28 August 2024
Where are we?
The Sustainable Finance framework put in place by the European Union in the last mandate was a transformative process for a nascent movement that had been up until recently mainly pushed forward by industry through various voluntary commitments, industry-led initiatives, and varying standards, guidelines and frameworks.
The regulatory initiatives introduced by the EU as part of the Green Deal have set out extensive new rules for businesses relating to their reporting requirements while also aiming to stimulate more capital flows for the green and digital transition through the widening availability of ESG data.
While the objectives of the EU sustainable finance agenda are still strongly supported, strong concerns about its proportionality, appropriateness and suitability have been raised by a multitude of stakeholders. The initiative is at a pivotal moment as it continues to evolve in response to growing environmental challenges, regulatory changes, and market demands. The implementation of the sustainable finance framework is one of the most resource-intensive projects in recent history. Therefore, a key consideration for the EU’s sustainable finance framework is how to ensure that the regulatory framework does not hold back the EU’s competitiveness. Competitiveness is set to be a key focus of the newly elected European Parliament and the European Commission.
Next Steps
Following the EU elections in June 2024, a new European Commission is yet to be formed. The reappointed Commission President Ursula von der Leyen is currently in the process of defining her new College of Commissioners and some EU Member States have been slow in nominating their candidates. Notwithstanding this ongoing procedure, Commissioner von der Leyen made clear that the next Commission will focus on the EU’s strategic autonomy, its defence and security, competitiveness and growth.
In her statements since the elections, Commission President von der Leyen renewed her commitment to reduce the administrative burden on companies by 25%, which she had made in 2023. It remains to be seen how this commitment impacts the future of the EU sustainable finance initiative.
Sustainable Finance Disclosures Regulation
The Sustainable Finance Disclosures Regulation (SFDR) was introduced to enhance transparency in companies’ financials and enable investors to make informed choices that are aligned with sustainability objectives. The legislation, which was proposed in 2018 and finalised the following year, has been in application since 2021.
The European Commission launched a consultation in 2024, calling for evidence from financial market participants on their experiences of using the SFDR. Among the issues facing the SFDR is the fact that it is being used by investors as a de facto labelling system thanks to the categorisation of products. It remains to be seen what the Commission is planning to do with the legislation, but a revision of the SFDR with a legislative proposal is expected in the near future.
Corporate Sustainability Reporting Directive
The Corporate Sustainability Reporting Directive (CSRD) was introduced to replace the Non-Financial Reporting Directive (NFRD) as a means of having companies disclose relevant information about their activities and impacts on other areas, including environmental, social and governance considerations. The CSRD was proposed in 2021, with an agreement found the next year. From the beginning of 2024, companies which were in the scope of the NFRD must comply with the legislation, meaning the first reports will come in 2025, covering the financial year 2024. Additional companies are to comply from the beginning of 2025.
The CSRD transposition deadline was July 6, 2024, and several Member States have missed this deadline, and are still working on getting their implementing legislation in place.
Ireland has completed its transposition of the CSRD with minimal changes made to the legislation, except for a change introduced to the reporting exemption for parent undertakings and for subsidiary undertakings. This is a significant additional burden to companies in Ireland, and a change that has not been mirrored in other EU Member States.
The Sector-Specific and non-EU companies European Sustainability Reporting Standards (ESRS), constituent parts of the CSRD, are still to be introduced. A 2-year delay was approved earlier in 2024. Originally scheduled to be introduced in June 2024, this has been pushed back to 2026.
Corporate Sustainability Due Diligence Directive
The Corporate Sustainability Due Diligence Directive (CS3D) has been agreed between the Co-legislators and published in the Official Journal in July 2024. The application of the Directive will begin in 2027 with the largest tranche of companies captured by the Directive coming into scope first. While financial services companies have been exempted from “downstream” due diligence requirements, it is still applicable to “upstream” activities.
Solvency II
The Solvency II Review has finally reached a conclusion with regard to the level one legislation. The revised Directive includes a wide range of measures, including a new proportionality framework, adapted cross-border rules, and additional reporting requirements on sustainability. Insurers will be required to emphasise sustainability-related aspects in their Financial Solvency and Condition Report (SFCR) and to file a sustainability risk report (at the group level).
With the review, the EU legislators aimed to free up capital to allow for further investment in the sustainable and digital transition and enhance capacity for providing insurance capacity for new and emerging risks. Positive steps, like the reduction of the Cost-of-Capital underlying the calculation of the Risk Margin, have been taken. However, more needs to be done.
The subordinated regulations on Solvency II (Level 2) are yet to be developed and the “technical” provisions can have a severe impact. The European Commission holds the pen on these rules and needs to make an ambitious move to let EU (re)insurers support the sustainable transition to its full capacity.