11 November 2021

Sustainability update

Sustainable finance remains a key enabler of globally coordinated net zero efforts now required as a matter of urgency. Meanwhile, the abundance of Environmental, Social and Governance (ESG) regulatory activities continue to dominate the European funds industry. Here is the latest summary of notable events now requiring attention:

1. EU developments

a) EU-Taxonomy: recap + climate change updates

Firstly, a quick reminder that the EU taxonomy is an evolving classification system that embodies the European Commission (EC) list of environmentally sustainable economic activities.

It is the key focal point of ESG disclosure for firms and their products across European continent, legally embodied in the Taxonomy regulation (TR) which contains six environmental objectives:

  • Climate change mitigation
  • Climate change adaptation
  • The sustainable use and protection of water and marine resources
  • The transition to a circular economy
  • Pollution prevention and control
  • The protection and restoration of biodiversity and ecosystems

Ongoing, for an economic activity to be classed as “sustainable” by the EU Taxonomy, it must successfully apply four basic conditions:

a) Contribute substantially to one of the six EU-TR environment objectives
b) Do no significant harm (DNSH) to any of the other five environment objectives
c) Comply with minimum social and labour safeguards
d) Comply also with underlying technical screening criteria (TSC) used to confirm both a) and b)


With global warming now on a critical path, the EC has already adopted delegated acts (DAs) regarding climate change mitigation and climate change adaption. Scheduled to apply from 1 January 2022, these will establish screening criteria and DNSH factors for TR environmental objectives 1) and 2) above.

However, given continuing debate in relation to nuclear energy and natural gas, the scrutiny period of the climate change DAs has been extended until 8 December 2021.

In the meantime, the EC has made available an interim Taxonomy compass tool to provide a visual representation of the climate change mitigation / adaption technical criteria, pending legal application.


b) EU-Taxonomy: screening criteria for other sustainable objectives

The Platform on Sustainable Finance (PSF) is an expert advisory group established by the EC in 2020 to assist in their development of sustainable finance policies, including those linked to the TR.

Later this month, they are expected to supply the EC with a finalised Taxonomy report containing their completed list of all TSCs – including those relating to TR environmental objectives 3) to 6) above.

This follows their recent presentation of a draft full list of technical screening criteria to wide selection of EU financial and non-financial businesses, representing all economic sectors.


c) ESMA highlight past and future ESG efforts

Last week, the European Securities and Markets Authority (ESMA) issued a summary of their contributions to a more sustainable financial system so far. They also flagged forthcoming activities facing investment managers, fund firms, climate transition benchmarks and ESG risk assessment monitoring in due course.


d) ESAs issue revised SFDR / TR disclosure requirements

The Sustainable Finance Disclosure regulation (SFDR) is a separate regime applicable since 10 March 2021.

SFDR applies to financial market participants (FMPs), including all AIF and UCITS firms.  It obliges FMPs to disclose standardised information on how ESG factors are integrated at both entity and product level.

In February this year, the European Supervisory Authorities (ESAs) issued a report containing regulatory technical standards (RTS) in relation to:

  • Entity level: Principal adverse impact (PAI) statement
  • Products level: pre-contractual, periodic and website disclosure required for:
  • “article 8” products:e. promoting environmental or social characteristics
  • “article 9” products:e. directly pursuing sustainability objectives.

The ESAs have now published their latest report containing a revised set of SFDR disclosures, expanded to incorporate additional TR requirements.  This forms part of an attempt to create a ‘single ESG rulebook’ for asset managers (previously facing separate disclosure obligations from SFDR and TR legislation).

In one major change, additional TR-aligned sustainability factors are applied to both SFDR product types. This effectively splits the initial categories into four types of sustainable fund (article 8, 8+,9,9+).

