In advance of the European Parliament elections in June and as the European Commission approaches the end of its five-year term, now seems like a good time to look back and take stock of the unprecedented volume of new legislation and regulatory initiatives that have been adopted at EU level over the past number of years and which are aimed at integrating sustainability into the financial system.

The development of a sustainable finance framework has run in parallel with the European Commission’s signature policy, the European Green Deal, which is intended to reduce net greenhouse gas emissions in the EU by at least 55% by 2030 with the ambition of becoming climate-neutral by 2050. These targets have been enshrined in law through its adoption of a new Climate Law and have been accompanied by a set of policies under the Fit for 55 programme which are intended to ensure that EU policies are in line with its climate goals.

In approaching the financial system, the Commission’s approach has been to build on the existing regulatory rulebook, to see where tweaks are needed and then to develop targeted proposals for change. However, it is fair to say that the legislation that has been introduced has been novel, technical and complex, and we take a look at some of the highlights below.

The Sustainable Finance Disclosure Regulation (SFDR) was the first piece of legislation to have a significant ‘real-world’ impact. It introduced significant firm-level disclosures for asset managers and other financial market participants and advisers relating to the integration of sustainability risks into the investment decision-making process and policies put in place to consider the principal adverse impacts of investment decisions on “sustainability factors” (i.e. environmental, social or employee issues, human rights, anti-corruption and anti-bribery matters). SFDR also introduced specific pre-contractual and periodic disclosure requirements depending on the sustainability profile of the product. In practice, in-scope entities have found the regime to be complex and implementation challenging and, notwithstanding that it was designed as a disclosure regime, it has been used as a de facto labelling system. The EU Commission launched consultations in September 2023 seeking on any shortcomings in the SFDR framework and options for improving the regime.

One of cornerstones of the new sustainability finance framework is the EU Taxonomy - a unified EU classification system established under the Taxonomy Regulation to define what constitutes an ‘environmentally sustainable economic activity’. The Taxonomy Regulation provides that to be classified as an environmentally sustainable economic activity, that activity must contribute to at least one of six specified environmental objectives, cause no significant harm to any of the other environmental objectives, meet minimum social safeguards, and meet detailed technical criteria developed by the European Commission. Disclosures against the EU Taxonomy are mandated for companies within scope of Corporate Sustainability Reporting Directive (CSRD) (see below) as well as for banks, investment firms and insurance undertakings. It also forms the basis of the ‘use of proceeds’ requirement for EU Green Bonds which must be aligned with requirements introduced by a new EU Green Bond Regulation.

CSRD has introduced a new corporate sustainability disclosures regime, in part to facilitate disclosures under the Taxonomy Regulation and SFDR. CSRD replaces non-financial reporting rules introduced by the Non-Financial Reporting Directive, which amended the Accounting Directive a decade ago. The aim of the new reporting regime is to ensure a consistent flow of sustainability information from companies which will be available to financial institutions and others that wish to scrutinise their social and environmental impact. CSRD widens the scope of the reporting obligations to capture about 50,000 companies in the EU (as well as certain non-EU companies), mandates alignment with new European Sustainability Reporting Standards (ESRS), and introduces a mandatory audit requirement (initially on a limited assurance basis). The first wave of companies will begin reporting under CSRD in 2025 (reporting on FY2024).

Other notable initiatives that have been advanced at EU level over the past few years include:
(a) the Low Carbon Benchmarks Regulation, which introduces two types of low carbon benchmarks (the EU Paris-Aligned Benchmark and the EU Climate Transition Benchmark) and provides for sustainability-related disclosures for all benchmarks,
(b) updates to the prudential frameworks applicable to banks including the adoption of significant measures with respect to Pillar 3 disclosures and, more recently, to manage ESG risks under Pillar 2;
(c) an EU Ratings Regulation which will regulate ratings providers who provide an opinion on a company’s or financial instrument’s sustainability profile, by assessing its exposure to sustainability risks and its impact on society and the environment;
(d) a new Corporate Sustainability Due Diligence Directive, which has been the subject of a rollercoaster ride through the legislative process, with a watered-down version being approved by the EU Council on 15 March 2024 (and which contains significant carve-outs for the financial sector).

In terms of what’s coming down the tracks, given the unprecedented pace at which regulation has been introduced over the past 5 years, and amid signs of increasing pushback by Member States and industry, the sense is that we are now entering a new phase where the pace of adoption of new legislation will slow with the focus being on the implementation of existing policies, with oversight of that implementation falling to the new EU Commission.