proposal on Pillar 3 disclosures puts forward very detailed and granular reporting templates and includes disclosures around: 

• Concentration risk
• Transition risk – exposures and financed emissions by sector
• Transition risk – facilitated emissions related to capital markets and financial advisory activities by sector (notably, in November PCAF published its final standard on measuring and accounting for facilitated emissions in capital markets transactions – see section below)
• Exposures subject to physical risk by geographical area
• Emissions forecasts
• Real estate exposures in the mortgage portfolio by energy efficiency level
• Emission intensity per physical output

The potential implementation date is set for 1 January 2026. Comments on the consultation should be submitted by 29 February 2024. The Committee will consider all feedback received through the consultation, with a view to publishing a revised or final proposal in H2 2024.

PCAF publishes its final standard on measuring and accounting for facilitated emissions in capital markets transactions 

The Partnership for Carbon Accounting Financials published [4] the first-ever Global Greenhouse Gas (GHG) Accounting and Reporting Standard for Capital Markets. The Standard aims to enable financial institutions to measure and disclose the GHG emissions associated with off-balance emissions for the first time. Reporting facilitated emissions associated with capital market instruments is currently “optional” under the GHG Protocol Scope 3 Standard and has therefore been excluded by many across the industry. The availability of the standard is expected to increase the level of disclosure across the industry, as has been the case with the publication of previous parts of the PCAF Standard (e.g. on financed emissions).

Transition Plan Taskforce launches draft implementation guidance on transition plan disclosures for seven sectors 

Following the publication of the final Disclosure Framework earlier in October, the TPT has launched the consultation [5] on its sector-specific guidance for preparers and users of climate transition plans. The sectors covered are: Asset Managers, Asset Owners, Banks, Electric Utilities and Power Generators, Food and Beverage, Metals and Mining, and Oil and Gas. These sectors were chosen given each sector’s greenhouse gas emissions; need for additional transition finance in the UK context and quality of existing guidance available in the market. The consultation on these drafts will be open until 29 December 2023.

EU Lawmakers agree on new Nature Restoration Law

The European Parliament and Council have reached a provisional agreement [6] on new legislation aiming to restore and protect natural habitats and ecosystems, including a mandated target for EU countries to implement measures to restore at least 20% of the EU’s land and sea areas by 2030, and for all ecosystems in need of restoration by 2050. Member states will be required to restore 30% of habitats that are in poor condition by 2030, increasing to 60% by 2040, and 90% by 2050 and also requires member states to regularly submit national restoration plans indicating how they will deliver the targets. 

The agreement includes a provision for the Commission to provide an assessment of the gap between restoration financial needs and available funding to facilitate solutions to bridge the gap. Lawmakers also agreed to a one year ‘emergency break’ that relates to permitting the suspension of agricultural ecosystem targets for up to one year in case of any unforeseen events that have consequences on food security.

The proposal will be submitted for formal adoption by the Council and Parliament. Within two years after the law being in place, member states will be required to submit their first nature restoration plans.

EU Lawmakers agree on the Critical Raw Materials Act 

The European Parliament and Council have reached an agreement on the proposed regulation which aims to address the materials required for electric vehicle manufacturing and the EU’s battery industry [7]. The regulation establishes a list of 34 critical raw materials, including 16 deemed strategic, with specific targets for increasing the EU’s contribution to these substances (10% for extraction, 40% for processing, and 15% for recycling).

To accelerate the achievement of these targets, the proposal advocates for a streamlined permit procedure for strategic extraction projects, to be centralised through a single national contact point. It emphasises the necessity of risk analysis for potential dependencies, member states’ exploration plans, increased investment in research and innovation, and environmental protection by promoting circular and sustainable raw material practices. On a global scale, the regulation outlines measures to diversify imports of critical raw materials, limiting any single third country to providing not more than 65% of the EU’s consumption for each strategic raw material.

The agreement now needs to be formally adopted by both the Council and the Parliament. 

The Commission publishes final EU Taxonomy criteria for non-climate related environmental objectives 

The European Commission has finalised legislative process for Environmental Delegated Regulation Act and Amended Climate Delegated Act [8]. The Environmental Delegated Act sets out new EU Taxonomy criteria for economic activities making a substantial contribution to the non-climate environmental objectives. The European Commission also adopted amendments to the Taxonomy Disclosures Delegated Act (so called “Art 8 disclosures”) and to the Taxonomy Climate Delegated Act, adding new activities and respective criteria contributing to climate change mitigation and adaptation objectives.

