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

• European Commission published extensive frequently asked questions (FAQs) to help the implementation of the EU Taxonomy

Other announcements and publications

Global

• Kunming-Montreal Global Biodiversity Framework was signed at COP 15

United Kingdom

• ESG Rating providers are likely to be regulated in the UK
• UK Net Zero Review results were published 

European Union

• The European Commission (EC) proposed amending the EU Prospectus Regulation to include ESG factors
• The final text of EU Corporate Sustainability Reporting Directive (CSRD) was published in the EU’s Official Journal
• European Council revealed its position on the EU Corporate Sustainability Due Diligence Directive (CSDDD)
• The EC proposed a voluntary framework for carbon removal certification
• The EC adopted final standards on ESG risk (Pillar 3) disclosures
• The European Central Bank (ECB) published new climate-related statistical indicators to help analyse climate-related risks in the financial sector and monitor green transition
• The European Banking Authority (EBA) published its new roadmap on sustainable finance
• European Insurance and Occupational Pensions Authority (EIOPA) published a discussion paper on the ‘Prudential Treatment of Sustainability Risks’

United States

• The Fed released ‘Climate Risk Management Proposals’ for the 6 largest U.S. banks
• The White House released a strategy fora system of natural capital accounting

What to look out for in the first half of 2023

• International Sustainability Standards Board (ISSB) to publish final sustainability reporting standards and consult on standards for issues beyond climate
• New UK Net Zero and UK Green Finance strategies to be revealed, and an update on the UK green Taxonomy is expected alongside
• ECB to publish first own climate report on corporate bond holdings
• SEC to publish its final legislation on climate related reporting and disclosure

European Commission published extensive FAQ to help the implementation of the EU Taxonomy

In December 2022, the Commission published two sets of FAQs [1] (in total covering more than 200 questions) to aid the implementation of the EU Taxonomy:

• The first set of FAQs [2], explores general (or “horizontal”) questions, as well as questions related to the technical screening criteria, including do no significant harm (DNSH).
• The second set of FAQs [3] provides clarifications regarding reporting requirements under the EU Taxonomy (under Article 8).

Key considerations for sustainable finance market participants

Issuers / Borrowers

Corporate issuers in the scope of the EU Non-financial Reporting Directive (NFRD) will be reporting on Taxonomy alignment of their revenues, capex and opex in 2023 for the first time, and financial institutions will be reporting on green asset and investment ratios in 2024.  The Article 8 FAQ should therefore come handy in providing guidance on some of the technicalities of the requirements ahead of the reporting deadlines.  Furthermore, issuers are increasingly seeking to update their green and sustainable bonds frameworks by including taxonomy-aligned economic activities as part of eligible project categories. The FAQs should naturally aid the issuers in performing the pre-issuance screening of the projects for taxonomy alignment as well as help with the post issuance allocation reporting, with the latter being seen as key.

The FAQs will also be helpful for issuers who have operations or activities that do not clearly or completely align to the technical screening criteria of the activity. The FAQs are clear that qualitative context is important on why the activity aligns to the Taxonomy. This also gives issuers further scope to explain their approach and / or any benchmarks used, and this can be helpful in clarifying why certain DNSH criteria may not apply. Furthermore, the first FAQ explicitly states that for issuers that operate in sectors not currently covered by the Taxonomy, there should be not effect on how investors view them from a sustainability perspective; other non-Taxonomy disclosures under the CSRD should help explain to investors their sustainability performance and impacts.

Finally, for issuers in specific sectors like defence and for issuers without Taxonomy-aligned activities, the FAQ provides expectations on how investors should view them from this perspective. In short, the EU is clear that ‘sustainability disclosures apply horizontally across all industries equally and they do not single out a particular sector’ and that there is ‘no obligation’ to have Taxonomy-aligned activities. The FAQs also provides the clearest guidance to date on applying national laws and regulation and non-EU standards (e.g. LEED). For real estate and construction activities, the standards and thresholds mentioned are explicit, but where other information can help in demonstrating this compliance, that is acceptable.

