This section provides a rough overview of the key Sustainable Finance regulation of the EU at the regulation/directive level. It does not claim to be comprehensive and does not represent legal or tax advice.
In summary, the Taxonomy Regulation (TR) (Regulation (EU) 2020/852) is one of the most important legal frameworks the EU is relying on to achieve the objectives of the European Green Deal. It introduces a classification system to define environmentally sustainable economic activities to create a common understanding of sustainability. The Taxonomy Regulation applies to financial market participants who make available financial products (defined by the SFDR) and to issuers of corporate bonds as well as to undertakings in scope of the Corporate Social Resonsibility Directive (CSRD). It entered into force on 12 July 2020.
An economic activity is considered environmentally sustainable if it contributes to at least one of the following six environmental objectives:
- climate change mitigation,
- climate change adaptation,
- sustainable use and protection of water and marine resources,
- transition to a circular economy,
- pollution prevention and control, and
- protection and restoration of biodiversity and ecosystems.
In addition, an economic activity that meets at least one of the six environmental objectives must
- not significantly harm any of the six objectives (DNSH), see Art. 17 TR
- fulfil certain safeguards (e.g. OECD Guidelines for Multinational Enterprises and UN Guiding Principles on Business and Human Rights
- comply with technical screening criteria (Delegated Acts)
The Climate Delegated Act (CDA) defines technical screening criteria (TSC) for economic activities that contribute to the first two environmental objectives (climate change mitigation and adaption). It entered into force on 29 December 2021. In addition, the Complementary Climate Delegated Act (CCDA) entered into force in July 2022 and became applicable on January 2023. It amends the CDA and includes nuclear energy and natural gas as transitional activities.
On 5 April 2023, the Commission launched a consultation on its draft of the long-awaited delegated act for the four remaining Taxonomy objectives. It is expected to be published in Q2 2023. At the same time, the Commission consulted on a draft amendment to the existing TSC for the first two environmental objectives, namely climate change mitigation and climate change adaptation.
The TR also provides disclosure requirements for products and entities (Art. 5-8 TR). Art. 8 TR sets out additional disclosure obligation for entities which are already required to include a non-financial statement in their management report under the Non-Financial Reporting Directive (NFRD). The Article 8 Disclosure Delegated Act (2021/2178; applicable from January 2022) specifies the Key Performance Indicators (KPIs) to be used by non-financial and financial undertakings to fulfill their disclosure obligations under Art. 8 TR.
The regulation 2019/2088 on Sustainability-Related Disclosures in the Financial Services Sectors (SFDR) has become applicable step-by-step, starting from 10 March 2021. It applies to financial market participants (FMP) and financial advisors. The regulation has the objective to create harmonized rules on the transparency expected from FMP and financial advisors. They must specify sustainability-related information on websites, in pre-contractual documentation and in periodic reports at entity and product level.
The website disclosures must inform about sustainability risk policies, adverse sustainability impacts at entity level and remuneration policies in relation to the integration of sustainability risks (Art. 3-5). It must also disclose Article 8 and 9 products (Transparency of the promotion of environmental or social characteristics and of sustainable investments, Art. 10).
Art. 6-9 SFDR set out the disclosure requirements for pre-contractual documentation regarding the integration of sustainability risks (Art. 6), the principle adverse impact at financial product level (Art. 7), the promotion of environmental or social characteristics of financial products (Art. 8) and sustainable investments (Art. 9). Products without any sustainability feature have to update their pre-contractual disclosures to explain why sustainability risks are not relevant to them (Art. 6).
Periodic reports must disclose information on financial products that promote environmental or social characteristics as well as sustainable investments (Art. 11).
On 6 April 2022, the EU Commission published its proposed Level 2 requirements for the implementation of the SFDR in the form of Regulatory Technical Standards (RTS) to implement the Level 1 measures which have been applicable since 10 March 2021 (see also drafts submitted by ESAs’ [European Banking Authority, European Securities and Markets Authority, and European Insurance and Occupational Pensions Authority] in February and October 2021). The RTS contain detailed implementation rules for the pre-contractual and periodic disclosures of Article 8 and 9 products and include five annexes, which provide mandatory disclosure templates. They must be used by FMPs as annexes to their reporting documents.
