Preparing the finance industry for ESG
Preparing the finance industry for ESG
Major changes require major preparation
Why is ESG important?
In March 2018, the Commission published its Action Plan on sustainable finance, built upon the group’s recommendations. The framework aims to set out an EU strategy for sustainable finance, as part of the broader efforts to connect finance with the specific needs of the European and global economy for the benefit of the planet and our society.
The three main focuses of the Action Plan are:
- reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth;
- manage financial risks stemming from climate change, resource depletion, environmental degradation, and social issues;
- foster transparency and long-termism in financial and economic activity.
Implementing this Action Plan will allow ESG to create value for future generations, shifting to a more sustainable economy!
The importance of the taxonomy regulation to define sustainability
The first goal of the Action Plan poses the question of what ‘sustainable’ means. It is for this reason that the Action Plan introduces the concept of Taxonomy, a classification system that provides a way to identify whether or not a given economic activity should be considered sustainable. This concept was translated into regulation on 22 June 2020. The Taxonomy Regulation applies to financial market participants that offer financial products, financial and non-financial undertakings subjected to the NFRD.
The EU legislative initiatives for ESG to support the Green Deal
The Taxonomy Regulation defines six environmental objectives:
- climate change mitigation;
- climate change adaptation;
- sustainable use and protection of water and marine resources;
- transition to a circular economy;
- pollution prevention and control;
- protection and restoration of biodiversity and ecosystems.
In 2014 the EU released the first directive aims to incorporate the ESG factors into corporate reporting: the NFRD (Non-Financial Reporting Directive).
The NFRD lays down the rules on disclosure of non-financial and diversity information by certain large companies. Specifically, it applies to large public-interest companies with more than 500 employees, covering approximately 11700 large companies and groups across the EU, including :
- listed companies;
- banks;
- insurance companies;
- other companies designated by national authorities as public-interest entities.
On 21 April 2021, the Commission adopted a proposal for a Corporate Sustainability Reporting Directive (CSRD) , which would broaden the reporting requirements of the NFRD. The proposal:
- extends the scope to all large companies (public and private) and all companies listed on regulated markets (except listed micro-enterprises);
- requires the audit (assurance) of reported information;
- introduces more detailed reporting requirements, and a requirement to report according to mandatory EU sustainability reporting standards, developed by the European Financial Reporting Advisory Group (EFRAG);
- requires companies to digitally ‘tag’ the reported information, so it is machine readable and feeds into the European single access point envisaged in the capital markets union action plan (example: through IXBRL).
The CSRD will ensure compliance with the SFDR and the Taxonomy Regulation. The CSRD will make sure that businesses submit the data that financiers and other SFDR-eligible market participants require. That specifically implies that the reporting requirements would include indications that match the SFDR’s indicator set.
The capital requirements regulation (EU) No. 575/2013, as amended in 2019 (CRR2), includes article 449a on disclosure of environmental, social and governance risks. This Article requires large institutions (total assets > 70 bn EUR) which have issued securities that are admitted to trading on a regulated market of any Member State, to disclose information on ESG risks, including physical risks and transition risks. Social and governance risks are also taken into account.
Published on the Official Journal of the European Union on November 2019, entry into force of the law from 10 March 2021, the SFDR (Sustainable Finance Disclosure Regulation) is a fundamental pillar of the EU Sustainable Finance agenda, having been introduced by the European Commission as a core part of its 2018 Sustainable Finance Action Plan, which also include the Taxonomy Regulation and the Low Carbon Benchmarks Regulation.
The Regulation applies mainly to financial institutions (banks, insurers, asset managers and investment firms) in the European Union.
Pillar 3 disclosures for ESG
The capital requirements regulation (EU) No. 575/2013, as amended in 2019 (CRR2), includes article 449a on disclosure of environmental, social and governance risks. This Article requires large institutions (total assets > 70 bn EUR) which have issued securities that are admitted to trading on a regulated market of any Member State, to disclose information on ESG risks, including physical risks and transition risks. Social and governance risks are also taken into account.
