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17.5.2023
5.2.2024

Your need-to-know summary of ESG regulations and frameworks

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Your need-to-know summary of ESG regulations and frameworks

Published: 17 May 2023 · Last updated: 18 May 2023

The Corporate Sustainability Reporting Directive (CSRD), The Sustainable Finance Disclosure Regulation (SFDR) and The EU Taxonomy are the three need to know legislative pieces for ESG focused Financial Market Participants. They are all interconnected parts of the European Union's efforts to promote sustainable finance and combat climate change and greenwashing.

In this blog we will review and summarise the EU’s official and mandated regulations around ESG reporting for Financial Market Participants. We will cover the implementation progress of the regulations, who they apply to and when. Included in the reading are links to more granular details on each legislation, plus a route to the official and original sources for reference.

Corporate Sustainability Reporting Directive (CSRD)

The Corporate Sustainability Reporting Directive (CSRD) is the latest legislative measure by the European Union to strengthen and extend the existing scope of Environmental, Social and Governance (ESG) reporting requirements for companies operating in the EU.

The CSRD endeavours to foster a culture of transparency with the purpose of tracking and evaluating the impacts of all business activities on people and the environment. Its aim is to gradually mandate, standardise and simplify ESG reporting across the board.

Particularly interesting for private equity companies and fund managers, this directive will ensure that investors and stakeholders have access to necessary information for evaluating investment risks related to ESG issues. It is a significant step towards the integration of sustainability considerations into business decision-making processes. In its aim to standardise the reporting process, investors and other stakeholders will have an easier time comparing companies' sustainability performance. This will ultimately assist them in making more informed and strategic decisions. Companies will also benefit from reduced reporting costs in the medium to long term, as the information required to be disclosed will be standardised and harmonised.

For those aware of and already working under the Non-Financial Reporting Directive (NFRD), CSRD is a revision and improvement on the existing NFRD regulations. These “original '' regulations only require large companies to disclose their ESG performance and do not go to the depth and detail that new reporting directives mandate. The CSRD will extend the reach to include a broader set of large companies as well as listed SMEs and eventually non-EU companies and subsidiaries operating in the EU. The requirements will go into effect in a gradual timeline contingent on company classification:

  • June 30, 2023: EU Commission to enact the first set of reporting standards
  • January 1, 2024: Large listed companies (those with more than 500 employees) will be required to track and collect ESG data under the CSRD directive (reporting year 2025)
  • January 1, 2025: Any company meeting the two of the three following criteria be required to track and collect ESG data under the CSRD directive: 250 employees, €40 million in revenues, or €20 million in balance sheet (reporting year 2026)
  • January 1, 2026: Effective date for law that will requires most SMEs (10-250 employees) to commence their reporting (reporting year 2027)
  • January 1, 2028: Effective date for CSRD compliance from third-country companies (European subsidiaries of non-European companies with a turnover of more than €150 million)

Read more about CSRD here:
3 Things you need to know about the Corporate Sustainability Reporting Directive

The Sustainable Finance Disclosure Regulation (SFDR)

The Sustainable Finance Disclosure Regulation is a mandatory European Union regulation that requires financial market participants (FMPs) and financial advisers (FAs) to disclose information about the environmental, social, and governance (ESG) risks and opportunities of their investment products.

The most significant aspect of this legislation is that fund managers are required to submit detailed, quantitative data on behalf of their portfolio companies, quarterly. This marks a critical turning point in sustainability disclosures for the Private Equity sector as the mandates gradually cascade into law over time.

The SFDR has three main requirements:

  1. Eliminating greenwashing and false claims
  2. Holding accountable the sustainability claims made by Financial Market Participants (FMPs)
  3. Improving transparency of sustainable investment products in the European Financial Sector

In brief, to meet these goals, the SFDR will require two levels of disclosure regarding the integration of sustainability risks and opportunities into their investment decision-making process.

