Sustainable finance regulations

The European taxonomy provides a definition of an ‘environmentally sustainable’ (i.e. ‘green’) economic activity, through a classification system for different economic activities. It classifies economic activities at a given point in time according to whether or not they are sustainable (bearing in mind that not being ‘green’ in the taxonomy’s sense does not necessarily mean being ‘brown’: a health-related activity is therefore not green, but is not necessarily brown either). It is based on six objectives (two climatic; four environmental):

• Objective 1: climate change mitigation
• Objective 2: adaptation to climate change
• Objective 3: protection of aquatic and marine resources
• Objective 4: circular economy
• Objective 5: pollution prevention and reduction
• Objective 6: protection and restoration of biodiversity and ecosystems

Two delegated acts define the criteria for determining the alignment of economic activities with each of these six objectives: one specific to the two climate objectives (mitigation, adaptation) was adopted in December 2021, and the other, adopted in 2023, relates to the other four environmental objectives.Based on these elements, the European Taxonomy requires the validation of three cumulative conditions to establish that an economic activity is ‘aligned with the taxonomy ‘:

• It contributes substantially to one or more of these six objectives. If we take the example of the ‘mitigation’ delegated act (objective n°1), it specifies thresholds and criteria for each economic activity in order to establish whether this economic activity can be considered as aligned with this objective.
• It does not cause significant harm to any of the other aforementioned climate or environmental objectives. This is the ‘do not significant harm‘ principle, and it is once again the delegated acts that specify the criteria and thresholds at which we can speak of harm to a given objective.
• It is exercised in compliance with minimum social guarantees.

Thus, to be aligned with the taxonomy, an economic activity must be sustainable in the sense of one of the six objectives, and not be detrimental to the other five objectives or in social terms. To ensure that transitional economic activities remain on a credible transition trajectory compatible with a climate-neutral economy, the Commission must review the criteria defined by the delegated acts at least every three years, and where necessary amend the delegated acts in line with scientific and technological progress.

Economic activities eligible for the Taxonomy :

Not all activities are eligible for the Taxonomy. Only those activities that can make a substantial contribution to each environmental objective are eligible for the Taxonomy. Today, some 90 so-called eligible activities are covered by the Taxonomy, covering 80% of GHG emissions. But this does not mean that they are necessarily aligned: an eligible activity does not necessarily meet the technical criteria for being considered aligned. Three different categories of activities are eligible:

• Green’ activities, which can be considered sustainable (even in 2050).
• Transitional activities[1], which only concern the objective of mitigating climate change, and are activities for which there is no technologically and economically feasible low-carbon alternative. They are considered to contribute substantially to the climate change mitigation objective.
• ‘Enabling’ activities, which are activities that ‘directly enable’ other activities to make a substantial contribution to one or more of the taxonomy’s objectives, provided that this economic activity (i) does not result in a lock-in of assets that compromise long-term environmental objectives, taking into account the economic life of these assets; (ii) has a significant positive environmental impact based on life-cycle considerations.

Who is the Taxonomy aimed at?

The Taxonomy concerns three types of actor (article 1 of the regulation):

• Member states and EU institutions that implement sustainable financial tools and public policies.
• Large non-financial companies covered by the NFRD Directive, which will have to publish a breakdown of their sales, capital expenditure and operating expenditure (CAPEX and OPEX) falling within the scope of the taxonomy.
• Financial players, i.e. at this stage institutional investors and managers offering financial products, who will have to make public the alignment of their products with the taxonomy.

What reporting obligations does the Taxonomy require?

The reporting obligations apply differently to these players.For non-financial companies, Article 8 of the Delegated Act sets out their obligations and the timetable for their implementation. Eventually, they will have to calculate and publish the proportion of their activities that are eligible and aligned with the Taxonomy, by calculating 3 key financial indicators: ‘sustainable’ sales, ‘sustainable’ Capex and ‘sustainable’ Opex.

• For the 2023 financial year, they must publish the breakdown of their sales and Capex and Opex expenditure (eligibility and alignment) relating to climate objectives, as well as eligibility indicators for other environmental objectives.
• For the 2024 financial year, they will again have to publish the three indicators mentioned above, but this time for all activities relating to the six environmental objectives.

