New EU Commission Sustainable Finance Package

The legislative text (expected to be the only regulatory proposal in the package) will be the result of the European Commission’s public consultation on the ESG market situation and need for regulation of ESG ratings in the EU from 2022.

What to expect

We expect to see the European Commission react to the key requests from the consultation, as well as other calls from market actors, civil society organisations and investors.

Based on the findings from the consultation, we can expect the rules to set minimum requirements for ESG rating providers that will touch upon:

• Transparency of methodology and data sourcing used by ESG providers;
• Risk of conflict of providers’ interests;
• Level playing field and fair competition in the market;
• Standardisation and comparability of ESG ratings;
• Central authorisation of providers.

The introduced measures will aim to reflect the market demand for improved ESG ratings as one of the key data points for investment decisions. At the moment, around a third of consultation answers assessed the quality of ESG ratings as not good enough, illustrated by the low correlation of results from different providers.

In line with the points listed above, we would like to see:

• ESG rating methodologies based on disaggregation of results, explicit link and coherence with other EU sustainable finance tools (such as EU Taxonomy and SFDR), clearly distinguishing impact vs. financial materiality, and giving results in absolute terms rather than relative to the rest of market;
• Results publicly available through European Single Access Point (ESAP) to ensure transparency and comparability for consumers;
• Prohibition for ESG rating providers to offer consulting services to rated companies and to provide ratings to their own shareholders;
• Central authorisation and supervision of all ESG providers’ methodology and governance, and penalties in case of a breach;
• Measures against concentration and monopolisation of the market under large ESG rating providers and overpricing;
• Measures to tackle market concentration of providers and deficient regional coverage, including in Central and Eastern Europe.

With such rules in place, the European Commission would set the way for better governance and improved credibility of ESG ratings in the EU market.

The new criteria will cover the four remaining environmental objectives of the EU Taxonomy – Sustainable use and protection of water and marine resources; Transition to a circular economy; Pollution prevention and control; and Protection and restoration of biodiversity and ecosystems. In addition, the Commission will publish updates of the technical screening criteria of the existing Climate Delegated Acts. The legislative texts are expected to be complemented by non-legislative communication on the overall Taxonomy usability, which would be welcomed market players and support its application.

What to expect

More detailed information with criteria analysis is available in E3G consultation response here.

This EU Commission recommendation will be a snapshot of the current legislative initiatives and policy tools for transition finance.

What to expect

We expect the first attempt to clarify what transition finance is in the EU, which could build on the work done by international actors like OECD, G20 WG on transition finance, the EU’s International Platform on Sustainable Finance and other relevant fora. The EU Commission will probably make an overall assessment and analysis of voluntary and regulatory transition finance tools to date in the EU, to clarify their role for having access to transition finance.

As EU transition finance tools listed in the recommendation, we expect, on the basis of public statements made by the Commission, to see mentions to:

• the EU Taxonomy “transitional” activities and related Do No Significantly Harm (DNSH) and Substantial Contribution Technical Screening Criteria (TSC) as benchmarks for entities’ investment plans.
• the possibility, under the EU Taxonomy framework, to consider as green Capex projects and investments that will reach the Taxonomy TSC for substantial contribution in the next 5 years (and exceptionally in the next 10 years).
• The Corporate Sustainability Reporting Directive (CSRD), the ongoing work to identify sector-agnostic European Sustainability Reporting Standards (ESRS) and the ongoing process by the European Financial Reporting Advisory Group (EFRAG) to develop sectoral ESRS.  
• the European Green Bond Standard (EU GBS) and the language for sustainability linked bonds.
• the ongoing work on CSDDD article 15 on the definition of transition plans for entities to decarbonise their businesses.

We also expect a first light effort to bring into the transition finance framework the requirements under the Capital Requirements Regulation/Capital Requirements Directive (CRR/CRD) on banking, to start building bridges between reporting rules and obligations and prudential requirements. Moreover, we also expect to see more material in support of SMEs, also given the ongoing work at EFRAG level.

What is next: key risks and challenges

The communication will be a welcome starting point, although much further work will be required in the coming years to establish a coherent framework for transition finance in the EU. It is therefore relevant to see what impact it will have on the priority setting of the next Commission and on open files. 

One important aspect that might be missing from the communication is a clarification of the link between private transition finance and public funding opportunities. Public and private synergies have been insufficiently tackled in the “EU’s Strategy for Financing the Transition”. A way to move this forward would be to explore the role of EU and Member States’ public banks and how they can leverage private financing. 

The European Commission is expected to publish the long-awaited European Reporting Sustainability Standards (ESRS), which will clarify the reporting requirements for EU businesses on a series of ESG factors under the CSRD, as a Delegated Act. The reporting standards will be based on the technical advice provided by EFRAG.

The ESRS publication has been delayed due to the political relevance that the standards have gathered with time. Coherence between new standards and existing legislation, an ESG backlash on corporate regulation, and interoperability concerns with the upcoming global reporting standards set by the International Sustainability Standards Board (ISSB), are all factors that have further postponed the final proposal.

What to expect

E3G expect backsliding on the mandatory nature of some. The standards would only require disclosure of information deemed ‘material’ by the same reporting company, removing the ‘always-to-be-disclosed’ clause on specific sets of the ESRS. 

1. The quality of reporting information could decrease. Companies will self-assess which information is relevant for their impact on the environment, leaving room for under-reporting or partial omission of crucial data for investors. 
2. Data comparability could become more complex. Allowing entities to set their own value chain boundaries (deciding which companies are part of their value chain) and deciding which emissions are relevant (especially Scope 3 emissions, known to be difficult to estimate precisely) could lead to fragmentated reporting, even between companies of the same sector.
3. Leaving disclosure requirements up to materiality assessment could create inconsistency with an entity’s SFDR-related obligations. EFRAG included mandatory SFDR Principle Adverse Impact (PAI) indicators in the ESRS, but the loss of the mandatory nature in the new standards would remove the SFDR alignment. This would only add complexity and incoherence to the EU reporting framework.