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Sustainability

Long-awaited agreement on the EU Corporate Sustainability Due Diligence Directive is reached

In our regular Sustainable Finance Policy and Regulation round-up we explore the latest developments shaping the market.

Table of Contents

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

  • European Council and Parliament reach agreement on Corporate Sustainability Due Diligence Directive (CSDDD)

Other announcements and publications

Global

  • Taskforce on Nature-related Financial Disclosures (TNFD) publishes draft sector guidance
  • International Organisation of Securities Commissions (IOSCO) consults on good practices to promote integrity and orderly functioning of Voluntary Carbon Markets (VCM)

UK

  • UK to introduce its own Carbon Border Adjustment Mechanism (CBAM)
  • New consultations launched on UK Emissions Trading Scheme (ETS)
  • UK government sets out the legislative framework to ensure that developers can meet their obligations under the UK’s Biodiversity Net Gain (BNG) law

EU

  • European Parliament and the Council reach a political agreement on new legislation to increase energy performance of buildings across the EU
  • European Financial Reporting Advisory Group (EFRAG) publishes its draft European Sustainability Reporting Standards (ESRS) implementation guidance on materiality assessment, value chain and ESRS data points
  • European Commission publishes FAQs on EU taxonomy disclosures for financial institutions
  • EU Platform on Sustainable Finance proposes creation of EU taxonomy-aligned benchmarks
  • European Banking Authority (EBA) proposes a voluntary EU green loan label to help spur markets
  • EBA consults on guidelines on the management of ESG risks
  • European Securities and Markets Authority (ESMA) proposes changes and updates timeline for its guidelines on funds’ names
  • European Insurance and Occupational Pensions Authority (EIOPA) consults on the prudential treatment of sustainability risks
  • EIOPA consults on its draft opinion on sustainability claims and greenwashing

Recent policy developments and financial market implications

European Council and Parliament reach agreement on CSDDD

The Corporate Sustainability Due Diligence Directive [1] is EU legislation that will require companies to conduct environmental and human rights due diligence. Captured companies will need to identify adverse environmental and human rights impacts arising from their own operations, subsidiaries, and business relationships. They will also need to disclose measures taken to prevent any potential impacts or mitigate any real impacts. If companies fail to comply and damage occurs as a result, they may be held liable and face financial penalties.

While the CSDDD applies to companies in the EU that have more than 500 employees and a net worldwide turnover of €150 million, financial firms will only have to conduct this due diligence for their own operations i.e. not for their lending clients or for their investments. The legislation envisions a review clause to assess in the future if the requirements around due diligence may need to be extended to also cover financing and investment transactions. Companies headquartered outside the EU will be captured in three years after the rules come into effect if they have €300 million of net turnover generated in the EU. The provisional agreement reached needs to be endorsed and formally adopted by the European Parliament and the Council, and the application dates are yet to be defined.

Key considerations for sustainable finance market participants

Issuers / Borrowers

The CSDDD includes a significant amount of work for captured companies and they must publicly disclose on the implementation of due diligence that considers human rights, climate change and environmental impacts of business activities. While the focus of the CSDDD is not on disclosure (in contrast to the Corporate Sustainability Reporting Directive (CSRD)), it does expand the requirements of due diligence across the supply chain and value chain and specifies that adverse human rights and environmental impacts should be identified and mitigated. This is also expected to influence treasury and finance functions and their management of suppliers.

And while financial institutions (i.e. banks and asset managers) are currently not required to include such elements yet, it’s possible that these financial institutions will still rely on CSDDD-related disclosures or ask about CSDDD processes when making investing or lending decisions.

Investors / Lenders

The outcome of the CSDDD application by corporates would mean greater transparency and accountability by investors’ and lenders’ portfolio companies. This could help investors and lenders better identify and manage ESG risk in their investment portfolios / loan books as it pertains to EU-domiciled firms, with particular relevance to those with large and complex supply chains.

CSDDD sets a mandatory requirement for corporates and financial institutions to publish climate transition plans and thus it is closely interconnected with the CSRD. It hence potentially provides greater ability to align portfolios with the 2050 net-zero goals, leveraging information in the corporate transition plans. 

Other announcements and publications

Global

TNFD publishes draft sector guidance

The Taskforce on Nature-related Financial Disclosures has published draft sector guidance [2] for eight priority sectors, including oil and gas, metals and mining, forestry and paper, food and agriculture, electric utilities and power generators, chemicals, biotechnology and pharmaceuticals, and aquaculture. The guidance documents outline sector-specific approaches to applying the LEAP process (Locate, Evaluate, Assess, Prepare), disclosure metrics and illustrative lists of impact drivers, risks, opportunities and response actions. The consultation for feedback is open until 29th March 2024.

