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New EU disclosure rules: A first step towards ESG transparency but weakened under pressure

The European Supervisory Authorities adopted their final report on technical standards for the Sustainable Finance Disclosure Regulation. But industry demands have seen this critical legislation weakened.

By Maria Van Der Heide, Head of EU Policy, ShareAction

The European Supervisory Authorities (ESAs) have adopted their final report on the technical standards for the Sustainable Finance Disclosure Regulation.

We’ve been a supporter of this legislation since it was first discussed in 2018.

It is a groundbreaking law. For the first time, investors will be forced to account for their negative externalities (“adverse impacts”) on people and planet.

But industry demands have seen this critical legislation weakened.

Bowing to industry pressure on ESG

The disclosure regulation sets out requirements for financial market participants to increase transparency of sustainability-related disclosures and to increase comparability of disclosures for end investors.

As currently presented, the technical standards build on the principles-based requirements that were adopted by the European Parliament and Member States in 2019.

But since the release of the draft standards in April 2020, there has been significant pushback from asset managers’ associations and even from sustainable investment groups.

They called on the ESAs to reduce the number of sustainability indicators investors report against, citing a lack of data.

The ESAs served industry’s interests by bringing down the mandatory indicators from 32 to 14.

Seven environmental indicators were moved instead to voluntary indicators. Just five out of sixteen social indicators were kept mandatory. Indicators related to corruption, human trafficking, deforestation and excessive pay ratio have all become optional.

The concessions made by the ESAs significantly weaken the transformative impact this legislation could have.

Lack of data – a false argument

Data on these impact indicators would not have been available in all cases from the outset, but with the forthcoming review of the Non-Financial Reporting Directive and the legislative initiative on mandatory due diligence for companies more data will become available.

And if the data is not available immediately, investors would be encouraged to ask investee companies to produce and report it as soon as possible. Where necessary, they could make good use of shareholder voting rights to press the case.

In this critical decade for climate and biodiversity loss, investor engagement has to become a serious tool for action.

The same applies to data providers. If investors feel they don’t get data in the form they require, it is for them to tell data providers what the services they are paying for should look like.

The investment system can be a force for good, but not if regulators allow the financial industry to dictate the terms of regulation.

Regulation must raise the bar

A massive effort is needed to meet EU’s sustainability ambitions. Tackling the climate crisis will require transformational change and substantial effort within the corporate sector, the investment sector and in society at large.

And not just the climate crisis: biodiversity loss, global water shortages, deforestation, modern slavery, racial discrimination.

If the corporate community and the financial sector are to play their part in addressing these interlocking social and environmental crises, challenging new legal requirements that set a level playing field are both necessary and inevitable.

Practical steps to drive positive change

The ESAs have also made some positive changes to the technical standards.

The indicator on fossil fuel exposure for instance, initially erroneously only referred to solid fossil fuels (coal), which was corrected to include gas and oil.

Furthermore, the ESAs have now introduced a section in which financial institutions need to disclose which actions have been taken to address the adverse impacts per indicator.

The additional requirements to the ‘Do No Significant Harm’ provisions is also positive. Under this requirement financial institutions must now also show whether their investments are aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.

The European Commission is expected to endorse the final draft in the next three months. The principles-based requirements of the SFDR will come into effect on 10 March 2021, while the application of the technical standards has been postponed.

The ESAs have proposed an application date of 1 January 2022, meaning that disclosures in the sales process will only kick in then, and that the first periodic disclosure under the technical standards would not take place until 2023.

ShareAction will continue to reach out to policymakers, financial institutions, NGO’s and standard-setters to provide practical recommendations and guidance to promote a responsible investment system.

See our previous op-eds on the SFDR here:

Find ShareAction’s feedback to the consultation on the technical standards of the Sustainable Finance Disclosure Regulation here.

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