Jonathan McKeown CIFD, MBA Director of ESG
Diya Iyer Investment and Sustainability Analyst
16th October, 2024
Sustainable finance continues to be an evolving area incorporating environmental, social and governance (ESG) factors into financial decision-making. In 2018, the European Union (EU) unveiled the EU Sustainable Finance Action Plan (the Plan) with the primary objective of bolstering economic growth while simultaneously alleviating the existing environmental pressures. The overarching aim is to propel progress towards meeting climate and environmental targets. Additionally, the Plan takes into account social and governance considerations to effectively uphold the objectives outlined in the EU Green Deal, ensuring a holistic approach to sustainable economic success. The EU's ambitious efforts are primarily driven by the need to address climate change, promote sustainable development, and ensure financial stability. As a result, reporting on sustainability metrics and the alignment of financial activities with ESG criteria have become central to the framework.
This insight highlights recent updates to the key regulatory initiatives within The Plan and the impacts on relevant stakeholders including:
The main goal of the EU Sustainable Finance Action Plan (The Plan) is to redirect capital towards sustainable investments. By establishing clear policy guidelines and incentives, the plan aims to channel financial resources into environmental sustainability, social inclusion, and long-term economic growth, all supported by the legal aspects of the action plan. The Plan also aims to ensure that financial markets fully incorporate the long-term risks and opportunities associated with ESG factors. The Plan aims to promote greater transparency in sustainability.
Various objectives established under The Plan include:
The Plan advocates the integration of climate and sustainability-related factors into reporting and governance for financial institutions and corporates, intending to create more robust markets that offer investors and other stakeholders information aiding them in making informed decisions. The long-term focus on sustainability-related risks and opportunities also allows investors to gauge risks better while allowing corporates to make informed evaluations regarding financial and other business decisions aiding in adapting to the evolving business environment.
The Plan sets out a roadmap of policy and legislative actions. The legal foundation of The Plan is based on several key regulations and directives that collectively establish a comprehensive framework for promoting and aligning with sustainable finance.
Figure 1: EU Sustainable Finance Action Plan
Source: EU Commission
The Corporate Sustainability Reporting Directive (CSRD)11 aims to significantly expand the range of sustainable investments by being the first comprehensive regional legislative instrument designed to impose substantial sustainability disclosure requirements on large businesses worldwide. This includes the obligation for companies to report robust transition plans aligned with the Paris Agreement and to adjust their strategies and operations to benefit all stakeholders.
The initial audited CSRD reports are expected from many public companies in 2025 on 2024 fiscal data and from many private companies by 2026. The requirement for all the disclosures to be audited ensures reliability, transparency and standardisation of the information.
Climate transition plans will become crucial strategic documents aiding financial stakeholders in decision making as climate risks become integrated into investment and credit assessments.
The latest updates on the CSRD include the European Commission releasing a detailed FAQ document in August 2024.12 This document provides comprehensive guidance on sustainability reporting requirements, including details on which companies are subject to reporting, the determination of company size for compliance, available exemptions, and auditing standards. It aims to reduce the administrative burden and clarify obligations to facilitate compliance, especially for SMEs and large groups.
In August 2024, EFRAG released its XBRL Taxonomy13 for ESRS Set 1, allowing for the digital tagging of ESRS statements. These digital taxonomies make it possible to markup sustainability reporting in a machine-readable XBRL format enhancing comparability and financial market participants’ decision-making abilities.
Sustainable Finance Disclosure Regulation14 (SFDR) came into force in 2021 dictating product and entity-level disclosures in key areas from greenhouse gas emissions to waste, biodiversity and human rights. SFDR was introduced to improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants.
Figure 2: Levels of disclosure under the Sustainable Finance Disclosure Regulation
Source: Davy Horizons
These disclosure levels and classifications provide investors with a clear direction based on their investment preferences.