IOSCO consults on good practices to promote integrity and orderly functioning of VCM

The International Organisation of Securities Commissions has released a consultation report [3] outlining 21 good practices to promote the integrity and orderly functioning of Voluntary Carbon Markets. The good practices cover regulatory frameworks, primary market issuance, secondary market trading, and use and disclosure when using carbon credits. The endorsement of these practices by IOSCO is expected to be a meaningful milestone for the evolution of this market. The deadline for submitting comments on the consultation report is set for 3rd March 2024.

UK

UK to introduce its own CBAM

The UK government will implement a Carbon Border Adjustment Mechanism by 2027 [4], which will apply a new carbon import levy on high-carbon and hard-to-abate sectors including steel and aluminium, cement, and ceramics. The levy aims to ensure that cheaper imports from countries with less strict climate policies face a comparable carbon price to ones produced domestically.

New consultations launched on UK ETS

The UK launched two new consultations on the UK Emissions Trading Scheme [5] [6] seeking views, among other matters, on the alteration of the free allocation methodology to better target those at risk of carbon leakage and to promote fair distribution of allocations.

UK government sets out the legislative framework to ensure that developers can meet their obligations under the UK’s BNG law

 

The UK government has published six draft Statutory Instruments (SIs) [7] which set out the legislative framework to ensure that developers can meet the duty to deliver a 10% biodiversity net gain now that BNG has gone live. As a reminder, BNG requires developers to include plans of how they will improve biodiversity when submitting planning applications.

Once enacted, a biodiversity gain plan must be submitted to the relevant planning authority prior to development. BNG currently applies to most major new developments (since January 2024) and will apply to small sites from April 2024. BNG is also due to apply to Nationally Significant Infrastructure Projects (NSIP) from November 2025, with guidance to be published in September 2024. Draft guidance from the Department for Environment Food and Rural Affairs (DEFRA) and the Department for Levelling Up, Housing and Communities (DLUHC) has also been published.

In addition, DEFRA have published a response to its Marine Net Gain (MNG) consultation [8], which outlined the intention to make MNG mandatory for all new in-scope development activities in English waters.

EU

European Parliament and the Council reach a political agreement on new legislation to increase energy performance of buildings across the EU

An agreement was reached between the European Parliament and the Council to revise the Energy Performance of Buildings Directive [9] which may impact issuers that include green buildings or renovations as eligible projects in Green Bonds, or investors that invest in such projects. The updated Directive will outline various measures to enhance the structural energy efficiency of buildings, placing particular emphasis on addressing the lowest-performing ones.

Among other improvements, the revised directive now states that national strategies must guarantee that at least 55% of the reduction in average primary energy consumption should be achieved through the renovation of the least energy-efficient buildings. Each Member State will adopt its own national trajectory to reduce the average primary energy use of residential buildings 16% by 2030 and 20-22% by 2035. Additionally, Energy Performance Certificates (EPCs) will be based on a common EU template with common criteria. The next step is for the European Parliament and the Council to formally adopt the provisional agreement and for the new legislation to be published in the Official Journal of the EU and enter into force.

EFRAG publishes its draft ESRS implementation guidance on materiality assessment, value chain and on ESRS data points

The European Financial Reporting Advisory Group has published three draft documents, suggesting implementation guidance for the European Sustainability Reporting Standards [10]. These standards are at the heart of the CSRD and provide guidance for these disclosures.

The first draft document is materiality assessment implementation guidance, which describes the requirements of the materiality assessment. The second document is on value chain implementation guidance, which describes the value chain reporting requirements including a ‘value chain map’. The last document published provides detailed ESRS datapoints implementation guidance and presents a complete list of ESRS requirements in Excel format. The opportunity to provide comments on the draft implementation guidance concludes on 2nd February 2024.

European Commission publishes further FAQs on EU taxonomy disclosures for financial institutions

The European Commission published a draft notice [11] providing FAQs on the implementation of disclosures under Article 8 of the EU taxonomy regulation (green asset ratios and other KPIs) for financial institutions.

The FAQs aim to address several issues relating to taxonomy disclosures in the scope of consolidation: treatment of exposures where taxonomy KPIs / information are unavailable from counterparties; treatment of derivatives, securitisations, covered bonds and structured notes, and funds; and evidencing compliance with technical screening criteria.

The notice also encourages financial institutions to make voluntary disclosures on:

  • Any estimates of taxonomy alignment of exposures that are excluded from KPIs (e.g. exposures to non-listed SMEs).
  • Any estimates of taxonomy alignment of their exposures covered by the KPIs, but where financial institutions lack sufficient data and adequate evidence specific to their exposures to prove taxonomy-alignment.
  • Any information in relation to a partial alignment of their exposures with the EU taxonomy (i.e. where only certain taxonomy criteria are met or are proven to be met).

