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

• EU Platform on Sustainable Finance recommendations on Social Taxonomy
• EU Directive on Corporate Sustainability Due Diligence

Other publications:

• EU Platform on Sustainable Finance Report on Extended Environmental Taxonomy
• SEC proposal on climate disclosure regime
• Taskforce on Nature-related Financial Disclosures (TNFD) Framework
• EBA Report on Sustainable Securitisations
• ESMA Sustainable Finance Roadmap 
• IPCC report on vulnerability and adaptation

What to look out for:

• UK Green Taxonomy consultation is still outstanding
• EBA discussion paper on differentiated prudential treatment of assets based on their environmental performance 
• Bank of England will publish aggregated results of it CBES (climate stress testing) exercise in May

EU Platform on Sustainable Finance recommendations on Social Taxonomy

The European Commission had previously given a mandate to the EU Platform on Sustainable Finance (EU PSF), the Commission’s advisory body, to provide views around extending the EU Green Taxonomy to also cover social objectives. On 28 February 2022 the Platform published a report [1] with recommendations following a stakeholder consultation process run in 2021.  The EU Taxonomy Regulation established a classification system for environmentally sustainable economic activities, and a "social taxonomy" would aim to determine the conditions for an economic activity or a company to be categorised as "social". The report notes that such a classification system could provide an additional incentive for investors to invest in projects that have been classified as "social", because it would provide clarity on which economic activities create social benefits. 

The EU PSF proposes to keep the structure of a social taxonomy close to the structure of the green taxonomy. The social taxonomy would therefore define social objectives, types of significant contributions to these objectives, and it would also clarify the criteria to determine that these objectives are not significantly harmed (Do-No-Significant-Harm-Principle (DNSH)). Furthermore, compliance with minimum environmental and/or social safeguards is also envisaged. For a more precise definition of the requirements and, in particular, detailed technical assessment criteria to determine what is considered a "significant contribution" and what is considered "significant harm" with regard to the social objectives, the EU PSF recommends that these would be defined by means of delegated acts – similar to the EU Green Taxonomy. 

Objectives in the social taxonomy would be based on the type of stakeholders that could be affected by the economic activities. These include a company's own workforce, capturing workers along the value chain, and end-users, as well as communities that are affected by economic activities directly or through the value chain. The core objectives of a social taxonomy could be:

• Decent work (including for value-chain workers);
• Adequate living standards and wellbeing for end-users;
• Inclusive and sustainable communities and societies.

A distinctive feature of the proposed structure of the social taxonomy is a recommendation to also identify sub-objectives – under each core objective. For example, ensuring access to quality healthcare could be a sub-objective under objective “adequate living standards and wellbeing for end-users”. The EU PSF report also suggests that some economic activities may need to be classified as socially harmful under any circumstances, for example, certain types of weapons or even tobacco. 

Finally, it is important to note that the recommendations outlined in the report are far from being finalised at this stage. The EU PSF suggests a number of actions that still should be taken before developing a social taxonomy: minimum safeguards should be clarified; a study on the possible impacts of a social taxonomy should be conducted; and objectives and sub-objectives should be defined and prioritised; criteria for significant contribution to social objectives and sub-objectives, as a well as DNSH criteria should be developed. It is now up to the European Commission to determine the course of direction of this initiative and the respective timeframe. 

EU Directive on Corporate Sustainability Due Diligence

The new proposal [3] by the European Commission sets out a corporate due diligence duty to identify, prevent, bring to an end, mitigate and account for adverse human rights and environmental impacts in the company's own operations, its subsidiaries and their value chains – in the EU and globally.

The scope of the Directive includes EU companies that:

(a) had more than 500 employees on average and had a net worldwide turnover of more than EUR 150 million in the last financial year; or
(b) did not reach the thresholds under point (a), but had more than 250 employees on average and had a net worldwide turnover of more than EUR 40 million in the last financial year, provided that at least 50% of this net turnover was generated in at least one of “high-risk” sectors (including but not limited to manufacture of/trade in textiles, leather and related products; agriculture, forestry, fisheries, the manufacture of food products; the extraction of/trade in mineral resources and others)

This Directive also applies to non-EU companies that (a) generated a net turnover of more than EUR 150 million in the EU in the financial year preceding the last financial year; or (b) generated a net turnover of more than EUR 40 million but not more than EUR 150 million in the EU in the financial year preceding the last financial year, provided that at least 50% of its net worldwide turnover was generated from activities in the “high-risk” sectors.