Investors / Lenders

Financial Market Participants in the scope of the Sustainable Finance Disclosure Regulation (SFDR) will have to report on the Taxonomy alignment of their financial products in 2023, and the additional guidance should provide some help in determining if investment should be deemed Taxonomy aligned. For example, for the real estate sector, the FAQ notes that the use of various green buildings certification regimes (LEED, BREEAM, DGNB) cannot be used as a proxy for taxonomy alignment as a default position (something that has been discussed widely and been pondered over) – any alignment, if exists, still needs to be clearly demonstrated. On the use of Energy Performance Certificate (EPC) equivalents for assessing alignment with the technical screening criteria of the activity “Acquisition and ownership of buildings”, the Commission allowed the use of alternative systems. Specifically, it noted that ‘within the EU, whenever an EPC is available for the relevant building considered, it should be used. When this is not possible, equivalents can be used instead. Outside the EU, equivalents can be used instead of the EPCs’.  

It is important to note that the evolution of the EU taxonomy will remain an ongoing process for years to come. The European Commission will continue to focus [4] on enhancing the usability of the EU Taxonomy. Early 2023 should also see additional guidance released, to clarify certain points around the requirements of the EU SFDR.  Much more information and technical details will need to be digested and put into application once the criteria for the rest of the environmental objectives have been adopted by the EU policymakers in 2023. Issuers and investors will therefore need to continuously monitor the developments and look out for new guidance, as well as be ready to adjust strategies, internal processes, policies and practice. 

Global

Kunming-Montreal Global Biodiversity Framework was signed at COP 15 (December 2022)

The Kunming-Montreal Global Biodiversity Framework [5], contains global goals and targets aimed at protecting and restoring nature for current and future generations. The UK and 194 other countries have signed on. The deal agrees to protect 30% of the planet’s land and 30% of coastal and marine areas by 2030 (known as “30-by-30”), thereby seeking to reverse natural ecosystem decline, through:

• Maintaining, enhancing and restoring ecosystems, including halting species extinction and maintaining genetic diversity
• "Sustainable use" of biodiversity: ensuring that species and habitats can provide the services they provide for humanity, such as food and clean water
• Ensuring that the benefits of resources from nature, like medicines that come from plants, are shared fairly and equally and that indigenous peoples' rights are protected
• Paying for and putting resources into biodiversity: ensuring that money and conservation efforts get to where they are needed
• Reduction of pesticide use and subsidies that deplete biodiversity by 2025, whilst eliminating, phasing out or reforming them

Signatories aim to channel $200 billion per year to conservation initiatives, from public and private sources. Developed nations will contribute a combined total of at least $25 billion of this every year by 2025, and $30 billion per year by 2030. The deal also calls for giving low-income countries “far more” in financial support than is currently provided for their efforts to protect nature (this may take time to agree though, as seen with the experience around transfer of climate adaptation support). Furthermore, parties agreed to make large companies and financial institutions being subject to “requirements” to make disclosures regarding their operations, supply chains and portfolios. 

United Kingdom

ESG Rating providers are likely to be regulated (December 2022)

Providers of ESG ratings face being regulated in the UK under a plan put forward by the UK government, which would make the UK the first country to do so [6]. Jeremy Hunt, the UK Chancellor of the Exchequer, announced the government will consult on potential regulation in Q1 2023 with the intention to improve transparency and market conduct. This follows on from similar sentiment expressed by European Securities and Markets Authority (ESMA) and other EU financial services regulators.

No further details of what the ESG ratings regulation would cover have been provided, although the FCA previously identified areas of focus. These include disclosure of methodologies, sources of information used and potential conflicts of interest. This follows the FCA announcement in November to convene a working group to develop a ‘code of conduct’ for ESG data and ratings providers. The UK Treasury will join this working group as an observer. The announcement has been welcomed by both the FCA and the investment industry.

