Blog: ESG from a European Perspective – Retail & Consumer Products Law Observer

business investment:plant growing on green background

Note: Judith Bussé will be presenting on this topic at the ICPHSO 2021 North America Virtual Workshop on June 23, 2021 at 9am ET.

The COVID-19 pandemic has made it clearer than ever that there is a pressing global need for a coherent, sustainable, social and climate-friendly business and governance model for both private and public companies. In line with the UN’s Sustainable Development Goals (2015) and the Paris Climate Change Agreement (2015), Europe set itself the ambitious target to reduce its emissions by at least 50% by 2030 and achieve climate neutrality by 2050.

Recent EU initiatives have repeatedly showcased a willingness to allow ESG a central role within the legislative process. Examples include the EU Action Plan of Sustainable Growth (March 2018), the Green Deal (December 2019), the Proposal for a European Climate Law (March 2019), the Circular Economy Action Plan (March 2020), the Farm to Fork Strategy (May 2020), the Climate Pact (December 2020) and the EU Regulation on Sustainability-Related Disclosures (March 2021).

Most recently, on April 21, 2021, the European Commission presented its new Sustainable Finance Package. This ambitious package is intended to help improve the flow of money towards sustainable activities across the European Union, and it includes proposals for an EU Taxonomy Climate Delegated Act, a new Corporate Sustainability Reporting Directive (CSRD) revisiting the rules introduced by the Non-Financial Reporting Directive (NFRD), and six Amending Delegated Acts updating the existing rules on sustainability assessments for investment and insurance products.

ESG from a European perspective

While the concept of “ESG” is now broadly understood, some confusion remains regarding which environmental, social and governance factors should count towards the EU’s sustainability target, and which legislative instruments should regulate the different aspects of ESG. Moreover, a lack of transparency, accountability and comparability makes it difficult for investors to fully understand the financial risks resulting from the various sustainability-related crises we face, and to proactively look for investment opportunities addressing environmental and social problems.

The 2019 Communication on the European Green Deal is the EU’s response to our current climate and environment-related challenges. This Communication proposes a series of measures and legislative instruments that are intended to transform the EU by 2050 into a modern, resource-efficient and competitive economy, with no net emissions of greenhouse gases, and where economic growth is decoupled from resource use. It also aims to protect, conserve and enhance the EU’s natural capital, and to protect the health and well-being of citizens from environment-related risks and impacts. The Green Deal is looking to achieve a socially-just transition to a sustainable economic system by providing a Just Transition Mechanism and Fund, focusing on the regions, sectors and citizens most at risk from this transition.

One of the means to achieve the objectives relating to climate neutrality is the transformation of industry towards a circular economy. With a focus on resource-intensive sectors (like textiles, construction, plastic and electronics), the Circular Economy Action Plan will include a “sustainable products” policy to support the circular design of all products based on a common methodology and common principles, as well as a “right to repair,” and measures to empower consumers to make informed decisions and play an active role in the ecological transition. By prioritizing the reduction and reuse of materials before recycling them, and by fostering new business models with innovative products / services, the Circular Economy Action Plan aims at preventing environmentally harmful products from being placed on the EU market.

As significant investments are required to achieve the climate and energy targets that have already been set for 2030, public and private funding will need to be explored and facilitated. Hence, as one of the first steps in the strategy towards sustainable growth, the European Commission has reviewed the Non-Financial Reporting Directive (2014/95/EU, see below for more details). The disclosure of non-financial information should contribute to the measuring, monitoring and managing of undertakings’ performance and their impact on society. In turn, this should allow investors to direct financial and capital flows to green, social and overall sustainable investments.

To further incentivize ESG commitments, investments and sustainable growth, the European legislator has developed a common language and definition of what is considered “sustainable” in the EU Taxonomy Regulation (2020/852). This Regulation, which established a framework to facilitate sustainable investment, will be amended, updated and completed in the course of the coming months and years. Currently, it sets out a classification system for environmentally sustainable activities in relation only to climate change mitigation and climate change adaptation objectives. In the near future, the Regulation will be amended to cover other objectives as well – relating to pollution prevention, the transition to a circular economy, the sustainable use and protection of water, and the protection and restoration of biodiversity and ecosystems.