TR-aligned environmental objective factors are now depicted as key performance indicators in the revised SFDR disclosure templates, including:

  • Pre-contractual: KPIs showing the market value of investments in the “green” economy
  • Periodic statements: KPIs showing EU-TR alignment in terms of Turnover, Capital expenditure and operational expenditure

Moreover, additional rules now apply to products marketed as “sustainable”, including:

  • Sovereign debt investment split
  • Additional product-level principal adverse impact (PAI) indicators: covering any investments in TR-aligned economic activities.
  • DNSH narratives: explaining how indicators in the entity-level PAI statement have been applied
  • Application of derivatives and netting rules when calculating TR-alignment

Finally, PSFs must also declare whether disclosures have been subject to third party review (e.g. auditor).

The EC has stated their aim to adopt the latest SFDR/TR RTS before the end of December 2021.

The EU Parliament & Council will then require a 3–6-month scrutiny period before the RTS can be published in the EU Official Journal.

Meanwhile, the ESAs consider it ‘likely’ that the EC will adopt all required ESG disclosure rules in one single delegated act, expected to apply from 1 July 2022. This includes TR climate change mitigation / adaptation objectives (previously scheduled to commence from 1 January 2022).


NB: although not included as appendices in the latest draft RTS:

  • Entity-level PAI statements: remain a core requirement before 30 June 2022. These apply also to FMPs marketing “article 6” products that continue to invest in non-sustainable activities (e.g. coal, oil or tobacco companies).
  • Website product disclosure summaries: remain obligatory when FMPs intend to market “sustainable” article 8 or article 9 funds (2 x pages A4, maximum).


e) ESMA publish results of ESG disclosure consumer testing

ESMA also recently made available two sets of consumer testing results of the draft SFDR pre-contractual and periodic disclosure templates.  These were conducted by the Autoriteit Financiële Markten (AFM) in the Netherlands and the Warsaw School of Economics (SGH).

  • The AFM reported a majority critical response, with those surveyed finding the templates “too long, too complex and complicated”, including “muddled text” and “jargon”.
  • The SGH highlighted the need for “substantial improvements, especially in the pre-contractual documents”, with retail investors in need of “well-tailored information”.


2. UK developments

a) UK-TCFD regime kick-off: 1 Jan 2022

“The UK will be the world’s first Net Zero-aligned Financial Centre.” HM Treasury, 3 November 2021.

At COP26 last week, the UK Government announced their creation of a new Transition Plan Taskforce, composed of industry and academic leaders, regulators and civil society groups.  By the end of 2022, the Taskforce will develop a ‘gold standard’ for “net zero” transition plans to a low-carbon economy, including ‘robust’ measures to tackle greenwashing.

Once the Taskforce report is issued, the Government will expect all UK listed companies and asset managers to begin publishing a net zero transition plan during 2023.  This was an essential part of the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations published in 2017.

Other TCFD-aligned measures were included in a recent consultation paper from the Financial Conduct Authority (FCA). The UK has now confirmed the new rules will now apply to larger UK-listed companies from 1 Jan 2022. These firms will have to publish a non-financial sustainability information statement starting in the next financial year, including:

  • Governance and management of climate-related risks and opportunities
  • An analysis of their business’s resilience to climate scenarios

Meanwhile, a reminder that the FCA has also consulted on proposals for additional TCFD climate-related disclosures from asset managers, life assurers and pension providers (with initial reporting starting from 30 June 2023).  A policy statement including finalised UK legal requirements is due before the end of 2021.


b) New UK-SDR regime announced

During the build-up to COP26, the UK Government published their new Green Finance Roadmap. This outlined a new UK-Sustainable Disclosure Requirements (SDR) regime to accompany previously announced TCFD reporting proposals.

Last week, the FCA issued an discussion paper with further details.  The SDR framework will:

  • Apply at corporate, investment manager and product levels
  • Be based on standards currently under development by the International Financial Reporting Standards (IFRS) Foundation (see section below).

