Global
The ISSB has announced additional transitional relief for companies applying new climate-related disclosure standards and launched a consultation on future standard setting priorities
On 4th April, the International Sustainability Standards Board (ISSB) decided [1] to provide further support to companies’ initially applying the ISSB’s first two Standards – S1 (general requirements) and S2 (climate). While the standards become effective starting January 2024, it is not disclosed when these reliefs might expire.
The full package of reliefs means that, for the first year they use the ISSB Standards, companies will be able to prioritise climate-related disclosures and will not need to:
- Provide disclosures about sustainability-related risks and opportunities beyond climate-related information
- Provide annual sustainability-related disclosures at the same time as the related financial statements
- Provide comparative information
- Disclose Scope 3 greenhouse gas (GHG) emissions
- Use the GHG Protocol to measure emissions if they are currently using a different approach
This is intended to provide companies with the ability to use their first year of reporting to get familiar with concepts and requirements within the ISSB Standards as well as implement the necessary reporting practices and structures required to provide information on climate-related risks and opportunities. Companies will then need to provide full reporting on sustainability-related risks and opportunities, beyond climate, from the second year. The ISSB’s first two standards are set to be issued at the end of Q2 2023.
Additionally, the ISSB has published a Request for Information to define its future standard setting for the next two years. Based on research into investor expectations, the ISSB is seeking feedback on four potential projects. Three research projects on sustainability-related risks and opportunities associated with: biodiversity, ecosystems and ecosystem services; human capital; human rights. And, a research project on ‘integration in reporting’, to explore how to integrate information in financial reporting beyond the requirements related to connected information in International Financial Reporting Standards (IFRS) S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures.
On the last point, the International Accounting Standards Board (IASB), IFRS accounting standard setter, has already added a project to its work plan to explore whether and how companies can provide better information about climate-related risks in their financial statements.
UK
Analysis launched to assess UK risk of financial collapse from nature degradation
The scale of nature-related financial risks to the UK economy is being estimated [2] for the first time with support from the Environmental Change Institute at the University of Oxford. This follows similar work done by the DNB on how climate change and environmental degradation can result in direct and indirect damage, including financial damage.
The analysis, to be revealed later this year, intends to assess the materiality of nature-related financial risks and the potential financial impact of biodiversity loss and ecosystem degradation on UK business and financial institutions. It builds on the work conducted by banks to understand and quantify their portfolio exposure to nature degradation.
The analysis was developed in partnership with the Green Finance Institute, supported by Defra and the Bank of England, and alongside the UN Environment Programme World Conservation Monitoring Centre and the University of Reading.
The analysis also builds on the UK Government’s support for the Taskforce on Nature-related Financial Disclosures (TNFD). In addition, it responds to recommendations made by the Financing UK Nature Recovery Coalition in its 2022 report to increase pressure on UK corporates to reduce negative nature-related impacts and invest in nature-positive outcomes.
EU
European Commission published additional guidance for interpreting existing SFDR requirements
The European Commission published a series of answers [3] to the interpretation of the SFDR. In response to questions submitted by European Financial Services Authorities - ESMA, European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) – collectively known as the ESAs.
The implementation of the SFDR has posed a selection of challenges to the investment management industry, which include the lack of legal precision of certain terms and requirements. Below is a summary of some of the key questions and respective responses.