The SFDR has seen various updates in 2024. Financial products classified under Article 8 and Article 9 must now report on their alignment with all six objectives of the EU Taxonomy starting from January 2024. This expanded reporting requirement aims to improve transparency regarding sustainability impacts and financial flows in the EU market, helping investors make more informed decisions about sustainable investments.
In 2023, the European Commission initiated a review of the SFDR to understand how the Regulation is being implemented and to gather suggestions for potential future changes. Some new proposals address the effectiveness of SFDR, its relationship with other sustainability laws, and potential revisions to product disclosures.15 The consultation also emphasised the need for a proper categorisation system for financial products, including a potential overhaul of the Article 8 and 9 categories.
In June 2024 the ESA’s, (European Supervisory Agencies – the European Banking Authority, EIOPA and ESMA), provided their own opinion16 on SFDR categorisation.
The ESAs suggest simple and clear categories for financial products, consisting of two voluntary product categories, “sustainable” and “transition”, that financial market participants should use to ensure consumers understand the purpose of the products.
The ESAs also recommend that the European Commission consider the introduction of a sustainability indicator that would grade financial products such as investment funds, life insurance and pension products.
In addition, the opinion covers the following areas:
Figure 3: ESAs Opinion on SFDR
Source: ESMA
The changes to SFDR funds classification could potentially lead to a closer alignment with the UK's Sustainability Disclosure Requirements, introduced by the Financial Conduct Authority in 2023.17
In 2024, the EU Taxonomy Regulation's (EU Taxonomy)18 scope expanded to include all six environmental objectives beyond the initial climate change mitigation and adaptation goals. New amendments were made to the Taxonomy Disclosures Delegated Acts19, including criteria for activities that promote sustainable water use, circular economy, pollution prevention, and biodiversity protection.
Figure 4: Environmental objectives
Source: EU Taxonomy
The first reports from this year are now becoming available and the initial evidence is encouraging: companies, public entities, and financial actors are increasingly using the Taxonomy for their business strategies, transition planning, investing and lending20.
The European Securities and Markets Authority’s (ESMA) opinion21 published 24th July 2024, focuses on mobilising more private capital into sustainable investments, in line with the EU targets to achieve net zero. It states that EU Taxonomy should become the “sole, common reference point for the assessment of sustainability and should be embedded in relevant sustainable finance legislation.”
Taxonomy-aligned capital investments are expected to increase reflecting companies' increasing use of the Taxonomy for strategic planning and green investments, particularly in the utilities sector.
In 2023, around 600 European companies reported capital investments into Taxonomy-aligned activities of €191 billion. In the first half of 2024, companies have already reported €249 billion, signalling significant growth.22
Table 1: Taxonomy-aligned investments
Source: Europa - The EU Taxonomy's uptake on on the ground.
Economic conditions such as movements in global bond yields and investor flows led to some withdrawal from sustainability-based bond products. Flows into sustainable bond funds declined to just over US$14 billion from US$20.5 billion in the previous quarter. Flows into conventional bonds dropped too but proved more resilient23. In terms of new issuance, Europe was the largest source of green bond volume with USD237bn issued – representing 62% of total global green bond issuance24. The European Union (EU) was the single largest issuer with US$12.2bn priced through one new deal maturing in 205025.
In 2023 the European Council of the European Union adopted a regulation creating the European Green Bond Standard.26 The Regulation lays down uniform requirements for issuers of bonds that wish to use the designation ‘European green bond’ or ‘EuGB’ for their environmentally sustainable bonds.
The EU Taxonomy framework is embedded within the EU Green Bond Standard where proceeds of green bonds designated as EuGB must be invested in economic activities aligned with the EU Taxonomy for sustainable activities. In 2023, 90% of green bonds issued by EU public actors referenced the EU Taxonomy to illustrate their commitment of using the raised funds for green projects27.
It remains to be seen whether the strict rule of 80% Taxonomy aliginment in the Green Bonds Use-of-Proceeds will hinder issuance under the standard.