UK Net Zero Review results published (January 2023)

In 2022 the UK government commissioned a review into its approach to achieving its Net Zero Strategy [7], published in 2021, given the change in the economic and macro environment. Chris Skidmore, former Energy Minister, led the review and in January 2023 the review report [8] was released making 129 recommendations. These focused on:

• Using infrastructure to unlock net zero
• Creating sustainable governance structures for net zero
• Backing businesses to go green
• Catalysing local action
• Increasing transparency and engaging people
• Delivering cleaner, cheaper, greener homes
• Conducting a strategic review on the UK’s international climate leadership
• Investing in R&D and technology

The results of the review are expected to feed into the updated Net Zero and Green Finance Strategies to be announced by the UK Government during Q1 2023.

European Union

European Commission proposed amend to the EU Prospectus Regulation to include ESG factors (December 2022)

The Commission adopted a proposal [9] for a regulation which included amends the EU Prospectus Regulation. For debt securities advertised as ‘taking into account’ ESG factors or pursuing ESG objectives, certain ESG-related information will be required to be included in an annex of the prospectus. The proposal clarifies that the delegated acts setting out specific requirements will be adopted by the Commission.

For issuers of equity securities, the delegated acts will also consider whether the issuer is subject to the sustainability reporting under the upcoming Corporate Sustainability Reporting Directive, and will require sustainability reporting to be incorporated (by reference) alongside / as part of the management reports.

This follows on a position paper [10] by the Dutch Authority for the Financial Markets (AFM) and Autorité des Marchés Financiers (AMF) published in 2019, outlining their common views on the content of the prospectus for green bonds.

Final text of EU Corporate Sustainability Reporting Directive published in the EU’s Official Journal (December 2022)

Final legal requirements of the CSRD have now been published in the Official Journal of the European Union [11]. The Official Journal is a statement of record for the European Union and only legal acts published in the Official Journal are binding

As a reminder, the CSRD will impact corporate reporting and the effective date will vary on the type of company. For companies already required to prepare a non-financial information statement under the EU NFRD, the CSRD is effective for periods starting on or after 1 January 2024 (i.e., first reporting to take place in 2025, in reference to the year of 2024). For other types of companies, a staged approach has been adopted:

• 2026 reporting for the financial year 2025 – for large companies (public and private) that are not currently subject to the NFRD
• 2027 reporting for the financial year 2026 for listed SMEs (except micro undertakings) and other smaller and non-complex companies
• 2029 reporting for the financial year 2028 for third-country companies with net turnover above 150 million in the EU if they have at least one subsidiary or branch in the EU exceeding specified thresholds

The European Commission is due to adopt the European sustainability reporting standards under the CSRD by June 2023.

European Council reveals its position on the EU Corporate Sustainability Due Diligence Directive (December 2022)

The CSDDD was published by the Commission in February 2022 and introduced rules on obligations for large companies regarding actual and potential adverse impacts on human rights and the environment, with respect to their own operations, their subsidiaries, and those carried out by their business partners. The proposal also requires the largest companies to publish mandatory climate transition plans aligned with the 1.5C scenario.

The Council has adopted its negotiating position on the directive which gives the Council a mandate to start negotiations with the European Parliament [12].

The European Parliament is currently shaping its own position and debates are taking place whether and to what extent financial institutions, and their business relationships, must be included in the scope of the legislation. The Parliament is looking to finalise its stance by May 2023.

Once adopted / fully adopted, member states will still have two years to transpose the Directive into national law before it applies.

EC proposed a voluntary framework for carbon removal certification (December 2022)

The European Commission announced its proposal on carbon removal certification, which would be the first EU-wide voluntary framework to certify high-quality carbon removals [13]. The aim of the proposal is to expand sustainable carbon removals and encourage the use of innovative solutions to capture, recycle and store CO₂ by farmers, foresters, and industries. The proposal forms part of the European Green Deal and is still to be debated by the EU Parliament and the EU Council.