It is also important to point out that, from January 1, 2024, this reporting will be integrated into the CSRD’s publication obligations. The reporting requirements will therefore be gradually extended to other companies subject to this directive (according to procedures specified by the December 2023 ordinance).For players in the financial sector, the required indicators are different: they must publish the proportion of their investments in activities aligned with the Taxonomy.

• Since January 1, 2022, they must calculate and publish their GAR(Green Asset Ratio), which establishes the proportion of assets invested in activities eligible for the European Green Taxonomy.
• As of January 1, 2024, they must publish the GAR calculating their proportion of investment in aligned activities.

The taxonomy can be read in two ways:

1. A static approach (allocation of financing to activities considered green according to this classification) ;
2. A dynamic approach: the taxonomy provides companies with a reference point for decision-making, to guide and steer their transformation. It defines the objectives to be achieved for each activity, without specifying the trajectory for reaching these objectives.

This dynamic reading of the taxonomy should be favored, as the challenge is not to allocate capital to activities that are already green, but to invest in activities that are currently carbon-intensive and have credible plans for transformation. Significant improvement is therefore the objective, and this could be limited by strict compliance with the thresholds set out in the taxonomy. Some are not achievable in the short term due to investment cycles, and not all companies start from the same starting point, and some are too far from the targets to qualify as ‘sustainable’ in the short term. All this, however, requires the production and publication of serious and credible transition plans, based on recognized reference frameworks such as ADEME’s ACT method. In addition, this work of interpreting the taxonomy must be adapted to the challenges of each sector. 1] In English in the ‘Transitional activities’ taxonomy.

The CSRD or Corporate Sustainability Reporting Directive is a European directive applicable from January 1, 2024, which sets new standards and obligations for non-financial reporting . It follows on from the NFRD, which was established in 2014, and aims to harmonize non-financial reporting by European companies and improve the availability and quality of published data.

Who will be affected?

The CSRD will gradually cover some 50,000 companies, according to the following timetable:

• From January 1, 2024(reporting published in 2025): the companies concerned will be those already within the scope of the current European NFRD(Non Financial Reporting Directive) and already publishing a declaration of extra-financial performance (DPEF). These are listed companies with more than 500 employees, and sales in excess of 40 million euros and/or balance sheet total in excess of 20 million euros;
• From January 1, 2025: all other large European companies will be concerned, i.e. those meeting 2 of the 3 following criteria: 250 employees, 40 M euros in sales or 20 M euros in balance sheet total;
• From January 1, 2026: the directive will apply to SMEs listed on a regulated market, with the exception of microenterprises. SMEs will apply lighter reporting standards and will have the option of deferring their obligations for a further two years;
• Finally, from January 1, 2028: certain large non-European companies will also be affected, if they have European sales in excess of 150 million euros and a subsidiary or branch based in the European Union.

A new standard

The CSRD directive also creates new, more detailed European sustainability reporting standards known as ‘ESRS’(European Sustainability Reporting Standards). Several types of ESRS are planned: transversal standards (which will apply to all companies), thematic standards (relating to ESG issues) and even specific standards for SMEs listed on regulated markets. ESRS 1 standards, known as ‘general principles’, describe the architecture, principles and general concepts of ESRS standards, notably the idea of double materiality.The ESRS 2 standards, known as ‘general information’, detail the information that companies are required to present in relation to material sustainability topics, and which overlap with the guidelines established by the TCFD: governance, strategy, processes for identifying and managing sustainability impacts, risks and opportunities, as well as indicators and targets. And these two cross-cutting standards are complemented by thematic standards which specify the specific information to be provided on material impacts, risks and opportunities linked to each sustainability topic for the three ESG issues (environmental, social and governance). The ESRS E1 standards relate to climate-related issues, ESRS S4 to biodiversity-related issues and so on.

A cardinal principle: double materiality

The cornerstone of the CSRD, double materiality, means that companies must publish the information they need to understand both the effects of sustainability issues on their financial situation and performance, and their impact on the environment and society.

