ESG Policy and Regulation Round up: July 2022

Providing a comprehensive ESG* Policy and Regulation update to help those in sustainable finance get ahead of the latest developments shaping the market.

Table of Contents

Recent key policy developments, mainly in the UK and EU, and implications for those in sustainable finance:

  • ECB to incorporate climate change into its monetary policy operations
  • Nuclear and natural gas-related economic activities will be included in the EU Taxonomy

Other announcements and publications:

  • EU Platform published recommendations on compliance with the minimum social safeguards in the EU Taxonomy
  • ECB published the results of its first (bottom-up) climate stress test
  • Financial Conduct Authority (FCA) to delay consultation on SDR and investment labels until autumn 2022
  • EU Social Taxonomy delayed indefinitely

Key developments to look out for:

  • Negotiations over the EU Green Bond Standard will continue through to the end of the year
  • COP27 in Cairo, Egypt from 7-18 November
  • Biodiversity COP15 in Montreal, Canada from 5-17 December

Recent sustainable finance developments and implications for investors, lenders, issuers and borrowers

ECB to incorporate climate change into its monetary policy operations

Following the announcement of its climate action plan in July 2021 and the related roadmap, in July 2022, the European Central Bank (ECB) detailed[1] its plan to better take into account climate-related financial risk on the Eurosystem’s balance sheet, and support the green transition of the EU economy. The ECB aims to gradually decarbonise its corporate bond holdings[2] in line with the Paris Agreement goals.

Amongst other actions, the ECB is planning to:

  • Consider climate change in corporate asset purchases (by tilting holdings towards issuers with better climate performance in the subsequent portfolio reinvestment).
    • Better climate performance will be measured with reference to lower greenhouse gas emissions, more ambitious carbon reduction targets and better climate-related disclosures.
    • The ECB expects the measures to apply from October 2022, and further details will follow shortly before then.
    • The ECB will start publishing climate-related information on corporate bond holdings regularly as of Q1 2023.
  • Introduce climate change-related disclosures as an eligibility requirement in the collateral framework and asset purchases, as well as through adjusting haircut requirements for eligible collateral.
    • In terms of the additional climate-related disclosure requirements, the ECB will only accept securities from companies and debtors that comply with the EU Corporate Sustainability Reporting Directive (CSRD) – with the new eligibility criteria expected to apply as of 2026.
    • New requirements on collateral eligibility based on issuers’ climate performance should apply before the end of 2024 provided that the necessary technical arrangements have been put in place.

Furthermore, the ECB will work with rating agencies to be more transparent about how they incorporate climate risks into their ratings and to be more ambitious in their disclosure requirements on climate risks.


ECB Holdings Analysis

As of 15 July 2022, the ECB held[3] circa EUR 344bn in corporate sector purchase programme (CSPP) holdings. As noted below in Table 1, the CSPP holdings (as of late 2020) had a weighted average carbon intensity (WACI) in tCO2/US$ million GVA[4] of 1,0004t compared to all corporate bonds in the market at 235t of direct emissions – showing a much higher WACI compared to the overall corporate bond market and a higher WACI when looking at the pool of overall CSPP-eligible bonds that were not in ECB purchases.

Source: Arbeitspapier_05_2021.pdf

This may not come as a surprise as when you look at the split of CSPP holdings by sector in Table 2, the three largest sectors are Utilities, Infrastructure & transportation and Automotive & parts – generally representing high carbon-emitting industries as also suggested by Figure 3. With the new ECB purchasing rules you would expect the emissions associated with the CSPP holdings portfolio to decrease over time as new potentially lower carbon bonds are added to the portfolio replacing higher carbon emissions instruments.





Key considerations for sustainable finance market participants


Investors / Lenders

As noted by the ECB, a significant proportion of the assets that can be pledged as collateral in its credit operations, such as asset-backed securities and covered bonds (largely originated by credit institutions), would not fall under the CSRD, and the ECB is therefore calling for disclosures of climate-related data for them. Lenders will need to proactively consider how this may impact their loan portfolios that may serve as collateral in the future securitised transactions, and their eligibility under the ECB’s asset-backed securities and future covered bonds purchase programmes.


Issuers / Borrowers

While the details of the ECB’s methodology to align its corporate bond holdings with the Paris Agreement are yet to be revealed, corporate issuers will have to focus on their carbon footprint reduction targets and plans, and the associated disclosures. This development continues the trend to assessing the greenness of issuers overall, not just a specific bond. It’s also important to note that the CSPP programme is no longer injecting new liquidity into the market, simply reinvesting maturities. Whilst this is not necessarily a new development on its own, the ECB’s actions are helping to further support and reinforce the European Climate and Sustainable Finance policies. It is also important to note that the ECB’s measures may facilitate the setting of more nuanced / transition-oriented investment and exclusion policies by other public sector and private sector investors. Sectors that are currently a high percentage of CSPP holdings, as shown in Table 2, will be under more pressure to align with the updated methodology.