The proposal sets out rules for the independent verification of carbon removals, as well as rules to recognise certification schemes that can be used to demonstrate compliance with the EU framework. To ensure the quality and comparability of carbon removals, the proposed regulation establishes four quality criteria:

1.     Quantification: Carbon removal activities need to be measured accurately and deliver unambiguous benefits for the climate

2.     Additionality: Carbon removal activities need to go beyond existing practices and what is required by law

3.     Long-term storage: Certificates are linked to the duration of carbon storage so as to ensure permanent storage

4.     Sustainability: Carbon removal activities must preserve or contribute to sustainability objectives such as climate change adaptation, circular economy, water and marine resources, and biodiversity

EC adopted final standards on ESG risk (Pillar 3) disclosures (January 2023)

The European Commission adopted its ESG Pillar 3 ITS [14] on ESG risk disclosures under the EU Capital Requirements Regulation.  Pillar 3 of the Basel Framework states the disclosure requirements to assess an internationally active bank's material risks and capital adequacy.

The summary fact sheet in short, sets out the fact the ITS has the following disclosure requirements:

• Qualitative information on ESG risks: describing the integration of such risks in business strategy and processes, governance, and risk management
• Quantitative information on climate change transition risks: covering credit quality of exposures, energy efficiency of immovable property as collateral for loans, using specific alignment metrics and disclosures on exposures to top 20 carbon-intensive counterparties
• Quantitative information on climate change physical risks: requiring a breakdown of exposures to activities by sector (NACE code) and geographic location, including for loans, debt securities, equity instruments that are NOT held for trading or sale, and loans collateralised with immovable property
• Quantitative information on mitigating actions associated with activities that qualify as environmentally sustainable under the EU Green Taxonomy: through the KPIs and green asset ratio (GAR), defined in under the Taxonomy Regulation (Article 8)
• Quantitative information on other mitigation actions and exposures to climate change-related risks that do not qualify under the Taxonomy: which still support the transition and adaptation process with regard to climate change mitigation and adaptation, explaining the type and nature of mitigation actions and risks they aim to mitigate

The application timeline follows a phase-in approach with first reporting due in 2023 in reference to 2022 (information on ESG transition and physical risks). The requirements will then progressively expand over 2023-2025 to include, among others, key performance indicators (KPIs) on Taxonomy-aligned exposures, Scope 3 emissions and temperature alignment portfolio metrics.

ECB published climate-related indicators to help analyse climate-related risks in financial sector and monitor green transition (January 2023)

As part of its climate action [15] plan, the European Central Bank has published its first set of climate-related statistical indicators to be able to assess the impact of climate-related risks on the financial sector and to monitor the development of sustainable and green finance [16].

The indicators cover three areas:

• Experimental indicators on sustainable finance: provide an overview of debt instruments labelled as “green”, “social”, “sustainability” or “sustainability-linked” by the issuer that are issued or held in the euro area
• Analytical indicators on carbon emissions financed by financial institutions: provide information on the carbon intensity of the securities and loan portfolios of financial institutions, and on the financial sector’s exposure to counterparties with carbon-intensive business models
• Analytical indicators on climate-related physical risks: analyse the impact of natural hazards, such as floods, wildfires or storms, on the performance of loans, bonds and equities portfolios

The publication of the new climate-related indicators is another step towards delivering on the ECB’s climate commitments. They are intended to start a broader conversation within the statistical and research community and with other key stakeholders on how to better capture data on climate-related risks and the green transition. The ECB, together with the national central banks, will work to improve the methodology and the data used.

European Banking Authority (EBA) published its new roadmap on sustainable finance (January 2023)

The European Banking Authority (EBA) published its roadmap outlining the objectives and timeline for delivering mandates and tasks in sustainable finance and environmental, social and governance risks [17].

The roadmap builds on and replaces the EBA’s first action plan on sustainable finance published in December 2019. It explains the EBA’s sequenced and comprehensive approach over the next three years to integrate ESG risks considerations in banking and support the EU’s efforts to achieve the transition to a more sustainable economy.

Key objectives of the EBA’s roadmap on Sustainable Finance

Source: European Banking Authority

The roadmap was developed based on the current state of the regulatory framework and reflects the EBA’s current expectations regarding specific mandates and tasks. However, considering the ongoing regulatory developments, including the review of the banking package (Capital Requirements Regulation (CRR)/Credit Requirements Directive (CRD)), the scope and timelines of specific tasks will only be fully known once the legislative processes are finalised.