The CS3D was adopted by the European Parliament on April 24, 2024. It is currently awaiting the final stage: formal approval by the Council.The European Directive on Corporate Sustainability Due Diligence (also known as CSDD or CS3D) would introduce a duty of care for certain European companies. It would impose an obligation on companies to monitor their negative impact on human rights and the environment, particularly with regard to child labor, slavery, labor exploitation, pollution, deforestation, excessive water consumption or damage to ecosystems. In this respect, it is largely inspired by the duty of vigilance enshrined in French law in 2017.

What does this text provide for?

The duty of vigilance would break down into 4 components:

• Mapping the potential or actual negative impacts arising from the activities of the company, its subsidiaries, or the entities in its value chain with which it has a commercial relationship. (This is a key dimension of the directive, inspired by the French law on duty of vigilance).
• Prevent potential negative impacts by deploying action plans, with monitoring indicators, contractual guarantees with direct partners, etc.
• Mitigate actual negative impacts and implement remedial measures (compensation policy, implementation of new contractual guarantees or termination of the business relationship in question).
• Set up internal complaint and alertmechanisms within companies to facilitate the reporting of negative impacts.

Companies would also have to adopt a plan (known as a transition plan) guaranteeing that their business model is in line with efforts to contain global warming to 1.5°C.

To whom would the legislation apply?

The legislation will apply, according to a progressive timetable until 5 years after its entry into force, to EU companies and parent companies with over 1,000 employees (compared with 500 previously) and worldwide net sales in excess of 450 million euros (instead of 150 million in the initial version). In all, 5,300 companies will be affected (compared with 15,000 in the initial text). Finally, it will also apply to companies from third countries and parent companies with equivalent sales in the EU.

Sanctions?

Each EU country would also have to designate a supervisory authority responsible for checking that companies comply with these obligations. The latter would be able to launch inspections and investigations, and impose sanctions on non-compliant companies, including public denunciation and fines of up to 5% of their worldwide net sales. Furthermore, companies would also be liable for non-compliance with their duty of care obligations, and victims could thus be entitled to compensation for damages. Also, to encourage companies, compliance with duty of care obligations could be a criterion for the award of public contracts and concession agreements.

The SFDR(Sustainable Finance Disclosure Regulation) is a regulation designed to promote the sustainability of the financial sector within the European Union. Coming into force in March 2021, it applies to all investment services providers (ISPs) and asset managers providing financial services in the European Union, requiring them to disclose information on the sustainability of their financial products and to classify their funds according to these criteria. The information to be published relates to sustainable investment policy, including how sustainability-related risks and the main impacts of investments on sustainability factors are taken into account. In particular, financial players are required to disclose Principal Adverse Impacts(PAI), i.e. the main negative impacts and the way in which sustainability objectives are achieved. The SFDR regulation also requires management companies to disclose remuneration policies that take account of the integration of sustainability-related risks. The players concerned (ISPs and asset managers) must also publish annual reports on their compliance with this regulation. One of the particular features of SFDR is the distinction made between financial products according to their contribution to sustainability. There are three types of fund, known as ‘Article 6’, ‘Article 8’ and ‘Article 9’, which provide investors with clear and comparable information on the sustainability of their investments:

• Article 6 funds = funds without an explicit sustainability objective. They are not subject to specific sustainability requirements and can invest without taking ESG criteria into account.
• Article 8′ funds = funds whose objective is sustainability, but which are not subject to binding sustainability criteria. These funds must provide clear information on how they take ESG criteria into account in their investments.
• Article 9′ funds = sustainable funds. They have binding sustainability criteria and clear sustainability objectives. Article 9′ funds must provide detailed information on how they integrate ESG criteria into their selection process, and on the results of their sustainable investment policy.

The aim is to make it easier to distinguish and compare sustainable investment strategies currently available in the European Union. By providing more transparent information on the extent to which financial products take ESG criteria into account, the SFDR helps investors make the right choice.

Limits and future revision

Following consultations, the European Commission is expected to propose a revision of the SFDR regulation in the coming months. This revision will clarify the role of the Taxonomy in the sustainable qualification of financial products.

