ESG Regulatory Primer Series - Corporate Finance Institute & Rho Impact
Note: This document is not legal advice; it alludes to the EU’s main ESG regulations and their key concepts. It is not comprehensive to all legal requirements and content updates.
The EU’s legal system has always included laws protecting and advancing environmental, social, and governance issues. However, the introduction of the Non-Financial Reporting Directive (NFRD), in 2014, began a new regulatory era of specific, ESG-focused regulations in the EU.
To understand the developing landscape and the regulations that we will discuss below, it is essential to review two key initiatives: The European Green Deal and the EU Action Plan for Financing Sustainable Growth.
The CSRD, EU Taxonomy, and Sustainable Finance Disclosure Regulation (SFDR) are all key elements supporting the advancement of these two overarching, governmental objectives.
These emerging, ESG-specific laws include the following three regulations that all financial analysts should be aware of:
The EU Taxonomy is a classification system (guideline) that provides financial entities with criteria, metrics, and definitions to help determine what activities are “sustainable.”
A sustainable activity is defined as any economic activity, like an investment, that makes a contribution to achieving the EU’s net zero goal by 2050. The Taxonomy acts as a common language for financial entities, providing greater clarity on the sustainability performance and intended impacts of their potential investments.
The Taxonomy states guidelines that the following entities must consider when investing:
Each category outlines technical screening criteria for evaluating the sustainability of economic activities. There isn’t a one-fits-all list of criteria the regulation uses to differentiate sustainable from non-sustainable activities. Rather, the Taxonomy sets different technical screening criteria for sectors and activities (energy, manufacturing, transportation, agriculture, and more).
This technical criteria is developed based on the latest science and expert input, considering issues such as greenhouse gas emissions, resource use, land use, and other environmental topics. The Technical Screening Criteria outlines specific thresholds, benchmarks, and methodologies to assess a specific activity’s environmental impacts.
a. Disclose how their investment products align with the Taxonomy’s criteria
b. Disclose the extent to which they consider the environmental objectives defined in the regulation
The main objective of the Corporate Sustainability Reporting Directive (CSRD) is to increase the quality, comprehensiveness, and transparency of sustainability reporting for companies operating within the EU. The CSRD provides a comprehensive framework for sustainability reporting that complements the existing financial reporting requirements within the EU.
Expanding disclosure requirements to include environmental, social, and governance information aims to promote sustainable business practices and meet the increasing demand for greater transparency on corporate sustainability performance.
The CSRD is mandatory for companies with the following characteristics:
Two additional categories are under more restricted obligations:
1. Reporting Deadlines: Companies that meet the criteria described above must start reporting by the following deadlines:
2. Reporting Requirements: The specific information that companies need to disclose under the CSRD can include, but is not limited to:
It is important to note that the exact details and requirements for disclosure may vary based on the company’s size, sector, and other relevant factors. The CSRD aims to introduce standardized templates and reporting requirements to enhance comparability and consistency across companies.
3. Comply or Explain: Companies must follow a “comply or explain” approach, which means they must disclose the requested ESG information or explain why they cannot do so. In either case, the statement must be approved by the board of directors and included in the annual financial report. It must also be audited by an independent third party to ensure accuracy and credibility.
The SFDR provides disclosure requirements for financial market participants (“FMPs”) regarding the sustainability risks, adverse impacts, and attributes of their financial products and investments.
The SFDR directly applies to financial institutions operating in the EU, which include banks, insurers, asset managers, and investment firms.
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