The intention is to enhance investors’ confidence in green investment by reducing the risks posed by greenwashing and ultimately stimulating capital flows into environmentally sustainable projects.
The European Parliament officially adopted the Corporate Sustainability Due Diligence Directive (CSDDD) in April 2024. It requires companies within its scope to take action on governance and due diligence processes. The directive establishes a framework to enhance how businesses operating in the EU manage human rights and environmental impacts in their operations and throughout their value chains. Despite the initial reduction in scope from the original proposal, the regulation will have significant implications in Europe and globally. The CSDDD also requires companies subject to it to develop a detailed climate mitigation transition plan.
Companies will need to adopt and implement a transition plan to "ensure, through best efforts, that the business model and strategy of the company are compatible with the transition to a sustainable economy with the limiting of global warming to 1.5°C in line with Paris Agreement and the objective of achieving climate neutrality".28
ESG ratings are a widely used indicator of a company’s ESG performance. ESG ratings agencies use diverse methodologies which has often led to ambiguity of results lacking transparency making it difficult for market participants to compare.
The lack of standardisation and the questions arising about the methodologies employed have led to the scrutiny of ESG ratings on a global platform. The reputation of ESG ratings has suffered as a result.
The reputation of ESG ratings might be subject to additional questions concerning methodologies and other processes. The complementary nature of CSRD with SFDR and EU Taxonomy allows for efficient sustainability reporting and disclosures, working in tandem within the same ecosystem. CSRD reporting will increase the availability of standardised sustainability-related information, offering transparency and allowing comparability for investors.
On 24th April 2024, the European Parliament adopted the Proposal for a Regulation of the European Parliament and of the Council on the Transparency and Integrity of Environmental, Social and Governance (ESG) rating activities29 (the ESGR). The ESGR regulates ESG rating providers that operate within the EU.
Table 2: ESGR general principles for organisation and governance
Source: The European Parliament.
Climate transition and Paris-aligned benchmarks are indices of equities or corporate bonds which aim to assist in meeting the decarbonisation objectives set by the European Union's Sustainable Finance Action Plan. These benchmarks incorporate stringent 7% year-on-year decarbonisation requirements for equities or bonds to be eligible for inclusion in the index.
Over €180 billion of assets under management currently meet the criteria of the EU Climate Transition Benchmark (CTB) and EU Paris-Aligned Benchmark (PAB). It is anticipated that this figure will exceed €200 billion in the near future.
Major investment institutions have acknowledged these climate benchmarks as reliable tools to assist investors in their decarbonisation strategies.30 The benefit for corporates is meeting Benchmark criteria can potentially access an additional source of capital.
Figure 5: Climate transition benchmarks
In December 2023 the EU launched a consultation on new taxonomy-based climate benchmark labels - The EU Taxonomy-Aligning Benchmarks31 - without and with exclusions (EU TAB and EU TABex).
The EU Sustainable Finance Action Plan comprises ambitious goals and regulations aimed at redirecting capital towards sustainable investments.
CSRD will be a key focus this year and next for corporates in scope. The availability and transparency of corporate sustainability information including climate transition plans will be transformative in financial stakeholder decision-making. Added to this it will facilitate sustainability KPIs to be credibly linked to capital allocation including financing structures such as Sustainability Linked Loans and Sustainability Linked Bonds.
Although SFDR was one of the first regulations to come into effect, it has seen some criticism, largely its timing (SFDR came into effect before CSRD). SFDR product definitions (Articles 6, 8 and 9) are also in the spotlight and although were categorically not designed to be product labels, they ended up becoming a de facto classification and labelling system for sustainability-related investment products. Time will tell whether or not SFDR is redefined in line with or similar to the ESAs opinion. Certainly, the ESA’s suggested classification system is simpler to understand (for retail) and widens the door for transition products, the demand for and supply of which is much needed for the net zero transition.