Coming into force in January 2018, this European directive known as Markets in Financial instruments directive II aims to strengthen investor protection by obliging financial institutions to offer financial products tailored to customer expectations. The idea is to provide customers with precise information on the process and the risks involved.Above all, a revision of the EU directive in the summer of 2022 now also obliges asset management companies to assess customers’ sustainability preferences.In concrete terms, this means that intermediaries offering investment advice or portfolio management services must collect information on customers’ ESG preferences in addition to information on their financial situation, investment objectives or risk tolerance. The questionnaires submitted by financial advisors must therefore make it possible to define clients’ expectations in three areas:

• The minimum proportion of investments aligned with the European Taxonomy
• the minimum proportion of sustainable investments as defined by SFDR
• The consideration by financial instruments of ‘main negative impacts on sustainability factors’, i.e. the negative impacts of investments on social or environmental issues.

The aim of this new regulation is to translate European regulations for retail investors into products that contribute to a more sustainable economy.Source : https://www.linfodurable.fr/investir-durable/analyses/recueil-des-preferences-esg-defis-et-opportunites-34457

These two standards were issued by theInternational Sustainability Standards Board (ISSB), and are designed to provide information on sustainability and on companies’ exposure to climate-change-related risks. IFRS S1 concerns general financial reporting requirements relating to sustainability, and requires companies to disclose information on their governance, strategy, risk management and measurable sustainability objectives. Specifically, it requires companies to disclose information on their governance, strategy, risk management and measurable sustainability objectives. IFRS 2 requires companies to disclose information on the opportunities and risks associated with climate change, and in particular its impact on their financial position: their financial performance, cash flow, strategy or, more broadly, their business model.In practice, a company that applies IFRS S1 will be required to apply IFRS S2. The ISSB has therefore chosen to base its two standards on simple financial materiality, taking into account only the impact of environmental change on company performance. The ISSB’s choice of simple materiality is at odds with that of the European ESRS standards. However, it is important to point out that these two standards have been designed to be used simultaneously. A player using ISSB standards and wishing to follow more demanding standards can easily use ESRS by reusing IFRS financial materiality information. They are interoperable.

The GRI standards are the world’s leading reporting standard, enabling organizations of all sizes – large and small – to report on their impacts on the economy, environment and people in a comparable and credible way, thereby increasing the transparency of their contribution to sustainable development. Beyond companies, GRI standards are highly relevant to a wide range of stakeholders, including investors, policy-makers, financial markets and civil society. There are different types: universal, sectoral and thematic.

The GHG Protocol provides the world’s most widely used greenhouse gas accounting standards, designed to provide a framework for companies, governments and other entities to measure and report their greenhouse gas emissions in a way that supports their missions and objectives. In 2016, 92% of Fortune 500 companies responding to CDP used the GHG Protocol directly or indirectly through a GHG Protocol-based program. It is the accounting platform for virtually all corporate greenhouse gas emissions reporting programs worldwide.

Non-financial reporting framework

The first regulatory obligations for extra-financial reporting by companies in France date back to 2001, and were gradually strengthened until Ordinance n°2017- 1180 and Decree n°2017-1265 transposing the requirements of the Non-Financial Reporting Directive / NFRD (European directive adopted in 2014). With this ordinance, the extra-financial performance declaration was born.It consists in the publication of a document by companies detailing their mode of governance as well as the impact of their performance and activities on environmental, social and societal aspects. This declaration then replaces the CSR report for all companies subject to this obligation or voluntarily subscribing to it. It concerns several types of company:

• Listed companies with more than 500 employees, a balance sheet exceeding 20M euros or sales exceeding 40M euros.
• Unlisted companies with more than 500 employees but with balance sheet or sales in excess of 100M euros.
• Credit, insurance, mutual and provident institutions are also subject to the reporting obligation, depending on their legal form and in line with the defined thresholds.