European Insurance and Occupational Pensions Authority published a discussion paper on the Prudential Treatment of Sustainability Risks (December 2022)

EIOPA published a discussion paper [18] on the ‘Prudential Treatment of Sustainability Risks’ and is now seeking comments by stakeholders on the approaches presented.

In the paper the EIOPA acknowledge the importance of ensuring that Solvency II, as a risk-based and forward-looking framework, reflects sustainability risks appropriately and emphasises the central role that insurers have in driving sustainable finance and that climate-related risks can materially impact the investments and underwriting activities of the insurance industry.

EIOPA has focused its’ assessment on three areas:

• Assets and transition risk exposures: this section of the Discussion Paper contains a study of how risks that stem from the transition to a more sustainable and less carbon-reliant economy could affect prudential risks related to assets such as stocks, bonds and real estate. Notably, EIOPA suggests that there ought to be consideration of the potential for a dedicated treatment of transition risk exposures in solvency capital requirements.
• Underwriting risk and climate change adaptation: this section contains a study of how physical risks related to climate change could impact the non-life insurance sector. This assessment focuses on the high (and substantially increasing) number of claims stemming from climate-related natural catastrophes, including in relation to property damage and business interruption. It also underlines the potential of the investment in climate-related adaptation measures in reducing loss exposure and premiums, outlining three dedicated case studies on the topic.
• Social objectives and social risks from a prudential perspective: this section seeks to define 'social objectives' and 'social risks' and to assess how social risks or harms to social objectives (for example, violations of labour or human rights) could translate into prudential risks and financial and reputational losses for insurance undertakings. It also assesses the corresponding prudential treatment in the context of current Solvency II requirements in respect of governance, risk management, reporting and disclosure.

EIOPA is seeking comments from stakeholders on the approaches presented in the Discussion Paper until 5 March 2023.

United States

Fed announced Climate Risk Management Proposals for the 6 largest U.S. banks (January 2023)

On January 17, the U.S. Federal Reserve Board announced its inaugural climate scenario analysis exercise. It will involve the six largest U.S. banks: Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo [19].

The objective is to evaluate the banks’ climate-related risk management practices and to build capacity to identify and manage climate-related risks. The exercise will gather data on governance and risk management processes, measurement methodologies, risk metrics, data challenges and lessons learned.

The pilot exercise explores the impact of both physical and transition risks on the banks’ loan portfolios under varying climate scenarios. The physical scenario includes different levels of climate shocks, such as hurricanes and wildfires, affecting residential and commercial real estate portfolios in the Northeastern US and at least one other region. The transition scenario assesses the risk to corporate loans and real estate portfolios during the transition to net zero greenhouse gas emissions (GHG) by 2050 [20].

The banks are expected to submit the results from the exercise by the end of July 2023. Insights from the exercise will be published (i.e. potential risks and effective risk management practices), but will not release firm-specific information.

White House released a strategy for a system of natural capital accounting (January 2023)

The Biden-Harris Administration published its national strategy to develop a set of statistics designed to capture the economic value of natural assets, such as animals, land, minerals, water and plants [21].

The national strategy to ‘Develop Statistics for Environmental-Economic Decisions’ aims to include natural capital in the national economic accounting system to organize data that enables measurement of the quantity and value of the country’s natural assets.

Extending the national economic accounting system to incorporate natural capital should improve the understanding between nature and the economy and create a more inclusive and comprehensive accounting of the U.S. economy [22].

ISSB to publish final sustainability reporting standards and consult on standards for issues beyond climate

The IFRS Foundation’s International Sustainability Standards Board (ISSB) will be releasing [23] the finalised versions for the first global standards for sustainability and climate-related reporting in June of 2023.

New UK Net Zero and UK Green Finance strategies to be revealed, and an update on UK Green Taxonomy is expected alongside

The UK Government is due to announce the reviewed Net Zero Strategy, as well as the updated Green Finance Strategy during Q1 2023. In terms of the UK Green Taxonomy development, the UK Government were obliged to adopt technical screening criteria (TSC) by the end of 2022, under the EU Withdrawal Act. However, as of 14^th Dec 2022, the Financial Services and Market Bill was set to repeal retained EU law relating to financial services; including the Taxonomy regulations, and with that, the statutory requirement to adopt the TSC.

