The EU’s Green Deal is important because it aims to decarbonise the EU economy by 2050.

This transformation will impact all financial actors in the EU economy, including banks, private companies, investment funds, and consumers.

Banks, private companies, investment funds, and consumers need to recognise that the EU is capitalising on its financial power to increase the flow of money towards sustainable activities. In this context, requiring financial actors to take into account environmental, social and governance (“ESG”) considerations appears as a potential solution to difficult issues being faced by the EU’s financial system. On close inspection, one can see that the “environmental” aspect of the expression is being defined by EU law, whereas the “social and governance” elements still lack clear explanation.

At a time when the Central Bank of Ireland (CBI) has announced that it will align itself with the EU’s ESG agenda, it is appropriate to discuss significant EU legal initiatives in the area of ESG investing and consider their consequences for all financial actors in the EU economy:

Sustainable Finance Disclosure Regulation (SFDR)

• Private equity firms, pension funds, hedge funds and asset managers need to recognise that the SFDR’s aim is to end attempts by financial companies to falsely brand their funds as being environmentally friendly. This behaviour is commonly known as “greenwashing”. The Regulation’s intent is to set minimum disclosure standards for private equity firms, pension funds, hedge funds and asset managers in respect of all fund types.
• Under the SFDR all European funds will be classified into three separate tiers based on the product’s sustainability rating, namely: All Funds; All ESG; and Sustainable. Within these three tiers, all European funds will be obliged to disclose an increasing level of information depending on their tier of categorisation. Therefore, products in the ‘Sustainable’ category will face the most disclosure obligations because they represent the highest tier.
• The SFDR’s Preamble defines ‘sustainable investment’ by reference to the environmental principle “do no significant harm” and also tries to put meat on the bones of the concept of “good governance”. Sound employee structures, employee relations, remuneration of staff and tax compliance are all mentioned as being indicative of good governance but the exact meaning of “good” is not defined and is regrettably left to the discretion of investors.
• The main (Level 1) provisions of the SFDR became law in March 2021 and are directly effective in Ireland. Additional disclosure obligations will be enacted in 2023 as part of SFDR Level 2.

EU Taxonomy Climate Delegated Act (TCDA)

• European investors and consumers need to understand the impact of the EU’s Taxonomy Regulation (“EUTR”). It came into force on 12 July 2020. The EUTR established a classification system listing environmentally sustainable economic activities. The taxonomy system aims to make clear to European investors and consumers which investment options are considered environmentally sustainable.
• The Taxonomy Climate Delegated Act (TCDA) came into force in Ireland on 1 January 2022. Its aim is to implement the EUTR by establishing criteria designed to determine whether an economic activity contributes to climate change mitigation and should be considered economically sustainable. The TCDA’s main scope relates only to environmental and climate-related objectives. The meaning of social and governmental sustainability is not actively discussed in the TCDA.
• It is important to note that the parameters of the classifications will be subject to continual review and may change over time to reflect scientific and technological progress.

Corporate Sustainability Reporting Directive (CSRD)

• Listed companies operating in the EU need to realise the importance of the CSRD. Once enacted, it will place additional reporting requirements on listed companies in relation to how sustainability issues impact them and how they impact society and the environment. The CSRD will also apply to a much broader number of companies than those caught by the existing Non-Financial Reporting Directive. Small and medium sized enterprises (SMEs) will be subject to these non-financial reporting obligations for the first time.
• Companies will also have to provide much more detailed non-financial information under the CSRD. The European Financial Reporting Advisory Group is due to publish what will become the EU’s common sustainability reporting standards in October 2022. Observers will have to wait and see whether the concepts of social and governmental sustainability will be clearly defined in the Directive.
• It is expected that the CSRD will be enacted later this year and oblige large listed companies to begin reporting in 2024. Listed SMEs will be given an additional 3 years to adapt to the requirements of the CSRD. It has not yet been confirmed whether the CSRD will be transposed into Irish law by means of an Act of the Oireachtas or via a statutory instrument.

Conclusion

All financial actors in the EU economy, including banks, private companies, investment funds, and consumers will be impacted by these pieces of legislation. It remains to be seen, however, how these stakeholders will react.

Requiring the EU’s financial system to accept higher standards when it comes to ESG investing is a noble pursuit. The SFDR, the TCDA, and the CSRD, referred to above, do much to clarify the EU’s view on environmental sustainability but they lack clear guidance on what social and governmental sustainability looks like.

As Ireland’s likely enforcer of the EU’s ESG standards, the CBI, may require clarification on the exact meaning of social and governmental sustainability in the years ahead.