EU sustainable finance package

The European Commission's latest package of final rules and new proposals will impact a wide range of corporates and many financial services firms.

The package includes the much-awaited detailed rules under the Taxonomy Regulation relating to climate change mitigation and climate change adaptation. Some sections in the draft rules are missing from the final rules and there is a new timeline for further work.

Final amendments to existing rules under the Solvency II Directive, the Insurance Distribution Directive (IDD), MiFID II, the UCITS Directive and the Alternative Investment Fund Managers Directive (AIFMD), to incorporate sustainability considerations, are included in the package. However, amendments originally considered to the directive on occupational pensions schemes (IORPD II) are not included at this stage.

A new legislative proposal - the Corporate Sustainability Reporting Directive (CSRD) - will expand current corporate reporting requirements and bring many more companies into scope. It will amend existing accounting, auditing and transparency requirements. Among other things, it includes a broader definition of social and governance factors.

The detailed annexes to the “delegated act” under the Taxonomy Regulation are long - at nearly 500 pages in total — and set out the technical screening criteria for economic activities that can make a “substantial contribution” to climate change mitigation and climate change adaptation. In order to gain political agreement at this stage - described as a “delicate compromise” — texts relating to crops and livestock production were deleted, and those relating to electricity generation from gaseous and liquid fuels now relate only to renewable, non-fossil sources. On the other hand, texts on the manufacture of batteries and plastics in primary form have been added, and the sections on information and communications technology, and professional, scientific and technical activities have been augmented.

The Commission estimates that this delegated act covers the economic activities of about 40% of EU-domiciled listed companies, in sectors which are responsible for almost 80% of direct greenhouse gas emissions in Europe. A complementary delegated act, expected later this year, will include criteria for the agricultural and energy sector activities that were excluded this time around. The four remaining environmental objectives — sustainable use of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems — will be addressed in a further delegated act scheduled for the end of this year.

The six delegated acts amend a web of seven sets of rules under Solvency II, IDD, MiFID II, UCITS and AIFMD. They require the integration of sustainability risks or factors:

• For insurers and reinsurers, in risk management, assessment of uncertainty associated with the calculation of technical provisions, prudent person policy and remuneration policy
• For insurers and insurance intermediaries, in the target market determinations of products, product information and suitability assessments (including potential conflicts of interest)
• For portfolio managers and financial advisers, in risk management policies and suitability assessments (including potential conflicts of interest) 
• For MiFID product manufacturers and distributors, in the target market determinations of products and product information
• For fund managers, in the management of UCITS and AIFs, risk management, due diligence on investments and conflicts of interest policy; and they should assign senior management responsibility and have sufficient resources and expertise

In relation to suitability assessments, the Commission notes that there may not be a direct read-across to the product categories under SFDR. This will add to operational complexities for firms.

The implementation date for all these amendments will be 12 months after their publication in the Official Journal. This would point to a deadline of early summer 2022, but the Commission indicates that it may be later, in October 2022.

CSRD adds to the new requirement under NFRD (introduced via Article 8 of the Taxonomy Regulation), which currently requires around 11,000 large companies to disclose proportions of turnover and expenses relating to environmentally sustainable activities. CSRD will:

• Extend the scope of NFRD to all large companies and all companies listed on regulated markets (except listed micro-enterprises)
• Require the audit (assurance) of reported information
• Introduce more detailed reporting requirements and a requirement to report according to mandatory EU sustainability reporting standards
• Require companies to add a digital tag to the reported information, so it is machine-readable and feeds into the European “single access point” envisaged in the Capital Markets Union action plan