The RTS also aim to establish a single rulebook for sustainability disclosures under the SFDR and the Taxonomy Regulation. Therefore, the SFDR’s product-level disclosures must be supplemented with information that satisfies the requirements of Art. 5 and 6 TR. The products which target sustainable investments contributing to environmental objectives must identify in their pre-contractual and periodic disclosures which environmental objective the product contributes to, as well as the extent to which the economic activities the product invests in are aligned with the taxonomy.
The SFDR RTS has been applicable since 1 January 2023.
Latest SFDR Developments: To acknowledge some of the concrete implementation issues of SFDR the EU Comission mandated the ESA’s to review and propose amendments to the RTS under the SFDR. The ESA’s published a joint consultation on the review of SDR Delegated Regulation on 12 April 2023. The consultation focuses on extending the list of social Principal Adverse Impact (PAI) indications and refining the contents of other indicators. In addition, the ESA’s are also consulting on 1) the improvement to disclosures related to how sustainable investments do not significantly harm environmental or social objectives, 2) Simplifications of the pre-contractual and periodic documents’ disclosure templates and 3) Technical adjustment on e.g. the treatment of derivatives or definition of equivalent information. The deadline for comments has been set on 4 July 2023.
The Corporate Social Responsibility Directive (CSRD) (Delegated Regulation(EU) 2022/2564) entered into force on 5 January 2023. It replaces the Non-Financial Reporting Directive (NFRD). The CSRD applies to all companies and/or groups that are based in the EU, regardless of the origin or domicile of the parent company.
a) Scope of application
- Large undertakings with balance sheets exceeding two of the following criteria:
> 250 employees during the financial year
> €40M net turnover
> €20M balance sheet
- Listed medium-sized undertakings with annual balance sheets that do not exceed two of the following criteria:
< 250 employees during the financial year
< €40M net turnover
< €20M balance sheet
- Listed small undertakings: Listed small undertakings with annual balance sheets that do not exceed two of the following criteria:
< 50 employees during the financial year
< €8M net turnover
< €4M balance sheet
- Excluded from scope of application: Undertakings that meet one of the following criteria:
< 10 employees during the financial year
< €20M net turnover
- Examples of exemption:
- Subsidiaries (entities controlled by a parent undertaking) if the consolidated management report of their parent undertaking includes these subsidiaries.
- Non-EU parent companies with multiple EU subsidiaries that are in scope of application of CSRD until 2030. However, the largest EU subsidiary of the non-EU parent company must submit a sustainability report that includes all EU subsidiaries (in scope of application of the CSRD) of the non-EU parent company.
b) Summary of information to be disclosed
- Double materiality perspective: companies must report about how sustainability issues affect their business and their own impact on people and the environment.
- Sustainability information must cover environmental, social and governance factors (e.g. environmental factors: climate change mitigation, climate change adaptation, water and marine resources, resource use and circular economy, pollution, biodiversity and ecosystems; social factors: equal treatment and opportunities, working conditions, respect for human rights; governance factors: role and composition of the company’s administratives, management and supervisory bodies, information about incentive schemes offered to members of the administrative, business ethics, risk management system, management and quality of relationships with customers, suppliers and communities).
c) Timeline for the reporting obligations
The timeline of application for the reporting obligation depends on the company size as well as its net turnover and total assets. At the end of the timeline companies based in the EU have to report even on the activities of the non EU-parent (e.g. Swiss parent company) if some complementary conditions are fulfilled.
- From 2025 reporting obligation for large public-interested companies based in the EU with more than 500 employees.
- From 2026 reporting obligation for all other large companies based in the EU meeting at least two of the following: > 250 employees, > €40M in net turnover, > €20M in total assets.
- From 2027/ 2028 reporting obligation for listed SME’s based in the EU and certain small and non-complex credit institutions and captive insurers, meeting at least two of the following: > 10 employees (annual average), > €2M net turnover, > €2M in total assets. For listed SME’s there is an option to opt out until 2029.