The Recent Sustainable Finance Package

Sustainable finance is about re-orientating investment towards sustainable technologies and businesses, by decoupling as far as possible economic growth from the use of resources, so as to minimize ESG-related damage. With the launch on April 21, 2021 of the Sustainable Finance Package, the European Commission announced its aim to adopt the legal fundaments and framework to create a sustainable financial EU ecosystem, focused on increased transparency and providing tools for investors to identify sustainable investment opportunities. Such opportunities have a key role to play in channeling private investment (as a complement to public funding) for the successful transition to a climate-neutral, climate-resilient, fair economy.

The Sustainable Finance Package, with its different proposals for legislative instruments (detailed below), represents another critical step in the European Commission’s ongoing efforts to influence investment preferences towards more sustainable financial strategies.

As a main game-changer, the Sustainable Finance Package introduces the EU Taxonomy Climate Delegated Act (supplementing the EU Taxonomy Regulation, described above), which makes it clearer which economic activities most contribute to meeting the EU’s environmental objectives and which categorizes the activities strongly contributing to preventing and responding climate change. It aims to help investors in their decision-making process and incentivizes sustainable solutions using science-based criteria. The Delegated Act was officially adopted by the EU at the end of May 2021.

Secondly, companies will be required to provide accurate and valid sustainability information following the implementation of the Commission’s proposal for a Corporate Sustainability Reporting Directive. One of the aims of this proposed directive is to expand the existing reporting rules for public-interest entities, introduced by the Non-Financial Reporting Directive (2014/95/EU) and in force since 2018, and extend them to private companies. The Commission will now further discuss the proposal with the European Parliament and the Council.

Furthermore, to minimize the risks to the financial system and markets, six proposed Amending Delegated Acts on investment and insurance advice, fiduciary duties, and product oversight and governance, would require that investment companies (including advisers, asset managers, and insurers) refer to sustainability matters in their protocols and investment advice to clients (for example, by highlighting the impact of potential natural disasters on the value of investments).

These Amending Delegated Acts would include the requirement that financial advisers obtain information about their clients’ sustainability preferences and provide a statement explaining the additional requirements financial firms are subject to in order to assess their own sustainability risks. The amendments would introduce adjustments to important existing legislative instruments on investor protection, namely the second Markets in Financial Instruments Directive (MiFID II) and the Insurance Distribution Directive (IDD). These amendments, among several other financial services rules, would constitute a major step in the battle against greenwashing and are expected to be in force as of October 2022.

Booted and spurred towards a more sustainable future

Although many steps still need to be taken, and time will certainly reveal legal gaps that still need to be tackled, these various EU action plans already show that ESG has become one of the most important new concepts for all those conducting business and investing in the EU’s internal markets.

The EU had already emphasized its commitment to implementing the UN Sustainable Development Goals in a variety of ways. The recent COVID-19 pandemic has further galvanized it in its aims, by providing an urgent need for Europe to re-boost its economy and therefore the ideal opportunity for this to be done in the most sustainable manner possible.

From an international point of view, the long awaited “sustainable finance taxonomy” will most likely become a global standard for green investment. The past has proven that EU standards often generate a global impact – a phenomenon called the “Brussels Effect.” In this way, third countries / international companies demonstrate a strong interest in aligning with EU standards, and adjust their operations to abide by EU regulatory requirements (this happened, for example, in the case of the GDPR). The Brussels Effect shows the EU’s capacity to influence global governments and operations through its policy making. Not only is it to be expected that global financial companies will follow the EU’s taxonomy in order to enter the world’s largest ESG market, it is also likely that the EU will ring its ideas on ESG-friendly investment to the table when negotiating international trade and other multilateral agreements, thereby further expanding its role globally and speeding up a world-wide roll-out of sustainable development.

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