On December 7, 2023, a new ordinance further amended the rules governing the DPEF in France by transposing the CSRD (successor to the NFRD), which extends the scope of companies concerned and enshrines the principle of double materiality. With the latter, investors, employees and customers of companies will now have easier access to detailed information on corporate sustainability, which will be standardized and comparable at European level:

• Firstly, the sustainability transparency obligations of large listed companies and SMEs as well as, through a specific regime, third-country companies with a branch or subsidiary in France have been strengthened. These obligations cover ESG issues and comply with the principle of double materiality, i.e. they must reflect both the impact of the company’s activity on sustainability issues and the impact of these issues on the company itself.
• The remit of the ANC (French accounting standards authority) has been extended to include this information.
• The information must be certified by an accredited auditor or independent third-party organization.

The ordinance also draws the consequences of the risk of redundant reporting frameworks: it seeks to improve the coherence of the systems in force by creating common definitions of company and group reporting, by facilitating the readability of the systems by bringing them together in a common section, and by unifying the judicial injunction procedures enabling individuals to demand compliance.

The case of the greenhouse gas emissions balance sheet (or BEGES)

The BEGES was introduced by the Grenelle II law of 2010.

• Its scope of application was fairly restricted: legal entities under private law with more than 500 employees (250 employees in overseas departments), local authorities with more than 50,000 inhabitants and public establishments (with more than 250 employees) and government departments.

With the 2015 TECV law, the application procedures have been strengthened:

• A company must publish a BEGES every 4 years, a local authority or public institution every 3 years, the BEGES is published on an information platform administered by ADEME and finally it is controlled at regional level by the DREAL.

With the Energy-Climate Act (2019), the terms of application are changing:

• The BEGES must be accompanied by a transition plan to reduce emissions, it will be integrated into existing reporting (e.g. extra-financial performance declaration for companies subject to NFRD transposition). Finally, a fine of up to 10,000 euros will be imposed in the event of failure to produce the BEGES.

The case of duty of care

The question of a duty of vigilance has been raised more head-on since the collapse of the Rana Plaza factory in Bangladesh in 2011, which caused the deaths of over 1,100 people. Since that day, the question of corporate responsibility has arisen, and France was the first to take concrete action in 2017 with a law on the duty of vigilance for parent companies and ordering companies.With this law, major companies have a duty to implement measures throughout their value chain to identify risks and prevent serious abuses towards human rights and fundamental freedoms, the health and safety of people and the environment. In concrete terms, they must draw up and implement a due diligence plan that contains measures to assess these risks as well as details of the resources put in place to remedy them. This report must be made public and forwarded to the company’s partners. An important aspect is therefore the implementation of monitoring systems to verify the effectiveness of the preventive measures established. In the event of failure to comply with these obligations, companies can be held civilly and criminally liable: a number of cases are still pending today.Today, the duty of vigilance applies only to very large companies headquartered in France, or to subsidiaries controlled by a French company and employing more than 5,000 people in France or 10,000 worldwide. As a reminder, as mentioned above, the principle behind this law should be generalized at European level via the CS3D directive.

Non-financial information framework for investors

France has also developed specific regulations applicable to asset management companies and institutional investors. In 2015, it introduced the world’s first legal provision with Article 173 of the LTECV or ‘Law on Energy Transition and Green Growth’, which requires asset management companies and institutional investors to publish their climate and ESG risk management policies and investment strategy in a sustainability report. Inspiring SFDR, France was thus a pioneer on the subject and is going even further with another text in 2019.In November 2019, Article 173 will be replaced by Article 29 of the Loi Énergie Climat, which establishes new disclosure obligations for investors.This is intended to be more ambitious than the European Disclosure Regulation (SFDR), with an explicit focus on climate and biodiversity issues. In concrete terms, Article 29 requires financial players to publish, on the one hand, the impacts of their portfolios on climate change and biodiversity erosion and, on the other, the vulnerability of their portfolios on these two themes. With regard to climate change, this means that financial players must publish their strategy for aligning their portfolios with the objectives of the Paris Agreement, as well as the alignment of their outstandings with the sustainable activities of the European taxonomy. The law’s reporting obligations apply to all financial players with assets under management in excess of €500m. According to the Climate Transparency Hub, the platform on which these reports can be found, over 400 entities published their reports in the first year.