The EU Taxonomy, whilst some might consider overcomplex, is increasingly embedded into the sustainable finance ecosystem as corporate disclosure grows. ESMAs statement that EU Taxonomy should become the sole, common reference point for the assessment of sustainability, its incorporation into the EU Green Bond standard and within ESMA’s opinion on SFDR classifications only strengthens its importance. EU Taxonomy is here to stay and corporates need to prepare for reporting Taxonomy-aligned CapEx, OpEx and Turnover.
ESG Ratings regulation is welcome and the improved transparency of methodology will add substance and accuracy of comparability for rated corporates. It remains to be seen what the introduction of assured non-financial data via CSRD will mean for the ratings agencies, particularly with XBRL-tagged data and the data analysis capacities of large language models.
Interest in Climate Transition Benchmarks continues to grow allowing investors to easily access investments with a decarbonisation theme. Corporates meeting the strict criteria for inclusion might see an expansion in investor base as a result.
Although the EU Sustainable Finance Action Plan was launched over six years ago, we remain in the nascent stages of its use. As the framework of policy and regulation falls into place, sustainable product innovation and demand will continue to rise as enhanced, assured, corporate sustainability disclosures feed transparently into the sustainable finance ecosystem.
1Financial Stability, Financial Services and Capital Markets Union (europa.eu)
2SMEs | EFRAG
3ESRS-ISSB Standards Interoperability Guidance.pdf (efrag.org)
4ESRS implementation guidance documents | EFRAG
5ESRS Q&A Platform | EFRAG
6Strategy for financing the transition to a sustainable economy - European Commission (europa.eu)
7Report on greenwashing monitoring and supervision.pdf (europa.eu)
8EBA report on green loans and mortgages_0.pdf (europa.eu)
9Study for a methodological framework and assessment of potential financial risks associated with biodiversity loss and ecosystem degradation - Publications Office of the EU (europa.eu)
10a5a3769b-8eb6-4c8c-8e84-644c469ca4c2_en (europa.eu)
11Directive - 2022/2464 - EN - CSRD Directive - EUR-Lex (europa.eu)
12Frequently asked questions on the implementation of the EU corporate sustainability reporting rules (europa.eu)
13ESRS XBRL Taxonomy, Concluded | EFRAG
14Regulation - 2019/2088 - EN - sfdr - EUR-Lex (europa.eu)
15Summary report of the open and targeted consultations on the implementation of the Sustainable Finance Disclosures Regulation (SFDR) (europa.eu)
16JC 2024 06 Joint ESAs Opinion on the assessment of the Sustainable Finance Disclosure Regulation (SFDR) (europa.eu)
17The new naming and marketing rules, originally set to take effect in early December 2024, have been postponed by the FCA to April 2025 due to some firms taking longer than expected to make the necessary changes.
18Regulation - 2020/852 - EN - taxonomy regulation - EUR-Lex (europa.eu)
19Delegated regulation - EU - 2023/2486 - EN - EUR-Lex (europa.eu), Delegated regulation - EU - 2023/2485 - EN - EUR-Lex (europa.eu)
20Factsheet: The EU Taxonomy’s uptake on the ground (europa.eu)
21ESMA36-1079078717-2587 Opinion on the functioning of the Sustainable Finance Framework (europa.eu)
22Factsheet: The EU Taxonomy’s uptake on the ground (europa.eu)
23Global_ESG_Flows_Q2_2024_Report_(2).pdf (contentstack.io)
24cbi_mr_h1_2024_02e_1.pdf (climatebonds.net)
25cbi_mr_h1_2024_02e_1.pdf (climatebonds.net)
26European green bond standard | EUR-Lex (europa.eu)
27Factsheet: The EU Taxonomy’s uptake on the ground (europa.eu)
28eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52022PC0071
29TA (europa.eu)
30Factsheet: The EU Taxonomy’s uptake on the ground (europa.eu)
31Climate Change Taxonomy and the EU Regulatory Response: (europa.eu)
8 April, 2024
29 April, 2024
24 November, 2022