The new proposal will require the companies (private and listed – across both the financial and non-financial sectors) within the scope above to:

• Integrate due diligence into company policies
• Identify actual or potential adverse human rights and environmental impacts
• Prevent or mitigate potential adverse impacts
• Bring to an end or minimise actual adverse impacts
• Establish and maintain a complaints procedure
• Monitor the effectiveness of the due diligence policy and measures
• Publicly communicate on due diligence

The proposal builds on the UN's Guiding Principles on Business and Human Rights and OECD Guidelines for Multinational Enterprises and responsible business conduct, and on other internationally recognised human rights and labour standards.

In addition, and specifically in relation to climate, the Directive requires companies in scope, and which are materially exposed to climate change risks, to publish a transition plan – “to ensure that the business model and strategy of the company are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 °C in line with the Paris Agreement”. Such transition plans should be taken into account when setting directors’ variable remuneration, if variable remuneration is linked to the contribution of a director to the company’s business strategy and long-term interests and sustainability.

The new Directive is unlikely to enter into application before 2025.

EU Platform on Sustainable Finance Report on Extended Environmental Taxonomy

On 28 March, the EU Platform on Sustainable Finance published its Final Report on Extended Environmental Taxonomy [4]. In this report the Platform is recommending extending the Taxonomy framework to classify activities as follows:

• Unsustainable performance requiring an urgent transition to avoid significant harm: These are activities that need to be improved urgently and could qualify for Taxonomy-recognised investment as part of a transition plan to avoid their current significantly harmful performance and move to intermediate performance levels.
• Intermediate (or Amber) performance: These are activities that operate between significantly harmful and substantial contribution performance levels and could qualify for Taxonomy-recognised investment as part of an intermediate/amber transition plan under which they continue to improve to stay out of significantly harmful performance.
• Unsustainable, significantly harmful (Red) performance where urgent, managed exit/decommissioning is required: These are activities that cannot be improved to avoid significant harm and will therefore remain always significantly harmful (ASH) and should be prioritised for Taxonomy-recognised transition investment as part of a decommissioning plan with a Just Transition effort.
• Low environmental impact (LEnvI) activities: These are activities that do not have a significant environmental impact and should not be regarded as red, amber or green.

We will include the analysis of this proposal in our next ESG Policy and Regulation Round up newsletter.

SEC proposal on climate disclosure regime

On 21 March, the SEC proposed [5] a new climate disclosure regime for public companies. According to the proposal:

• Disclosures of Scope 3 carbon emissions will depend on how material they are to a company’s business.
• The SEC used the Task Force on Climate-Related Financial Disclosures as a model because of its global support among thousands of companies and financial institutions worldwide.
• Disclosure will be required on how and how often companies purchase carbon offsets to neutralise some of their emissions.
• SEC said the new requirements would be phased in over several years. The largest companies would need to start disclosing climate risks for the fiscal year of 2023 (in 2024), while other firms would have to report for the first time in 2025 (for 2024). Companies will get an extra year beyond those dates to include supplier and customer emissions, and to get emissions data audited.

The public will have 60 days to submit comments after the proposed rule is published and those comments will be taken into consideration before issuing a final rule, which will be voted on by the SEC’s four commissioners. Experts said this process could take several months. This announcement comes at a time of growing US focus on climate regulations and is expected to have a major impact on companies’ climate reporting and potentially on their carbon credit strategies in the US.

Taskforce on Nature-related Financial Disclosures Framework

The Taskforce on Nature-related Financial Disclosures (TNFD) unveiled the beta version of its framework [6] to help corporates better understand and disclose nature-related risks and impacts. The framework follows a similar approach to the TCFD, aiming to give companies and financial institutions a more complete picture of how to think about environmental risks. It currently consists of three main components: key science-based concepts and definitions, disclosure recommendations and guidance on how nature can be incorporated into enterprise risk and portfolio management processes. It also outlines the intricacies of how nature varies based on location and proposes location-specific disclosure.

The framework is being designed to align with the work by the International Sustainability Standards Board (ISSB), which was officially unveiled at COP26. Future iterations of the Framework are scheduled for June, October 2022 and February 2023 with the final version in late 2023.

The development of the framework is a welcome step which should help enhance the transparency around the nature and extent of a broader spectrum of environmental risks beyond climate – also enhancing connectivity with climate related risk considerations (in particular, measurement, mitigation and adaptation).
 

