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To mobilise sustainable finance for the transformation of the European economy, the EU strategy rests on two complementary lines of action aimed at covering the gap of additional investments needed to meet the EU’s climate objectives (half a trillion EUR every year). First, an overhaul of the incentives in financial markets and corporate governance (these are mainly tackled through the Sustainable Finance agenda and the upcoming Sustainable Corporate Governance initiative). Second, transparency on both positive and negative impacts on sustainability by companies as well as providers of capital.
The strategy to achieve transparency on sustainability impacts relies on the following three pillars:
This article addresses three questions: How do these instruments fit together? What needs to be reported and by whom? What are the gaps that the CSRD will have to close?
Information flows (SFDR, CSRD, Taxonomy). Photo: ©Frank Bold
The SFDR applies to all financial market participants, primarily institutional investors, including banks and insurers’ investment activities. Today, the NFRD applies to listed companies, as well as banks and insurers’ own activities – they are both preparers and users of sustainability information. The reporting requirements outlined in the Taxonomy and addressing sustainable activities will apply to both groups, and will become the standard for sustainable lending and investment, irrespective of the recipient entity’s size.
The requirements of the SFDR and the Taxonomy will be supported by technical standards and screening criteria that will enter into force in 2022. Although these are yet to be adopted in law by the European Commission, the draft standards are already available and the EU institutions have recommended investors and companies to follow them. A report by UNEP, FI and EBF already provides practical understanding of the applicability of the EU Taxonomy to banking products. The UN PRI developed case studies sharing insights into how over 40 investment managers and asset owners have worked to implement the Taxonomy on a voluntary basis in anticipation of the upcoming European regulation.
The draft SFDR standards list concrete adverse impact indicators which should be disclosed, and specify how to calculate the impact associated with the investments. The draft screening criteria for the Taxonomy specify the classifications, thresholds and indicators for sustainable activities – that is, activities that substantially contribute to EU environmental objectives and thus qualify for sustainable financing.
What is missing are the corporate sustainability reporting standards, clarifying what needs to be reported by companies on both the risks and impacts of their activities and across their supply chains. They are critical to ensure that companies disclose meaningful and comparable information needed by investors and banks under the SFDR, to fill in methodological gaps on collecting and presenting information, and to reduce companies’ administrative burden. Rients Abma, executive director of Eumedion (Dutch organisation representing the interests of institutional investors), insists on the alignment between the above and stresses that “A harmonized set of ideally global sustainability reporting standards would significantly improve the consistency, comparability, and reliability of sustainability data for us as institutional investors and other users. The revised NFRD should lay the foundation for establishing such a harmonized set of standards.”
The adoption of such EU standards is one of the key objectives of the legislative revision of the NFRD (re-named as CSRD). Another aim of the reform is to ensure that all large and ideally all high-risk companies are included, and not left out of the capital flows that are being mobilised to finance the sustainable transformation and innovation.
Visual timeline: Standards development. Photo: Frank Bold
The SFDR and Taxonomy rely on the corporate sustainability reporting standards to clarify KPIs, quality criteria and methodologies in four critical areas:
The reform of the NFRD (CSRD) and development of corporate sustainability reporting standards are necessary to complete the system for several reasons:
Europe’s corporate sustainability reporting standards are of critical importance to bridge these gaps and thus secure that data is comparable and meaningful, to alleviate companies’ administrative burden, and ensure that smaller businesses are not shut out from access to sustainable finance.
In the absence of such clarifications, companies’ strategies and investors’ decisions will continue to be based on a high degree of uncertainty on both adverse impacts and financial risks.
In this article, we highlight gaps that need to be addressed, in order to improve the quality of company reporting and ensure it is useful for investors, which in turn will enable companies to more easily access sustainable capital and drive capital flows to support climate transition overall.
The key findings are that the picture can be completed by adding:
Additional information & materials:
This is the third article by Frank Bold as part of the series of monthly briefings on sustainability reporting in 2021. The previous article focused on reporting on governance (G of ESG) .
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