The ECB’s measures will initially focus on corporate debt instruments issued by non-financial institutions, however the ECB’s officials also noted that additional asset classes may fall under the updated collateral framework: “There are other assets which are very relevant and therefore we already now plan to extend these measures to unsecured bank bonds and also to credit claims,” Executive Board member Isabel Schnabel said[5].


Nuclear and natural gas related economic activities will be included the EU Taxonomy

The European Parliament voted against an objection put forward earlier by two parliamentary committees to the Commission’s proposal to include nuclear and natural gas related activities as sustainable investments in the EU Taxonomy via a complementary delegated act.

This means that the Parliament does not oppose the complementary Taxonomy Delegated Act put forward by the European Commission in March 2022 – i.e. some nuclear and natural gas-related projects will be included in the EU Green Taxonomy as shown in Table 3 below, as long as they also abide by the social safeguards and Do No Significant Harm (DNSH) criteria (e.g. consideration of local water quality, waste management, radioactive discharges, and undertaking environmental impact assessments)[6].

Source: Factsheet: EU taxonomy accelerating sustainable investments


Key considerations for sustainable finance market participants


Investors / Lenders

The inclusion of additional activities in the EU Taxonomy means more flexibility for investment managers and asset owners to diversify their Article 8 and 9 funds which will be required to report EU Taxonomy-aligned exposure. This may also make it easier for generalist / transition-focused investors to tap into Luxembourg tax benefits, as investors are offered a lower tax rate with higher levels of EU Taxonomy alignment – where funds can show that a minimum percentage of their investments are ‘sustainable’ as defined by the EU Taxonomy. This can have significant implications given the high proportion of Luxembourg-domiciled funds in Europe.

However, the changes are unlikely to lead to major new interest for impact investors signed-up to certain initiatives (e.g., Fossil Fuel divest), or already strong exclusionary polices. Furthermore, it is worth noting broad investor sentiment in relation to the two categories of economic activities. A similar debate is now taking place in the UK, leading investor groups (including global investors) have recently called for natural gas to be excluded from the UK Green Taxonomy; they stayed silent on nuclear which can suggest that related economic activities may be considered less controversial.


Issuers / Borrowers

It may be potentially easier to identify environmentally-sustainable projects, as defined by the EU Taxonomy, given the broader portfolio of potentially eligible green assets/projects for green financing, provided that they meet the relevant Technical Screening Criteria (TSC). Yet, it is important to note that certain green bond investors will still add their own gas/nuclear exclusionary overlay and that meeting the TSC may not be an easy task. However, potential issuers from the oil & gas sector may already be focusing on ‘greener’ projects such as hydrogen and biogas or issuing sustainability-linked bonds.

Other Announcements/ Publications

EU Platform published recommendations on the compliance with the minimum social safeguards in the EU Taxonomy

Under the EU Taxonomy Regulation, an economic activity can be considered as environmentally sustainable only if it is carried-out in compliance with so-called minimum social safeguards set-out in Article 18 of the Regulation. Under the same Regulation, the EU Platform on Sustainable Finance received a mandate to advise the European Commission on the application of Article 18 and the possible need to supplement its requirements. The minimum safeguards recommend that companies implement procedures to comply with OECD Guidelines for multinational enterprises and the UN guiding principles on business and human rights.           

On 11 July, the Platform published a report[7] with recommendations on how compliance with minimum safeguards (MS) could be assessed.

The report identifies four core topics for which compliance with MS should be defined:

  • Human rights, including workers’ rights
  • Bribery/corruption
  • Taxation
  • Fair competition   


The report specifically recommends considering as a sign of non-compliance with MS:

  • Inadequate or non-existent corporate due diligence processes on human rights, including labour rights, bribery, taxation, and fair competition
  • Final conviction of companies in court in respect of any of these topics
  • Lack of collaboration with a National Contact Point (NCP)[8]
  • Non-response to allegations by the Business and Human Rights Resource Centre


Amongst others, the report provides advice on project finance, SME financing, and green bonds, as well as advice on how to assess sub-sovereign compliance with MS.


ECB published the results of its first (bottom-up) climate stress test

On Friday 8 July, the ECB announced the results of its first bottom-up (based on real submissions from participating banks) climate stress test[9]. The objective was to optimise banks’ and supervisors’ capacity to assess climate risk and enhance the available information on climate risk stress testing. The ECB tested the participating banks on (1) own climate stress-testing capabilities, (2) reliance on carbon-emitting sectors, and (3) performance under different scenarios over several time horizons.

For climate stress-testing capabilities, the results showed that:

  • Around 65% of the banks scored “poorly” and showed significant limitations in their stress test capabilities.
  • Around 60% of the participating banks do not have a climate risk stress testing framework and most banks have not yet included climate risk in their credit risk models.


The reliance on carbon-emitting sectors showed that:

  • Almost two-thirds of banks’ income from non-financial corporate customers comes from greenhouse gas-intensive industries.
  • Banks lack actual data and often rely on proxies to estimate their exposure to emission-intensive sectors – which is acceptable at these early stages but will need to be improved over time.