- From 2029/2030 the EU-based subsidiary/branch of the non-EU parents with substantial activities in the EU report for the complete group. A non-EU parent company (e.g. based in Switzerland) becomes subject to the CSRD if it generated net turnover > €150M in the EU for each of the last consecutive years and has at least one subsidiary meeting general scoping of the CSRD or a physical presence (branch) that generated a net turnover > €40M in the preceding year.
d) Compliance with ESRS
Companies in scope of the CSRD are required to report in compliance with the European sustainability reporting standards (ESRS). They are being developed by the European Financial Reporting Advisory Group (EFRAG) and the Global Reporting Initiative (GRI) and provide twelve standards with detailed requirements for corporate ESG reporting.On 9 June 2023, the European Commission published the draft Delegated Act laying down the contents of the first set of ESRS. The Delegated Act and its Annexes are available for public consultation until 7 July 2023.
e) Audit and European Single Access point
The CSRD introduces a general EU-wide external audit requirement for reported sustainability information to ensure that reported information is accurate and reliable. It also requires companies to digitally ‘tag’ the reported information, so it is machine readable and feeds into the future European single access point (ESAP) for public financial and sustainability-related information about EU companies and EU investment products.
f) Link with the SFDR and Taxonomy Regulation
- To fulfil their own SFDR reporting obligation, financial market participants need the information that companies in scope of the CSRD have to report.
- The Art. 8 Taxonomy Delegated Act provides level 2 measures under the Taxonomy Regulation. It specifies the KPIs for financial undertakings and sets outs detailed rules on the content, methodology and presentation of the KPIs. Companies subject to the CSRD must disclose key figures based on the taxonomy in their CSRD report.
4) AIFMD, UCITS, SOLVENCY II, IDD AND MIFID II
To harmonise sustainability-related disclosure requirements, the EU amended AIFMD, UCITS, Solvency II, IDD and MiFID 2. The new measures integrated sustainability risks and factors into the existing directives. Most of these amendments started to be applicable from August 2022. The measures under MiFID II applied from August 2022 (sustainability risks and factors, sustainability preferences) respectively 22 November 2022 (product governance obligations).
b) Key changes requiring the integration of sustainability risks and factors
- Organisational structure: embed a consideration of sustainability risks in the existing governance and organisational structure (including risk management process).
- Identification of conflicts of interests (which may arise from the integration of sustainability or a client’s sustainability preferences): update existing conflict registers, policies and processes to take account of conflicts relating to sustainability.
- Due diligence processes when making investment decisions (UCITS, AIFMD): update the investment processes to take account of sustainability risks.
- Suitability assessment (MiFID II): change investment advisory and management process to ensure that they properly reflect a client’s sustainability preferences.
- Product governance: update the product origination and marketing/ distribution strategies to ensure that they take account of the sustainability preferences of the target market.
c) Focus: MiFID II
i) Sustainability preferences
The MiFID II (Delegated Regulation (EU) 2021/1253 amending Delegated Regulation (EU) 2017/565) requires inter alia financial advisers to gather the client sustainability preferences during the suitability assessment (for retail and professional clients).
Sustainability preferences are a client’s or potential client’s choice as to whether and, if so, to what extent, one or more of the following financial instruments will be integrated into their investment:
- A financial instrument for which the client or potential client determines that a minimum proportion shall be invested in environmentally sustainable investments as defined in the EU Taxonomy Regulation.
- A financial instrument for which the client or potential client determines that a minimum proportion shall be invested in sustainable investments as defined in the SFDR (article 2(17)).
- A financial instrument that considers principal adverse impacts (PAIs) on sustainability factors where qualitative or quantitative elements demonstrating that consideration are determined by the client or potential client.
ii) Product governance obligations
Delegated Directive (EU) 2021/1269 (amending Delegated Directive (EU) 2017/593) introduces the following product obligations for distributors:
- Products and services must be compatible with the sustainability preferences of the target market.
- Review of products by investment firms to assess consistency with the target market’s sustainability preferences