This article was written by Joe McHale and Christian Benson, Regulatory Affairs Specialists at Bloomberg.
Despite recent talk of global disunity, an outbreak of global consensus has emerged on the salience of the climate crisis and European policymakers are already setting a quick-regulatory pace.
We have seen the 2018 Sustainable Finance Action Plan bear fruit in its attempt to foster greater transparency and longer-term mindset in the industry through three key legislative proposals: the Taxonomy Regulation, the Low Carbon Benchmark Regulation and the Sustainable Finance Disclosure Regulation (SFDR).
The amendments to the EU’s Benchmark Regulation – which went into force last December – specified new disclosure rules and established minimum standards in line with EU climate-related goals. The amendments created two new categories of benchmarks: (1) EU Climate Transition Benchmarks (EU CTB); and (2) EU Paris-aligned Benchmarks (EU PAB).
This primarily affects firms that administer benchmarks, and administrators have been encouraged to identify Environment, Social and Governance (ESG) benchmarks and to ensure they are able to complete the required disclosure template.
Then in March this year an important milestone was passed when the Sustainable Finance Disclosure Regulation (SFDR) came into effect, imposing mandatory ESG disclosure obligations on many EU regulated entities. More detailed disclosure requirements are expected to come into force on a phased basis from mid-2022.
The Taxonomy Regulation is the core element of the 2018 Action Plan and the key to reaching EU Paris-aligned targets by 2050. It essentially sets out a list of environmentally sustainable economic activities, which in turns allows investors to determine what investments are truly green. While the Taxonomy Regulation does not require financial market participants to invest in so-called "Taxonomy-aligned" products, financial market participants subject to the CSRD are required to report their alignment with the Taxonomy. This reporting obligation will kick-off on a phased basis beginning January 2022.
The Taxonomy implementation is moving ahead as the EU Commission published revised draft rules in May that specify the disclosure obligations. Those under the scope of the Non-Financial Reporting Directive (NFRD) – now being revised by the Corporate Sustainability Reporting Directive (CSRD) – are required to publish non-financial information on how and to what extent their activities are associated with the economic activities specified under the Taxonomy as environmentally sustainable.
Under the draft rules, non-financial undertakings shall disclose the proportion of their turnover, capital and operational expenditures that results from environmentally sustainable activities, while financial undertakings will have to disclose the what extent they finance, or invest, in environmentally sustainable economic activities.
Ahead of the EU’s Taxonomy implementation, the European Banking Authority (EBA) published the results of its first pilot exercise on climate risk in the EU in May. This was designed as a learning exercise to understand how existing and newly developed climate risk assessment and classification tools perform, and to test banks' readiness to apply EU Taxonomy criteria.
Looking ahead, the CSRD will revise existing reporting rules under NFRD and establish a set of mandatory European sustainability reporting standards applicable to all large companies, and all companies listed on EU-regulated markets with a few minor exceptions.
The proposed CSRD would expand its coverage to approximately 49,000 companies, up from the 11,000 companies or so that are subject to existing sustainability reporting rules under the NFRD.
In early July the EU Commission released a second revamped sustainable action plan that signals the next wave of ESG measures in the bloc. Alongside the renewed strategy, the EU Commission has published a legislative proposal for a European Green Bond Standard in effort to anchor rules to the EU Taxonomy list of what counts as an environmentally sustainable investment. In the strategy there is also a commitment to take action by 2023 to reinforce the reliability and comparability of ESG ratings. Having already adopted the technical screening criteria for the first two environmental objectives under the Taxonomy, the EU is planning to publish the criteria for activities making a substantial contribution to the other four objectives sometime this autumn per the revamped strategy.
With only a few months to go until the UK hosts the COP26 conference in Glasgow in November, the UK is keen to use the international spotlight to mobilize private finance to support the economic re-engineering for net-zero. Having brought together over 160 financial services firms collectively responsible for assets worth more than $70 trillion, the Glasgow Financial Alliance for Net Zero will be used to rally the financial services industry in support of climate transition plans.
Further details on how firms should publish their transition plans will be released before the end of the year.
Then, of course, there’s Brexit. The UK is embarking on its own ESG measures to further cement the central role of ESG in the policy and regulatory agenda. This was evident in the decision to not onshore the SFDR, but instead push ahead with its ambition to set mandatory climate-related financial disclosures in line with the TCFD framework across the economy by 2025.
The Financial Conduct Authority (FCA) finalized its policy on TCFD-aligned disclosures late last year for premium-listed companies, which went live at the start of 2021. The FCA is now consulting on TCFD disclosures to expand the scope of listed companies, and introduce new obligations for asset managers, life insurers and FCA-regulated pension schemes and plans to confirm its final policy before the year-end. In addition, the FCA is also exploring proposals to regulate ESG data and ratings providers given their growing prominence with a feedback statement scheduled for the first half of 2022.
On the taxonomy front, the Chancellor has announced that the UK will develop and implement its own green taxonomy for determining what it defines as environmentally sustainable activity and to avoid ‘greenwashing’. This taxonomy will use the EU taxonomy science-based metrics as a starting point and a UK Green Technical Advisory Group will review these metrics to ensure they are appropriate in a UK context and provide technical advice to the government.
The Bank of England is also playing a key role in the UK’s ESG agenda having published the Climate Biennial Exploratory Scenario (CBES) in June. This is meant to better understand the financial risks posed by climate change for the largest UK banks and insurers by using three scenarios of early, late and no additional action to explore the transition risk and the physical risk associated with climate change. The results of the CBES are expected to be released by May 2022 at the latest and will be used to inform the Bank’s supervisory policy.
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