ESRS, European Sustainability Reporting Standards:

Companies would need to publish separate sustainability statements as part of their management reports from 1 January 2024. This will significantly affect the scope, volume and granularity of sustainability-related information that companies need to collect and disclose. The 12 ESRSs, issued by the European Financial Reporting Advisory Group (EFRAG), would apply for companies located or listed in EU member states as well as non-EU companies with significant operations in the EU. When assessing whether a topic is material under ESRSs, a company would need to present information on its impact on sustainability matters and on how sustainability-related matters affect the company itself (the double materiality concept). Double materiality requires companies to approach their materiality analysis from two separate perspectives.

 

Materiality

The definition of financial materiality has been amended to align more closely with that in the draft IFRS Sustainability Disclosure Standards.

The definition of Impact materiality' considers the sustainability matters that relate to a company's actual or potential impacts on people or the environment, but impact materiality has been amended to align more closely with that used by the Global Reporting Initiative. The rebuttable presumption that all topics are material for all companies has been replaced. Under the draft ESRSs, companies would assess a topic’s financial materiality or its impact materiality.  Disclosures under the draft climate standard (ESRS E1) and certain disclosures from other topical standards are mandatory irrespective of the company’s materiality assessment.

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Reporting structure

EFRAG was instructed to align the ESRSs more closely with the draft IFRS Sustainability Disclosure Standards.

 

Topical standards on climate

EFRAG aimed to align the topical standards on climate with those under draft IFRS Sustainability Disclosure Standards to the extent possible.

 

Phase-in relief

To ease a company’s transition to ESRSs, a phase-in relief from providing certain disclosures for up to three years has been introduced.

 

Governance

Certain reporting requirements in the governance standard (formerly known as G1) have been integrated into the reporting area on governance in ESRS 2 and others have been removed because they are no longer required. The former G2 standard is now the G1 standard on business conduct, which includes various disclosure requirements from the former G2.

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SFDR, Sustainable Finance Disclosure Regulation:

Here's a breakdown of some key components and recent updates in the regulation:

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SFDR Overview:

• SFDR is a part of the EU's broader action plan aimed at harmonizing ESG disclosure standards across the continent. It mandates a comprehensive sustainability disclosure requirement covering a broad spectrum of environmental, social, and governance metrics and criteria.

• The regulation primarily targets financial market participants (FMPs) and financial advisors, requiring them to integrate sustainability risks into their investment processes and report on this integration at both company and product levels.

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Classification and Reporting under SFDR:

• Investment products under SFDR are categorized into:

• Article 8 (Light Green) funds, which integrate ESG factors focusing more on financial materiality.

• Article 9 (Dark Green) funds, emphasizing sustainable economic activities or impact, and/or aiming to reduce carbon emissions in alignment with the Paris Agreement.

• Article 6 funds, encompassing all other funds without specific ESG considerations integrated into the investment process.

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Latest Developments:

• On 27 December 2022, a publication detailing the regulatory technical standards on the principle of ‘do no significant harm, sustainability indicators, and the promotion of environmental or social characteristics in pre-contractual documents, on websites, and in periodic reports was made.

• On 12 April 2023, the three European Supervisory Authorities (ESAs) - EBA, ESMA, and EIOPA - jointly published a consultation paper proposing significant amendments to SFDR Level 2 Regulatory Technical Standards (RTS) concerning Principal Adverse Impacts (PAI) and financial product disclosures.

• On 14 September 2023, the EU Commission initiated a targeted and public consultation regarding the implementation of SFDR. This consultation is expected to continue until 15 December 2023.

• SFDR Level 2 rules, which amplify the reporting requirements for sustainable and ESG-labeled financial products, were enacted on 1 January 2023. However, there`s ongoing market confusion regarding these rules.

• On 17 February 2023, a publication regarding the amendment and correction of regulatory technical standards concerning disclosures in pre-contractual documents and periodic reports for financial products investing in environmentally sustainable economic activities was made.

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Alignment with Other Regulations:

• The SFDR has been augmented to include EU Taxonomy Regulation since March 2021, establishing specific environmental criteria related to economic activities for investment purposes, effective from January 2022.

 

Upcoming Consultations and Changes:

• The ongoing consultations and proposed amendments to SFDR Level 2 RTS indicate a potential for further changes in SFDR regulations, aiming to refine and enhance the existing disclosure requirements.

• These updates reflect the EU`s ongoing commitment to bolstering sustainable finance and enhancing transparency in the financial sector through standardized disclosures, albeit with challenges and evolving regulatory landscapes.

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Objective:

• The SFDR aims to provide clarity to investors regarding the sustainability of their investments, enabling them to make informed choices.

• This is part of the EU's broader effort to redirect private capital towards sustainable activities to achieve its sustainability objectives, including climate neutrality by 2050.

 

Scope:

• The regulation applies to financial market participants, including investment firms, insurance companies, pension funds, asset managers, and financial advisers within the EU.

• It mandates them to provide disclosures on how they integrate sustainability risks in their investment decision-making and advisory processes.

 

Implementation:

• The core of the SFDR came into effect on 10 March 2021, requiring financial entities to provide certain sustainability-related disclosures.

• The regulatory technical standards (RTS) under the SFDR, which provide more detailed requirements, are expected to apply from a later date.

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Classification and Reporting:

Funds are classified as grey, light green, or dark green based on their sustainability profile, with stricter reporting requirements for green funds. This classification helps in identifying the degree to which financial products are environmentally sustainable.

 

Article 8 (Light Green Funds):

• Financial products that promote environmental or social characteristics, or a combination of both,

• If the investments adhere to good governance practices

• Products are known as "light green" products.

• To determine financial product meets the criteria of Article 8, financial market participants need to use various criteria;
  o   the United Nations' Sustainable Development Goals ;
  o   OECD Guidelines for Multinational Enterprises,
  o   conduct their own due diligence.

 

Article 9 (Dark Green Funds):

• Article 9 applies to financial products with explicit sustainability objectives;

• majority of the portfolio comprises ESG (Environmental, Social, Governance) focused investments

• often referred to as "dark green" funds

• covers a wide range of financial products including;
  o   UCITS (Undertakings for Collective Investment in Transferable Securities) and
  o   AIFs (Alternative Investment Funds) that meet sustainable investment goals and reference benchmarks.

• Compliance requirements
  o   disclosing information on the sustainable investment objective pursued by the fund,
  o   the fund's investment approach,
  o   asset allocation,
  o   methodologies used to assess and monitor the realization of sustainable investment goals, among other elements.

 

Article 10:

• mandates asset managers of funds promoting environmental or social characteristics or sustainable investments;
  o   to publish and maintain on their websites information about their;
  o   methodologies,
  o   data sources,
  o   screening criteria,
  o   sustainability indicators.

• aim to enhance the transparency and comparability of funds claiming to have sustainability objectives or features.

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These articles are essential in creating a standardized framework for sustainability disclosures, aiding investors in making informed decisions based on the sustainability profile of the financial products.