The FCA seek feedback on their proposed design of reporting linked to sustainable investment labels, which appear to diverge from the EU-SFDR product categories (articles 6, 8 and 9):

The FCA paper is open for comments until 7 January 2022. Respondent input will be used to determine the detailed UK-SDR policy statement, including reporting obligations, likely to apply from 1 Jan 2023.


c) UK Green Taxonomy: consultation pending

The UK Green Finance Roadmap also included further details of the new UK Green Taxonomy.

The UK confirm theirs will be based on the EU version (“which the UK helped design”) and share the same six environmental objectives.

During Q1-2022, the UK Green Finance Institute (GFI) will present their first set of Technical Screening Criteria (TSC) for consultation. These are to be based initially on the TR-aligned climate change mitigation / change adaption objectives adopted by the EC earlier this year (see section 4. below).

d) FCA publish Climate Change Adaption report

Also coinciding with COP26, the FCA have published a Climate Change Adaption report. This includes:

  • an outline of the UK financial regulator’s evolving ESG strategy (including net zero transition)
  • details of their plans to engage with firms to tackle greenwashing
  • a high-level timeline of upcoming ESG activities over the next year
  • a pledge to publish their TCFD-aligned report (as an operating entity / regulator) next summer.

The FCA also updated their ESG strategy; this sets out revised priorities and milestones based on five core themes: transparency, trust, tools, transition and team.


3. Other key ESG developments

a) TCFD: updates Climate Change Disclosure implementation guidance

The TCFD’s original 2017 recommendations have now been adopted by the UK alongside Switzerland, Hong Kong, Singapore and the EC (in their forthcoming Corporate Sustainability Reporting Directive [CSRD]).

Shortly before COP26, the TCFD published their 2021 Status report and updated key guidance covering:

b) IFRS: create International Sustainability Standards Board (ISSB)

At COP26 last week, the International Financial Reporting Standards (IFRS) Foundation formally announced the creation of their International Sustainability Standards Board (ISSB).  This will now determine “high quality, transparent, reliable and comparable reporting by companies on climate and other ESG matters.”

The ISSB rules will form the “backbone” of the UK’s new UK-SDR regime corporate reporting framework.

c) IOSCO: publish greenwashing recommendations

Last week, the International Organization of Securities Commissions (IOSCO) published their latest recommendations for regulators to improve ESG-related practices and disclosures in the funds sector.

The report refers to most of the emerging EU /UK sustainability regime elements covered in this article.

During COP26, the chair of IOSCO’s sustainable finance taskforce (also Director of the Swedish financial regulator) supported the ISSB’s pending global standards as “the right tool to respond to the existing ‘alphabet soup’ of sustainability disclosures”.


4. ESG market reaction, trends

Some recent market reactions to unfolding events:

  • SFDR amendments will create major ‘operational barriers’: experts raise ‘serious concerns’ about asset managers ability to comply with the latest SFDR / TR disclosure rules (summarised above), which risks ‘undermining end-investor trust’.
  • Fund firms undecided over updated EU product categories: following ESA’s latest changes to their SFDR product categories, many firms are reportedly sceptical these will prevent asset managers from classifying their funds as “sustainable”.
  • UK to diverge from EU ESG model: tasked with designing the UK’s Green Taxonomy, the GFI reportedly plans to diverge from the EU classification system. Meanwhile, cross-border firms express concerns as they confront de-aligned UK-SDR and EU-SFDR disclosure regimes.
  • 75% non-retail clients now ‘likely to divest’ from poor ESG firms: in a latest Global Study issued during COP26, it was concluded that three-quarters of institutional investors (surveyed across 19 countries) are now poised to divest from companies with poor ESG track records, with increasing distrust in reporting quality and transparency.
  • €95 trillion funds industry about to get ‘tougher on climate’: there were reports this week of growing trends in larger “traditional” investors taking a rigorous approach in the face of global warming; this may see sizeable divestments with “huge ramifications” for the global marketplace.
  • Non-sustainable funds ‘still going strong’: despite everything mentioned above, new “brown” fund launches have attracted EUR41bn of net inflows (41% of total market) so far in 2021.
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