"If the regulator wants to curtail greenwashing and add more clarity to investors, it needs to allow some flexibility for companies"
Regulatory heatwave in Europe: After SFDR, the Taxonomy and MiFID2 Suitability requirements, now CSRD. But what about the EU Parliament’s vote on gas and nuclear?
Anyone getting lost here?
At first, it looks like regulations continue to pile up (now with CSRD), but their reach continues to be limited (nuclear and gas accepted in the Green Taxonomy) ?
Let’s start by looking at this new Directive: “CSRD”, which stands for Corporate Sustainability Reporting Directive. Its purported objective is to provide enhanced transparency on environmental and social matters to help ESG investors make better-informed decisions on investee companies.
The new EU Directive comes from another initiative by the European Commission, supported by the Council and the EU Parliament, together with the Eurosif as well as the UNPRI. All parties, representatives of the ESG investor community, sought to push for more climate disclosures with the aim of effectively enlightening ESG investors on companies’ transition planning. The idea was to bring more figures and more scientific information to today’s disclosures. In other words focus on factual evidence and actual achievements, and to provide a framework for ESG and Green Investors to evaluate the feasibility of those net zero commitments and the credibility of companies’ transition business plans.
The law derives from this new war against greenwashing and regulators’ willingness to make sure that companies have set up realistic transition plans and will be able abide by their multiplied net zero carbon objectives.
This willingness to make sure corporates are doing what they say in fact also derives from the UN Secretary General himself, Antonio Gueterres, who, during the COP26, reiterated the need to make sure “Net Zero” commitments are actually met. Mister Gueterres created an “expert group” whose mission is to monitor that net zero targets are in line with companies’ action plans.
Who is captured by this Directive ? Is it another law applicable only to the EU and not concerning the rest of the world ?
The Directive applies to private corporates with more than 500 employees or listed companies with 250 employees and a 40-million-euro turnover, as well as to their subsidiaries.
The disclosure obligation will take effect in 2024 for all of the companies already subject to the Non-Financial Reporting Directive (NFRD) 2014/95/EU, and in 2025 for the rest. Some small and medium corporates will also have to abide to a set of lighter reporting standards by January 2026.
The obligation goes beyond Europe, as it covers all companies generating more than €150 million of revenue with at least one subsidiary within the EU. Those companies are considered to have “substantial activity in the EU market”.
What is particular about this new Directive ?
If other initiatives are seeing the light outside Europe, such as in the UK with the ISSB (International Sustainability Standards Board) working to create a baseline for general sustainable disclosures, one should keep in mind the key distinction between the two legal approaches to ESG.
ISSB works on the materiality of ESG factors for companies, whereas the EU Commission has developed the concept of the double materiality of ESG factors.
For those who are still unclear as to what the double materiality concept stands for, it involves looking at the impact a company has on its environment and ecosystem in addition to the impact of ESG factors on the company itself. CSRD therefore adds the responsibility that companies be mindful about the impact they have on people and on the environment instead of solely understanding the ESG potential risks that they may be facing. The ultimate idea is that a company failing to understand and integrate ESG into its business plan may not only be harmed by external ESG risk factors which can hinder its business but may also damage its environment or put at risk human capital.
What about the new disclosure itself ?
CSRD is particularly focused on the environmental pillar, for instance asking companies to disclose their carbon emissions (scope 1, 2 and 3).
This sounds like a new heaven for ESG investors. No more need to ask companies. No more need to buy expensive data from an external ESG provider (data which is also not always up to date). Corporates will now have to disclose it all, including their scope 3 emissions!
Additionally, investors should now also have access to information on the degree of exposure to fossil fuels and on alignment with the taxonomy objectives: biodiversity and ecosystems protections, water and marine resources, pollution management and the circular economy.
The focus is definitely on improving access to tangible climate data, and this is one way to speed up transition planning.
Extra-territorial applicability, double materiality concept, and a strong focus on climate data: how do corporates welcome this new law ?
With its entry in force in 2024 for most, companies are already working hard on their upcoming disclosures. One can confidently expect that this wave of regulatory implementation will become a headache (some actually call it “a nightmare”) for both companies and investors in the next couple of years.
As investors, if we do welcome the rise of more reliable, accurate and comparable ESG data, we see that one risk we may face is to end up with too many regulatory packages, potentially leading to regulatory fragmentation and divergence. This could ultimately undermine cross-border investment flows and could eventually become a barrier to investment, ESG standards acting as passporting rights for investors.
Corporates might face even more pressure, as indicated during our many ESG engagement calls, and they are already significantly struggling with the tsunami of ESG reporting frameworks they have to work on. We therefore only hope that this new CSRD will put an end to the multiplication of ESG data provider platforms and streamline their messaging to one - or at least fewer - channels.
What we need as investors is enough clarity for the end-clients to maintain their confidence in the meaning of sustainable finance and its different levels of implementation, and to be able to set coherent objectives and achieve our targets while relying on accurate data. A fine balance to be found by our regulators…
Moving on to the regulator…
Moving back to highly debated Parliament vote of the 6th of July, shall we interpret this decision as a step back or a U-turn now that nuclear and natural gas-fired power plants are considered as sustainable investments in the meaning of the EU Taxonomy ?
As a reminder, with this new rule gas and nuclear power plants will now be added to the EU “Taxonomy” rulebook from 2023.
If the regulator wants the CSRD to add clarity as to what companies’ transition plans are, and to assess the extent to which those plans are realistic, it seems that it also now wants to allow gas and nuclear power to be a potential solution for those realistic energy transition plans.
One should remember that incorporating gas and nuclear into the Taxonomy does not mean that all natural gas and nuclear activities will qualify. On the contrary, the EU Commission sets strict technical screening criteria that defines which activities meet the Taxonomy objectives.
In practice, it is for instance considered that to meet the criteria targets of gas (i.e.: 100g CO2e/kWh of life-cycle emissions), gas operators will have to use very significant carbon capture technologies or to use blending of green hydrogen, preventing a number of existing operators from qualifying for Taxonomy alignment. According to Pascal Canfin, President of the Environmental Commission of the EU Parliament, “If we want to move forward on the taxonomy regulation which is a key element of the EU Green Deal we need to find a compromise without putting at risk the credibility of the taxonomy”. Some consider that the set requirements will significantly narrow the use of gas (i.e.: gas allowed only to replace coal in power generation and if standing below the given threshold).
We therefore believe that, if the regulator wants to curtail greenwashing and add more clarity to investors, it needs to allow some flexibility for companies to set up their plans. It needs to remain pragmatic and realistic.
Whether these different legal packages will effectively impact today’s investment trends, drive future investments, and really make a difference on global emissions remains to be seen.