Q: Definition of ‘Sustainable Investment’ and its application to Use of Proceeds Instruments
- No specific approach prescribed to determine contribution of an investment to environmental or social objectives
- Financial market participants (FMPs) must disclose the methodology applied to carry out their assessment of sustainable investments including the methodology for determining contribution to environmental / social objectives; compliance with do no significant harm criteria (DNSH); and how investee companies meet ‘good governance practices’ requirements
- Notion of sustainable investment can be measured at the level of company or specific activities
- Products tracking a Paris-aligned Benchmark (PAB) or a Climate Transition Benchmark (CTB) are deemed to make sustainable investments
Q: Definition of ‘Contribution to Environmental or Social Objectives’:
- No minimum requirements that qualify concepts such as contribution, do no significant harm or good governance
- Where activities are covered by transition plans that have a future aim to meet DNSH criteria, such activities cannot be considered sustainable
Q: Principle adverse impact (PAI) consideration
- Description related to the PAI should include both a description of the adverse impact and the procedures put in place to mitigate those impacts
- FMPs should include this information on their website
Q: Carbon emissions reduction objective in passive and active investment strategies
- Article 8 of SFDR does not limit the types of characteristics that can be promoted by financial products including carbon emissions reductions as part of its investment strategy even if the product does not have sustainable investment as its objective
- Information disclosed in pre-contractual, website and periodic disclosures about carbon emissions reduction characteristics of the product should not mislead investors that this is part of the product’s objective and possibly misrepresent the product as a sustainable investment (e.g., Article 9)
- Marketing communications should not contradict the content of disclosures made pursuant to the SFDR
- Financial products with an objective of reducing carbon emissions can use a passive or active investment strategy but where no PAB/CTB is passively or actively tracked, the SFDR requires a detailed explanation of what effort is being made to ensure the reduction of carbon emissions
- Where financial products are passively tracking PABs or CTBs, these products are deemed to be sustainable investments
The Q&A and recent consultation paper summarised in the following section, illustrates that the SFDR remains very much a work in progress. A separate consultation by the European Commission on a wider review of the SFDR (primary legislation) is expected in the second half of 2023, which may propose other changes to the regime.
ESAs have launched a joint consultation on the review of SFDR Delegated Regulation
The three ESAs jointly published a consultation paper ‘Review of SFDR Delegated Regulation regarding PAI and financial product disclosures’ [4] [5]. The purpose of the review was to:
- Address some technical issues that have emerged concerning sustainability indicators in relation to principal adverse impacts (PAI)
- Propose amendments to the RTS disclosure regime to include GHG emissions reduction targets, including intermediary targets and milestones and actions pursued
The paper noted the Commission’s concern that the transparency and compatibility on the sustainability impact of financial products is not keeping pace with an increased demand for high quality sustainability information on the underlying sustainability profile of issuers and on the methodologies underpinning ESG ratings and data in general.
The ESAs set out the following proposals:
- Extend the list of social indicators for the disclosure of PAIs of investment decisions on the environment and society, such as earnings from non-cooperative tax jurisdictions or interference in the formation of trade unions;
- Refine the content of other indicators for adverse impacts and their definitions, applicable methodologies, calculation formulas, presentation of the share of information derived directly from investee companies, sovereigns, supranationals or real estate assets; and
- Add product disclosures regarding decarbonisation targets, including intermediate targets, the level of ambition and how the target will be achieved.
The ESAs also proposed additional technical revisions intended to:
- Improve the disclosures on how sustainable investments “do not significantly harm” the environment and society;
- Simplify pre-contractual and periodic disclosure templates for financial products; and
- Adjust/clarify existing requirements, for example, on the treatment of derivatives, the definition of equivalent information, and provisions for financial products with underlying investment options.
The consultation is open until 4 July 2023. The revised Delegated Regulation could be expected in Q4 2023 or Q1 2024.
European Council and Parliament reach provisional deal on renewable energy directive
To support the EU’s climate transition goals under the ‘Fit for 55’ package, the European Council (EC) and European Parliament (EP) reached a provisional political agreement [6] to:
- Raise the share of renewable energy in the EU’s overall energy consumption to 42.5% by 2030 with an additional 2.5% indicative top up that would allow it to reach 45%. Each member state will contribute to this common target.
- Implement more ambitious sector-specific targets across sectors to speed up integration where incorporation of renewables has been slower.
Sector-specific targets and sub-targets include:
- Transport: Member states will have a choice between i) a binding target of 14.5% reduction of GHG intensity in transport from the use of renewables by 2030; or ii) a binding share of at least 29% of renewables within the final consumption of energy in the transport sector by 2030. Additionally, the provisional agreement sets a binding combined sub-target of 5.5% for advanced biofuels and renewable fuels for non-biological origin, with a minimum requirement of 1% of renewable fuels of non-biological origin (RFNBOs) as a share of renewable energies supplied to the transport target.
- Industry: Industry to increase renewable energy use by 1.6% annually, with 42% of the hydrogen used in industry to come from RFNBOs by 2030 and 60% by 2035.