Level one requires FMPs to disclose whether and how sustainability risks are considered in their investment decision-making process. FMPs must also provide an explanation of the likely impacts of sustainability risks on the returns of the financial products they offer. This disclosure became mandatory in March 2021.

Level two requires FMPs to disclose the principal adverse impacts of their investments on sustainability factors. This level of disclosure requires adherence to the Regulatory Technical Standards (RTS) on ESG and became mandatory in January of this year (2023). In June of 2023, adherence to Principle Adverse Impacts (PAIs) under RTS will also be mandatory. PAI disclosures include specifics about sustainability risks such as greenhouse gas emissions, water usage, and human rights impacts.

SFDR is a complex and evolving piece of regulation, so we’d recommend FMPs to stay updated on both current and future requirements. By doing so, they can ensure they take the necessary steps to collect relevant data and maintain compliance.

You can read more about SFDR in our resources here:

SFDR Blog Series:

Everything you need to know about SFDR

Introducing the Principal Adverse Impacts (PAIs)

Our top FAQs for all things SFDR

Whitepaper:

Navigating the EU SFDR regulation

EU Taxonomy

The EU Taxonomy is a classification system created to provide a streamlined and common language for European sustainable finance regulations. A detailed piece of legislation, it defines both what is - and, crucially, what isn’t - sustainable. Created by the EU as a tool to foster transparency around ESG reporting and claims, it helps companies and investors make sound business and investment decisions based on objective truths rather than marketing ploys.

Through clarity and transparency, it aims to eliminate greenwashing by creating a holistic understanding of sustainable economic activities, holding companies accountable to the evolving ESG reporting mandates. As such, it also helps companies and fund managers to assess their actual contribution to sustainable finance. CSRD and SFDR legislation is aligned with the scope and definitions outlined in the EU Taxonomy.

There are six core environmental objectives that make up the EU Taxonomy,:

  1. Climate change mitigation
  2. Climate change adaptation
  3. Sustainable use and protection of water and marine resources
  4. Transition to a circular economy
  5. Pollution prevention and control
  6. Protection and restoration of biodiversity and ecosystems.

Regulations for two of the six objectives were enforced at the start of 2022. The remaining four objectives are expected to be implemented by early 2024, contingent on public feedback under the Environmental Delegated Act.

EU Taxonomy legislation is still in development with information and updates evolving as it unfolds. For more information of EU Taxonomy and how it specifically applies to fund managers, you can check out this reading:

What does EU Taxonomy mean for fund managers?
How does the EU Taxonomy work with SFDR?

Summary

To summarise how each of these legislations support and enable one another, here’s a quick summary of their significance and interconnectedness. The EU Taxonomy provides a classification system for sustainable economic activities, which is incorporated into the SFDR and CSRD legislation as a baseline for objective truths around ESG definitions and expectations.

It is incorporated into the SFDR's disclosure requirements for financial market participants and is included in the Corporate Sustainability Reporting Directive (CSRD) legislation as a framework to guide companies in reporting on their sustainability performance in a standardised and consistent manner.

All these regulations are aimed at creating a sustainable financial system that supports the EU's goal of becoming climate-neutral by 2050. Together, they provide a framework for companies and financial market participants to disclose their sustainability risks and impacts, and to help investors make informed decisions.

How KEY ESG can help

KEY ESG's solutions facilitate compliance with ESG regulations such as the CSRD, SFDR and EU taxonomy.

KEY ESG enables FMPs and companies to automate and centralize their ESG data collection, KPI calculations, reporting and management. Importantly, the software is kept up to date for the latest legislative developments.

KEY ESG's software makes ESG management efficient and effective for the business user.

Get in touch with a member of our team to find out more. Alternatively, book a free demo to see how our software could simplify your ESG management.

For an up to date and detailed timeline and history of the EU’s ESG regulations in relation to FMPs, check out our article here: New Regulations for Fund Managers: Are you prepared?

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