Financial institutions would be expected to consider the guidance as they continue to implement EU taxonomy reporting requirements, however given the proximity of the publication to annual reporting deadlines, institutions may only be able to consider the guidance on a best effort basis for the first reporting cycle.

EU Platform for Sustainable Finance proposes creation of EU taxonomy-aligning benchmarks

A draft report on EU Taxonomy-Aligning Benchmarks (TAB) was published by the Platform for Sustainable Finance [12]. The proposed benchmarks provide investors and benchmark administrators with appropriate tools to align the taxonomy with their investment strategy or index development.

The report introduces two voluntary benchmark proposals, without and with exclusions (TABex and TAB), to initiate discussion on the role the taxonomy could play in shaping climate and environmental benchmarks. EU TAB are defined as benchmarks where the underlying assets are selected, weighted, or excluded in such a manner that (i) the resulting benchmark portfolio is on a scaling environmentally sustainable CapEx trajectory, (ii) while the non-environmentally sustainable CapEx proportion is on a decarbonisation trajectory and is also constructed in accordance with the minimum standards laid down in the delegated acts of EU Paris-Aligned Benchmarks (PAB). EU TABs with exclusions also include specific activity exclusion thresholds for fossil fuel related activities. The feedback period runs until 13th March 2024.

EBA proposes a voluntary EU green loan label to help spur markets

The European Banking Authority published recommendations to the European Commission [13] on the definition and possible supporting tools for green loans and green mortgages targeting retail borrowers and small and medium-sized enterprises. The EBA advised introducing a voluntary green loan definition based on the EU taxonomy – with the definition mirroring the features of the framework under the European Green Bond Standard (GBS) and being consistent with the taxonomy disclosure requirements.

Additionally, the EBA advises the Commission to consider integrating the concept of green loans and mortgages, in regulation such as the Mortgage Credit Directive (MCD).

EBA consults on guidelines on the management of ESG risks

EBA launched a public consultation [14] on draft guidelines regarding the management of ESG risks. The draft guidelines set out requirements for institutions: identification, measurement, management and monitoring of ESG risks; including through plans aimed at addressing the risks arising from the transition towards an EU climate-neutral economy. The consultation runs until 18th April 2024.

ESMA proposes changes and updates timeline for its guidelines on funds’ names

The European Securities and Markets Authority provided an update [15] on the status of its guidelines on ESG and sustainability-related terms in fund names; including details on the timing of their publication. This is separate to the Sustainable Finance Disclosures Regulation (SFDR) as that regulation currently focuses on fund disclosures.

Since the launch of the work on the guidelines, reviews on the Alternative Investment Fund Managers Directive (AIFMD) and Undertaking for Collective Investment in Transferable Securities (UCITS) Directive have progressed. ESMA has decided to postpone the adoption of the guidelines to ensure that the outcome of these reviews may be fully considered. The guidelines are expected to be approved and published in Q2 2024. The guidelines would apply three months after the date of their publication.

EIOPA consults on the prudential treatment of sustainability risks

The European Insurance and Occupational Pensions Authority published a consultation paper on the prudential treatment of sustainability risksd [16] focusing on three areas:

  1. The potential link between prudential market risks in terms of equity, spread and property risk and transition risks.
  2. The potential link between non-life underwriting risks and climate-related risk prevention measures.
  3. The potential link between social risks and prudential risks, including market and underwriting risks.

This represents the second phase of EIOPA’s mandate under the Solvency II Directive, following the first phase in December 2022. EIOPA aims to ensure that the prudential framework continues to adequately address sustainability risks to safeguard solvency, consumer protection, and financial stability. EIOPA welcomes comments on the consultation paper by 22nd March 2024.

EIOPA consults on its draft opinion on sustainability claims and greenwashing

The principles within the draft opinion [17] aim to help build a more effective and harmonised supervision of sustainability claims across Europe, and limit the risk of greenwashing in the insurance and occupational pensions sectors.

  • EIOPA has put forward four principles to be observed when firms make sustainability claims:
  • Claims made by a provider should be accurate, precise, and consistent with the provider’s overall profile and business model, or the profile of its product(s).
  • Claims should be kept up-to-date, and any changes should be disclosed in a timely manner and with a clear rationale.
  • Claims should be substantiated with clear reasoning and facts.
  • Claims and their substantiation should be accessible by the targeted stakeholders.

 

This follows similar such consultations from other UK and European regulators, such as the FCA. EIOPA also compiled examples of good and bad practices for each principle. The deadline for stakeholders to respond to the consultation is 12th March 2024.

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

 

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