Environmental, social and governance (ESG) issues have soared up the corporate agenda recently and Europe has been at the forefront of policy making and legislative developments in this area. First presented in December 2019, the European Green Deal is a set of policy initiatives with the aim of making the European Union climate neutral by 2050.
In July of this year, the European Commission (“Commission”) announced a renewed Sustainable Finance Strategy (“Strategy”). The Strategy follows the Commission's 2018 Sustainable Finance Action Plan, which aimed to direct more investment towards environmentally sustainable activities.
As 2021 draws to a close, we turn the spotlight on the key EU and domestic developments in the ESG arena which Irish companies and their directors need to know about.
EU Regulation 2021/1119 ‘Fit For 55'
Regulation 2021/119 establishing a framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 (“Fit for 55”) was published in July 2021. Its proposal and adoption was a fundamental component of the European Green Deal. It is a set of interconnected proposals, strengthening eight pieces of existing legislation and introducing five new initiatives across an array of sectors including climate, energy and fuel, transport, buildings, land use and forestry. Fit for 55 refers to the binding objective to reduce greenhouse gas emissions by at least 55% by 2030 as compared to 1990 levels. Proposals include:
- an enhanced Emissions Trading System (including in in the field of aviation);
- extending emissions trading to maritime, road transport, and buildings;
- an updated Energy Taxation Directive;
- a New Carbon Border Adjustment Mechanism;
- stricter CO2 performance for cars and vans;
- new infrastructure for alternative fuel;
- more sustainable and cleaner aviation and maritime fuels; and
- higher carbon reduction targets for Member States.
Climate Action and Low Carbon Development (Amendment) Act 2021
The Climate Action and Low Carbon Development (Amendment) Act (“Climate Act”) was signed into law in July. It commits Ireland to reaching set targets to reduce its greenhouse gas emissions by 2030 and 2050 and provides a framework within which to reach those targets. The Climate Act significantly amends and strengthens the earlier Climate Action and Low Carbon Development Act 2015 by committing Ireland to achieve net zero emissions by 2050. It introduced the concept of carbon budgets for each budget period to be finalised by the Minister for the Environment, Climate and Communications and approved by Government. The first two carbon budgets must provide for a reduction in greenhouse gas emissions of 51% by the end of 2030 as against 2018 levels. Should these quotas not be met, the relevant Government Ministers will be required to outline intended corrective measures in order to achieve those targets.
Sustainable Finance Disclosure Regulation (“SFRD”)
The SFRD requires private equity firms, pension funds, hedge funds and other asset managers to consider and disclose in a consistent and harmonised manner how ESG factors are adopted in their decision making processes. Its main provisions came into effect in March 2021 on a phased basis (Level 1). It introduced entity and product level sustainability-related disclosure requirements for financial market participants (“FMPs”) and financial advisers. It aims to harmonise disclosure standards among EU Member States to facilitate the comparability of different financial products and services. A significant portion of the SFRD applies to all asset managers, whether or not they have an express ESG or sustainability focus. The SFRD manifests in additional disclosures for financial market participants:
- on websites;
- in prospectuses and;
- in periodic reports
The more detailed disclosure requirements relating to disclosures in the periodic reports of ESG-focused products (Level 2) were initially proposed to apply from 1 January 2022 but have now been deferred to 1 July 2022.
Corporate Sustainability Reporting Directive
In the wake of calls for greater consistency and transparency in the area of corporate sustainability reporting, in April 2021, the Commission adopted a proposal for a Corporate Sustainability Reporting Directive (“CSRD”) which would oblige companies in scope to report against common EU reporting standards adopted by the Commission as delegated acts. Current indications are that the CSRD will be enacted in late 2022 with companies likely to start reporting in 2024, based on FY2023 information. The CSRD aims to address perceived gaps in the operation of the Non-financial Reporting Directive 2014 (“NFRD”) (which was transposed into Irish law in 2017). The CSRD as proposed has a much expanded scope and will apply to all large companies and all companies listed on regulated markets (except listed micro-enterprises). Organisations must not only disclose how sustainability issues impact the company (impacts inward), but also how the company impacts society and the environment (impacts outward). A general EU-wide audit (assurance) requirement for reported sustainability information will be introduced, a requirement not seen to date under Irish law.
The European Financial Reporting Advisory Group has been tasked by the Commission with devising common EU sustainability reporting standards, with the first set of reporting standards anticipated to be released by October 2022.
EU Taxonomy Climate Delegated Act (“ETCDA”)
The ETCDA was adopted at the end of May and will apply from 1 January 2022. It sets out technical screening criteria for disclosures required under the EU Taxonomy Regulation, designed to determine whether an activity makes a substantial contribution to climate change mitigation and does no significant harm to environmental objectives. In our view, it should provide a useful guide for financiers and borrowers seeking to ensure that their respective financial products meet the necessary hallmarks to be considered sustainable financing and will significantly contribute to the development and harmonisation of the green loan and green bond markets.
European Green Bond Standard
In July 2021, building on key ESG policy initiatives announced by Commission President, Ursula Von der Leyen, the Commission proposed a regulation on a European Green Bond Standard. In a similar vein to SFDR, the European Green Bond Standard will create a high-quality voluntary standard for bonds financing sustainable investment which will sit alongside existing voluntary standards published by the International Capital Markets Association and other industry bodies. Issuers will have a recognised way of demonstrating that they are funding green projects aligned with the EU Taxonomy. The standard will be open to any issuer of green bonds, including those located outside the EU.
There are four key requirements under the proposed framework:
- The funds raised by the bond should be allocated fully to projects aligned with the EU Taxonomy Regulation;
- There must be full transparency on how bond proceeds are allocated through detailed reporting requirements;
- All EU green bonds must be checked by an external reviewer to ensure compliance and to ensure that funded projects are aligned with the EU Taxonomy Regulation. Specific, limited flexibility is foreseen here for sovereign issuers; and
- External reviewers providing services to issuers of EU green bonds must be registered with and supervised by ESMA.
The proposal is progressing through the EU legislative process with a view to its adoption in 2022.
These legislative developments are representative of the growing focus, and indeed scrutiny, on ESG at a global and national policy level. Consumer and investor pressure on businesses, together with these legislative initiatives, are key drivers behind sustainability policy changes within organisations today. The impacts of recent ESG measures may be financially material and may necessitate significant changes to a company's fundamental strategy and business model. Policies that have science based, targeted initiatives and contain solid, transparent goals that are externally validated are more likely to succeed. In preparing such policies, boards and management would do well to consider the obligations and objectives of the legislation outlined above.
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