And lastly, for performance under different scenarios over several time horizons:

  • Banks don’t have robust long-term strategies in place and show little differentiation between different possible long-term scenarios.
  • A sudden jump in carbon prices coupled with floods and droughts would lead to losses of at least EUR 70 billion for the euro zone’s largest banks.
  • Ultimately, an orderly green transition translates into lower losses than disorderly or no policy action.

The conclusion of this test was that banks need to continue working on improving their stress test frameworks’ governance structure, data availability and modelling techniques. The ECB noted that there will be no direct impact on capital through the Pillar 2 guidance this year. Participating banks have received individual feedback and are expected to take action accordingly, in line with the set of best practices that the ECB will publish in the final quarter of 2022.


FCA to delay consultation on SDR and investment labels until autumn 2022

The FCA moved plans[10] to consult on policy proposals for the Sustainability Disclosure Requirements (SDR) and the Investment Labels (DP21/4)[i] from July 2022 to autumn 2022 to take into account other international policy initiatives. DP21/4 sought initial views on SDR and a new labelling system for sustainable investment products with the aim to increase transparency for consumers and meet information requirements of institutional investors.

The key focus areas for the proposal are to have a standardised product classification and labelling system that helps customers understand the sustainability characteristics of different products, standardised information on the product’s key sustainability attributes, and granular information essential to institutional investors and a broader range of stakeholders.

EU Social Taxonomy delayed indefinitely

The EU’s effort to create a ‘social taxonomy’ has been slowed by political divisions[11] and is unlikely to be published in the next few years. While there hasn’t been any official statement from the Commission, lack of progress means that the initial timeline will not be achieved as investors were originally promised an EU Commission report outlining how it would go about creating a social taxonomy by the end of last year. That process was never completed, and no guidelines have been put forward by the EU since. While the EU’s Platform on Sustainable Finance, a body that advises the Commission, did publish a set of proposals for the social taxonomy back in February, those recommendations did not expedite the process. However, the EU’s existing taxonomy already requires companies to comply with a minimum of social safeguards such as basic labour rights and the EU may pursue other policy initiatives to give investors and companies guidance on social areas.

Key developments to look out for

Negotiations over the EU Green Bond Standard (EU GBS) will continue through to the end of the year

Interinstitutional negotiations (commonly known as trilogues) between the European Commission, the EU Parliament and the Council of Member States have started on the EU GBS, but the achievement of consensus on the final legislation is not expected until the end of the year given the highly divergent positions of the three institutions. There are several points to agree on, particularly the degree of Taxonomy-alignment of the Use-of-Proceeds, grandfathering of the EUGB designation and the requirement to publish transition plans at issuer-level as part of bond documentation, as well as extending the reporting requirements to other types of sustainable bonds issued in the EU beyond green.

COP27 to be held in Cairo from 7-18 November

Environment ministers from over 40 different countries met at the Petersberg Climate Dialogue in Berlin, Germany to prepare the ground for this year’s annual UN climate conference in Sharm el-Sheikh, Egypt, from 7-18 November. It is likely that both environmental loss and damage, and climate change adaptation, are set to be key issues at the forthcoming COP.

Biodiversity COP15 to be held in Montreal from 5-17 December

After more than two years of delays, the UN Biodiversity Conference (COP15) will take place in Montreal, Canada, from 5-17 December[i]. Governments will negotiate new targets to protect biodiversity and transform society’s relationship with it so that by 2050, the shared vision of living in harmony with nature is fulfilled. The upcoming preparatory session in Nairobi should see countries progressing the draft deal. The final global biodiversity framework agreement is to be finalised and presented at the COP15.


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

*For any unfamiliar terms used within this article please refer to our Insights glossary.


[1] ECB takes further steps to incorporate climate change into its monetary policy operations

[2] Bonds issued by non-financial corporates only

[3] Asset purchase programmes

[4] GVA - Gross Value Added – gross value added by sector (comprising several factor inputs such as wages, depreciation, other net taxes on production and gross operating surplus) over carbon emissions. A measure of showing the amount of carbon output per ‘economic output’ – the higher the value the more the sector emits per unit of economic output.

All corporate Bonds in the market – 61,750 active, euro denominated corporate bonds issued from financial and non-financial corporations

ECB eligible bonds - 9,005 active, euro-denominated corporate bonds issued by financial and non-financial corporations, listed as eligible marketable assets for Eurosystem operations (with eligible seniority)

CSPP-eligible bonds - 1,822 ECB-eligible corporate bonds that comply with the ECB's CSPP selection criteria

Actual CSPP-holdings - 1,415 CSPP-eligible corporate bonds purchased by the ECB under the CSPP

[5] Source: Bloomberg

[6] Commission Delegated Regulation (EU) 2022/1214 of 9 March 2022 amending Delegated Regulation (EU) 2021/2139

[7] Call for feedback on the draft report by the Platform on Sustainable finance on minimum safeguards

[8] Agencies established by OECD countries for the UNGPs

[9] Banks must sharpen their focus on climate risk, ECB supervisory stress test shows

[10] FCA: DP21/4: Sustainability Disclosure Requirements and investment labels

[11] EU Puts Key Plank of ESG Rulebook on Hold Amid Infighting - Bloomberg


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