The Government confirmed they will “proceed carefully” from this point, with the aim to “maximise the effectiveness of [UK’s] sustainable finance agenda”. The Government is set to provide a further update as part of its publication of the Green Finance Strategy [24]. The Green Technical Advisory Group (GTAG) have confirmed they will continue advising the Government on the development and implementation of a Green Taxonomy, with a final implementation decision anticipated later in 2023 [25].

ECB to publish first own climate report on corporate bond holdings

The ECB is expected to publish its first climate-related disclosure information report on its corporate bond portfolio at the end of Q1 2023. This comes from the announcement in September 2022 where it laid out its plan to decarbonise the corporate bond holdings.

SEC to publish its final legislation on climate related reporting and disclosure

The US SEC is expected to issue its climate disclosure legislation [26] by April. The new rules would require companies to report on their GHG amongst other climate related issues that can have material effect on their businesses. Requirements around the disclosure of emissions from companies’ supply chains (Scope 3) have been particularly contentious.

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

• Tonia Plakhotniuk, Vice President, Climate & ESG Capital Markets
• Daniel Bressler, Vice President, Climate & ESG Capital Markets, Corporates
• Jaspreet Singh, Vice President, Sustainable Finance US Capital Markets
• Roze Warren, Associate, ESG advisory
• Tyler Mayzes, Analyst, Climate & ESG Capital Markets, Corporates
• Siobhan Wartnaby, Analyst, Climate & ESG Capital Markets

References

[1] EU Green Taxonomy

[2] DRAFT COMMISSION NOTICE on the interpretation and implementation of certain legal provisions of the EU (PDF)

[3] DRAFT COMMISSION NOTICE on the interpretation and implementation of certain legal provisions of the Disclosures (PDF)

[4] EU says making sustainability rules easier to apply is a top priority | Reuters

[5] COP15: historic global deal for nature and people

[6] COP15: historic global deal for nature and people – subscription required. Also, can be read subscription free here.

[7] Net Zero Strategy: Build Back Greener - GOV.UK (www.gov.uk)

[8] Net Zero Review: UK could do more to reap economic benefits of green growth - GOV.UK (www.gov.uk)

[9] European Commission: Amending Regulations (EU) 2017/1129, (EU) No 596/2014 and (EU) No 600/2014

[10] AMF: Sustainable finance: the AMF and AFM publish a common position on the content of the prospectus for green bonds

[11] CSRD published in the Official Journal of the European Union (iasplus.com)

[12] Council adopts position on due diligence rules for large companies - Consilium (europa.eu)

[13] Commission proposes certification of carbon removals (europa.eu)

[14] Implementing Technical Standards (ITS) on prudential disclosures on ESG risks in accordance with Article 449a CRR | European Banking Authority (europa.eu)

[15] ECB presents action plan to include climate change considerations in its monetary policy strategy

[16] Discussion paper on the Prudential Treatment of Sustainability Risk

[17] The EBA publishes its roadmap on sustainable finance

[18] ECB publishes new climate-related statistical indicators to narrow climate data gap

[19] Federal Reserve Board - additional details on how its pilot climate scenario analysis exercise will be conducted and the information on risk management practices that will be gathered over the course of the exercise

[20] ESG Weekly Update – January 25, 2023 | 01 | 2023 | Publications | Insights & Publications | Debevoise & Plimpton LLP

[21] National Strategy to develop statistics for environmental-economic decisions (PDF)

[22] Fact Sheet: Biden-⁠Harris Administration Releases National Strategy to Put Nature on the Nation’s Balance Sheet | U.S. Department of Commerce

[23] esgtoday.com/ifrs-chair-global-sustainability-and-climate-reporting-standards-to-be-released-in-june

[24] Written statements - Written questions, answers and statements - UK Parliament

[25] Statement from the Green Technical Advisory Group in response to written ministerial statement on a UK Green Taxonomy (greenfinanceinstitute.co.uk)

[26] Reginfo.gov