- Buildings, heating and cooling: An indicative target of at least a 49% renewable energy share in buildings by 2030. Agreement provides for a gradual increase in renewable targets for heating and cooling, with a binding increase of 0.8% per year at national level until 2026 and 1.1% from 2026 to 2030. The minimum annual average rate applicable to all member states is complemented with additional indicative increases calculated specifically for each member state.
- Bioenergy: Strengthening of the sustainability criteria for biomass use for energy, to reduce the risk of unsustainable bioenergy production. It ensures the application of the cascading principle, with a focus on support schemes and due regard to national specificities.
- Faster permits: Accelerated permitting procedures for renewable energy projects to support the EU’s RePower EU plan to become independent from fossil fuels supplied by Russia. Renewable energy deployment will also be presumed to be of ‘overriding public interest’ which would limit the ground of legal obligations to new installations.
This provisional political agreement needs to be formally approved by member state representatives in the EC and the EP. It was due to happen on 17 May however has been postponed following a last-minute objection by France, which is advocating for further “guarantees” on low-carbon hydrogen derived from nuclear power.
European Parliament and Council approved EU carbon market overhaul
The European Parliament approved [7] reforms to make EU climate change policies more ambitious, including an upgrade of the bloc’s carbon market that is set to hike the cost of polluting in Europe.
Parliament voted to approve [8], a deal agreed last year by negotiators from EU countries and Parliament to reform the carbon market and cut EU emissions by 62% below 2005 levels by 2030. Under the upgrade, by 2034 high carbon emission industries in scope will lose the free CO2 permits they currently receive, and shipping emissions will be added to the CO2 market from 2024 – under the revised EU Emissions Trading System (ETS).
Additionally, lawmakers also backed the EU’s world-first plan to phase in a levy on imports of high-carbon goods from 2026 (“Carbon Border Adjustment Mechanism”), targeting imports of steel, cement, aluminium, fertilisers, electricity, and hydrogen.
As part of the same package, the Parliament also voted on plans to launch a new EU carbon market covering emissions from fuels used in cars and buildings in 2027, plus an €86.7 billion EU fund to support households affected by the costs (“Social Climate Fund”).
The laws have also been approved by the Council of Member States and are now awaiting for a formal sign off by the Council and the European Parliament before entering into force.
The Legal Affairs committee of the European Parliament voted its final report on the CSDDD
The Corporate Sustainability Due Diligence Directive is progressing through EU institutions with the aim of implementing human rights and environmental due diligence requirements for companies. Recently, the Parliament's Committee on Legal Affairs voted in favour of a compromise text in response to the Commission's proposed CSDDD, which included amendments specifying details about the companies and sectors to be covered under the legislation [9]. The approved text is now heading for a full plenary vote at the Parliament in June 2023. Negotiations between the Commission, the Council, and the Parliament are expected to take place, as these institutions have differing approaches to key provisions of the CSDDD, such as employee and turnover thresholds, applicability to the financial sector, scope of operations, issues addressed, directors’ duties, and civil liability.
The Council’s negotiating position introduced a phased-in approach, allowing larger companies more time to comply with the CSDDD. It made the applicability to financial services companies optional for Member States and narrowed the concept of the value chain. On the other hand, the Parliament Committee’s draft report expanded the scope of companies subject to the CSDDD by lowering the employee and turnover thresholds. It proposed additional high-impact sectors and emphasised due diligence on products and services, including good governance issues. The Committee also removed a safeguard on civil liability.
Once the Parliament reaches a consensus on its official stance on the CSDDD, it will engage in negotiations with the Commission and the Council. Given the significant variations in approach between these three entities, discussions are expected to be intense, accompanied by active involvement from stakeholders in the upcoming months. However, there is a strong political drive to finalise the Directive, and Spain, set to assume the Council chair in the second half of 2023, has already expressed its commitment to prioritise the CSDDD. These recent developments within the EU indicate that corporate human rights and environmental due diligence will remain a crucial business requirement moving forward.
The European Parliament adopted a resolution in March 2021, providing recommendations to the Commission on corporate due diligence. The Commission formally proposed the CSDDD in February 2022, and the Council of the European Union adopted its negotiating position in December 2022.