EBA Report on Sustainable Securitisations

The European Banking Authority (EBA), one of the EU’s three supervisory agencies, has recently come out with a report [7] providing an overview of recent developments and challenges of introducing sustainability to the securitisation market. EBA says that the EU sustainable market is still at an early stage of development and the application of sustainability requirements in securitisation may need further clarification. The Report explores whether and how the EU regulations on sustainable finance, including the EU Green Bond Standard (EU GBS), the EU Taxonomy, and the Sustainable Finance Disclosure Regulations could be applied to securitisation; the relevance of a dedicated regulatory framework for sustainable securitisation and; the nature and content of sustainability-related disclosures for securitisation products.nFor example, EBA recommends that the EU Green Bond Standard could be amended to enable a securitisation that is not backed by a portfolio of solely green assets to meet the EU Green Bond Standard requirements, provided that the originator commits to using all the proceeds to generate new green assets.

This report comes at a time of heightened discussions in the market around the definition of sustainable securitisation, specifically a discussion around whether it is both the collateral and the use of proceeds that should explicitly support sustainability objectives, or whether “the use of proceeds only” model would still be appropriate. The EBA’s recommendation, whilst not binding, helps bring in some clarity to the market in this respect and may boost the issuance that would not be possible otherwise in light of the still lacking pool of assets that could serve as green, social or sustainability collateral.

ESMA Sustainable Finance Roadmap 

The European Securities and Markets Authority (ESMA) has published [8] its Sustainable Finance Roadmap for 2022-2024 along with a detailed work plan covering the three main areas below:

• Tackling greenwashing and promoting transparency
• Building ESMA’s capacities in the sustainable finance field, as well as capacities of national markets supervisors
• Monitoring, assessing and analysing ESG markets and risks

ESMA is also planning further research on corporate disclosures, EU-wide labels such as the EU Green Bond Standard, the disclosure requirements under Sustainable Finance Disclosure Regulation Articles 8 and 9, and the use of existing climate indices and benchmarks.

ESMA’s focus on tackling greenwashing in sustainable finance markets would be a helpful step towards addressing relevant concerns from investors and stakeholders alike. Issuers and fund managers will need to be mindful of the greater scrutiny expected from their respective supervisory authorities in relation to sustainability claims and of potential reputational and litigation risks arising from it.

IPCC report on vulnerability and adaptation

The Intergovernmental Panel on Climate Change’s (IPCC) latest report [9] details the current negative impacts of climate change. In particular events such as droughts, extreme heat and record floods are already more widespread and more severe than anticipated. As the global temperature rises, the risks will quickly escalate causing irreversible impacts, meaning more support is needed for vulnerable communities. This latest report highlights the need for more drastic action from governments and organisations to tackle climate change – action that is expected to accelerate the need for climate adaptation finance.

March-April 2022: UK Green Taxonomy consultation and criteria for the rest of the environmental objectives under the EU Taxonomy

• As outlined in more detail in our previous newsletter [10], the UK Government will consult on the initial set of criteria for economic activities to count as ‘green’ (UK Green Taxonomy).
• The EU Platform on Sustainable Finance is about to publish recommendations on criteria for the rest of the environmental objectives under the EU Taxonomy (a launch webinar was held on 30 March [11]).
• The ISSB will publish its exposure drafts on climate and general sustainability-related financial disclosures on 31 March [12]

May 2022: The Bank of England will publish aggregated results of it CBES (climate stress testing) exercise in May

• The Bank of England ran its Climate Biennial Exploratory Scenario (CBES) exercise in 2021 and early 2022, testing the climate risk resilience of the largest banks and insurance companies in the UK, and expects to publish aggregated results in May 2022.

Q2 2022: EBA discussion paper on differentiated prudential treatment of assets based on their environmental performance

• EBA is expected to publish [13] an initial discussion paper for public comment exploring whether rules around banks’ capital requirements should be adjusted to consider environmental performance of banking assets. EBA has a mandate to deliver its final assessment on this topic to the European Commission by the end of 2023. A similar initiative will be conducted by the EU insurance sector supervisor EIOPA.

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
• 📧 Tyler Mayzes, Analyst, Climate & ESG Capital Markets, Corporates

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

References

[1] Final Report on Social Taxonomy (PDF)

[2] AIB Group PLC: January 2023, Social Bond Framework (PDF)

[3] Proposal: Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937

[4] Platform on Sustainable Finance’s report on environmental transition taxonomy (PDF)

[5] Proposed Rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors (PDF)

[6] TNFD Nature-Related Risk & Opportunity Management and Disclosure Framework

[7] EBA report on sustainable securitisation (PDF)

[8] Sustainable Finance Roadmap 2022-2024

[9] Climate Change 2022: Impacts, Adaptation and Vulnerability

[10] ESG Policy and Regulation Round-up: January / February 2022

[11] YouTube: EU Platform on Sustainable Finance launches: New criteria for all six taxonomy objectives

[12] IFRS - ISSB to publish exposure drafts on climate and general sustainability-related financial disclosures

[13] EBA 2022 Annual Work Programme (PDF)