Implications of the European Commission’s June 2023 Sustainable Finance Package
On 13 June 2023, the European Commission (the Commission) published a new sustainable finance package to strengthen the existing EU sustainable finance framework in three key areas:
1. the EU Taxonomy;
2. ESG ratings; and
3. transition finance.
In principle, the package should facilitate more Taxonomy-aligned reporting for companies and asset managers. In addition, it includes additional guidance materials to address key implementation issues and support the usability of the sustainable finance framework for companies and the financial market.
The package does not propose any new reporting obligations on market participants beyond what is already applicable under the EU Sustainable Finance Disclosure Regulation (Regulation (EU) 2019/2088, the SFDR) or the upcoming Corporate Sustainability Reporting Directive (Directive (EU) 2022/2464, the CSRD). For more information on the SFDR and the CSRD, please see our Updates EU ESG Disclosures Required from March 10, 2021 — Action Points for Non-EU Fund Managers and EU Corporate Sustainability Reporting Directive — What Do UK- and U.S.- Headquartered Companies Need to Know?
Furthermore, the Commission has indicated that it is working on a comprehensive assessment of the SFDR framework, which will consider increasing its usability and role in mitigating greenwashing as well as its interaction with other sustainable finance legislations. A public consultation is expected in autumn 2023.
1. Proposed additions to the EU Taxonomy
The Commission has approved, in principle, a new set of EU Taxonomy technical screening criteria (TSCs) for economic activities that make a substantial contribution to one or more of the four remaining (non-climate) environmental objectives (the Taxo4) through a draft Taxonomy Environmental Delegated Act. The Taxo4 are:
- sustainable use and protection of water and marine resources;
- transition to a circular economy;
- pollution prevention and control; and
- protection and restoration of biodiversity and ecosystems.
The draft Taxonomy Environmental Delegated Act outlines 35 economic activities across eight industries (including certain software creation, professional services, and pharmaceutical activities) that substantially contribute to the Taxo4.
In addition, the Commission has proposed amendments to expand the existing set of economic activities that contribute towards the objectives of climate change mitigation and climate change adaptation. The changes would amend the current Taxonomy Climate Delegated Act1 and add technical screening criteria (TSCs) for 12 new economic activities in six industries including manufacturing, transport (including aviation), technology, and professional sectors.
The Delegated Acts are approved in principle by the Commission. It is expected that financial market participants would be able to disclose the Taxonomy alignment of their products against the Taxo4 environmental objectives (and the new activities for the existing climate objectives) from 1 January 2024, with reporting by companies subject to CSRD against key performance indicators required from 1 January 2026.
Further additions to the EU Taxonomy are expected. The Commission has stated that the EU Taxonomy remains a “living document” as the Commission has suggested that a second set of activities related to the Taxo4 will be proposed at a later stage.
The addition of new Taxonomy-aligned economic activities for all six environmental objectives aims to increase the usability of the EU Taxonomy. It will allow new industries and companies to show Taxonomy alignment in their reporting, if they are required by the CSRD or by investors subject to Taxonomy-aligned reporting in their SFDR disclosures.
In principle, these changes should help asset managers with Article 8 or Article 9 financial products that are already subject to Taxonomy-alignment disclosures under the SFDR. The expansion of the Taxonomy to cover the remaining four non-climate-related environmental objectives and additional activities in respect of the two climate objectives should bring more Taxonomy-alignment data into the market — particularly when combined with the upcoming reporting obligations on companies in scope of the CSRD.
Many asset managers subject to disclosure obligations under SFDR have been cautious of making commitments to their investors in respect of Taxonomy alignment. This is because of the compliance challenges associated with data availability and the investable universe for Taxonomy-aligned investments being limited to only economic activities that substantially contribute towards the two climate objectives (climate change mitigation and adaptation).
However, in principle, the package should enable investments in more industries and economic activities that will be recognised as contributing to the EU’s environmental objectives. For Article 8 or 9 financial products that commit to a minimum percentage of alignment with the EU Taxonomy, the package may expand the overall investable universe of Taxonomy-aligned investments. Accordingly, the market may see a trend towards more ambitious Taxonomy alignment commitments being made.
2. Proposal for a regulation of ESG ratings providers
The Commission has noted that ESG ratings providers perform an increasingly important role in the sustainable finance value chain. Consequently, the Commission has proposed a new regulation affecting ESG ratings issued by ESG rating providers operating in the EU that are disclosed publicly or that are distributed to “regulated financial undertakings” in the EU as well as companies that are subject to the EU Accounting Directive (Directive 2013/34/EU).
The proposed regulation aims to increase the reliability, comparability, and transparency of ESG ratings activities in the EU. Notable requirements on EU-based ESG ratings providers include:
- using methodologies that are “rigorous, systematic, objective and subject to validation;”
- publicly disclosing information on data sources, methodologies, and assumptions used in their activities and products;
- preventing and mitigating conflicts of interest; and
- being authorised and supervised by the European Securities and Markets Authority (ESMA), (third-country providers that deliver ESG ratings to EU firms would be subject to an equivalence or endorsement regime).
The regulation will now be subject to the EU ordinary legislative procedure among the Commission, European Parliament, and Council.
Firms should note that the proposal does not intend to harmonise the methodologies used by ESG ratings providers but aims to increase the quality of ESG ratings provided in the EU by fostering transparency and good governance across the market. It also does not affect private ESG ratings (i.e., those provided on an individualised basis or created internally).
3. Transition finance
The package also includes the Commission’s non-binding recommendations on transition finance that provides guidance on how firms, investors, and financial intermediaries can use the EU sustainable finance framework to approach “transition finance” and manage risks arising from climate change and environmental degradation.
The Commission’s recommendations clarify that the concept of transition finance (although not a legal definition) is understood as:
“the financing of climate - and environmental performance improvements to transition towards a sustainable economy, at a pace that is compatible with the climate and environmental objectives of the EU.”
Increasingly, the EU is highlighting transition finance as a means to help ease the mismatch between the high demand for ESG products and the limited supply of “sustainable” and “Taxonomy-aligned” investment opportunities (see ESMA’s discussion of this topic in our Investment Management Update from June 2023).
The Commission’s recommendations are particularly relevant for asset managers with investment strategies that seek to help finance the transition of companies and sectors that require more resources in their transition to sustainability.
1The Commission also adopted corresponding amendments to the Taxonomy Disclosures Delegated Act to clarify the timing of the disclosure obligations for the additional economic activities.
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