The adopted texts were published in the Official Journal of the EU on 21 November 2023 and will apply as of January 2024.

EBA, EIOPA and ESMA propose to amend SFDR PAI indicators and streamline disclosures

The three European Supervisory Authorities (ESAs) (EBA, EIOPA and ESMA) published their Final Report [9] amending the draft Regulatory Technical Standards (RTS) under SFDR. The ESAs propose adding new social indicators and streamlining the framework for the disclosure of principal adverse impacts of investment decisions on the environment and society. The new social indicators include: 

• Amount of accumulated earnings in non-cooperative tax jurisdictions for undertakings whose turnover exceeds €750 million; 
• Exposure to companies involved in the cultivation and production of tobacco; 
• nterference with the formation of trade unions or election worker representatives; share of employees earning less than the adequate wage

The ESAs also suggest new product disclosures regarding “GHG reduction” targets. Additionally, the ESAs propose further technical amendments, such as:

• Improvements to the disclosures on how sustainable investments “Do No Significant Harm” (DNSH) to the environment and society;
  
• Simplification of the pre-contractual and periodic disclosure templates for financial products; and
• Other technical adjustments concerning, among others, the treatment of derivatives, the calculation of sustainable investments, and provisions for financial products with underlying investment options
  

Next steps: The European Commission will study the draft RTS and decide whether to endorse them within three months. These draft RTS would be applied independently of the comprehensive assessment of SFDR announced by the European Commission in September 2023 and before changes resulting from that assessment would be introduced.

ESMA publish a series of “explanatory notes” to existing legislation

Separately from the proposed changes to SFDR RTS, ESMA has published three explanatory notes [10] to help stakeholders to navigate and better understand the Sustainable Finance legislative framework:

1. Application of do no significant harm (DNSH) requirements
   
2. Definition of sustainable investments 
3. Use of estimates

ESMA clarifies that the documents are purely descriptive. They are not intended to replace relevant legal texts or to provide guidance on the application of relevant provisions.

ESMA publish report on climate-related disclosures in financial statements

In 2022, ESMA outlined its strategic priorities for the period spanning 2023 to 2028, emphasising its commitment to fostering sustainable finance through the promotion of high-quality sustainability disclosures. This report [11] from ESMA aims to enhance issuers’ ability to deliver robust disclosures and establish consistency in accounting for climate-related matters in financial statements according to IFRS. Focusing on topics with a potentially higher impact, the report provides practical examples drawn from the 2022 annual financial statements of European non-financial corporate issuers. It clarifies that the report does not prescribe disclosure practices but offers illustrative examples.

For those looking to discuss any of the above further, please reach out to our authors:

• Tonia Plakhotniuk, Vice President, Climate & ESG Capital Markets 
• Daniel Bressler, Vice President, Climate & ESG Capital Markets, Corporates
• Roze Warren, Associate, ESG Advisory
• Tyler Mayzes, Analyst, Climate & ESG Capital Markets, Corporates
• Siobhan Wartnaby, Analyst, Climate & ESG Capital Markets
• Nirav Patani, Analyst, ESG Advisory

[1] Sustainability Disclosure Requirements (SDR) and investment labels
[2] Testing how Authorised Fund Managers are embedding the Guiding Principles in ESG and sustainable investment funds
[3] Disclosure of climate-related financial risks
[4] PCAF launches a new Accounting and Reporting Standard for Capital Markets
[5] TPT Consultation launched for Sector Deep Dives
[6] EU Lawmakers Agree on New Nature Restoration Law
[7] Council and Parliament strike provisional deal to reinforce the supply of critical raw materials
[8] Implementing and delegated acts - Taxonomy Regulation
[9] Final Report on draft RTS on the review of PAI and financial product disclosures in the SFDR Delegated Regulation
[10] ‘Do No Significant Harm’ definitions and criteria across the EU Sustainable Finance framework
[11] The Heat is On: Disclosures of Climate-Related Matters in the Financial Statements