Sustainability Assembled
As we come to the end of the third quarter of 2024, in this issue of Sustainability Assembled we consider how policy makers and regulators are supporting market participants to ease the burden of regulatory compliance whilst also addressing greenwashing risk.
With Climate Week in New York upon us, in this issue we remind ourselves of the key recommendations set out in the Report on the Future of European Competitiveness (the Draghi Report). The need for public and private collaboration in mobilising capital and ensuring social cohesion during the transition have been highlighted in the Draghi Report and will also no doubt feature high on the agenda across New York this week. As policy makers consider the impact of regulation on SMEs and mid-caps, it is worth reminding ourselves of the importance of the loan market in a just transition. The LMA has published the Sustainability-Linked Loan Principles, Green Loan Principles and Social Loan Principles, as well as additional supporting documents such as the sustainability-linked loan model provisions, the accompanying term sheet and the sustainability coordinator letter. The LMA has also recently started work on the development of a transition use of proceeds label. The suite of labelled loan products is versatile and intended to be used across the market and can therefore be used in conjunction with benchmarks and ESG standards to create innovative financing structures accessing greater liquidity whilst maximising impact and addressing risk. This can include for example, blended finance structures or green loans which are aligned to investor ESG demands, and which increase efficiencies for borrowers by utilising data and information gathered for regulatory compliance.
Although the Draghi Report refers to a lack of guidance as a barrier for regulatory compliance, this quarter has seen the publication of additional guidance and support in the form of Q&As, mapping and alignment tools and guidance in Europe. The UK Financial Conduct Authority (FCA) has also provided additional time and support to firms in order to meet the higher standards of disclosure under the UK’s Sustainability Disclosure Requirements.
The Draghi Report
According to the Draghi Report, a minimum annual additional investment of EUR 750-800 billion is needed to achieve the objectives set out in the report. This needs to be a combination of both private and public capital and further changes to the financial sector are recommended in order to ensure that such finance is suitable for the levels of innovation required for a just transition.
One of the key recommendations of the Draghi Report is to reduce the regulatory burden on companies, particularly SMEs. The Drahi Report highlights the well-known challenges faced by companies and market participants as a result of the accumulation and frequent changes to regulation across the EU. It also points to the cost of compliance and the overlap and inconsistencies between sustainable regulation, made worse by the lack of available guidance to assist companies to navigate the interaction between various pieces of regulation.
The recommendations included in the Draghi Report include the appointment of a new commission Vice President for Simplification to streamline and quantify the flow of regulation and cutting regulation for SMEs by a further 50% upholding proportionality for SMEs and extending it to mid-caps.
There has been a mixed response from the market on the analysis and recommendations relating to regulation. The evolving and overlapping nature of key pieces of regulation is of course a challenge however some stakeholders consider that any attempted simplification of the regulation may cause additional issues – particularly for those organisations who have designed and implemented controls and processes based on the current and/or anticipated regulatory regime. In addition, this also poses the risk of increasing the misalignment between regulation and market expectations, leaving banks and funds struggling to obtain the information they are required to disclose to investors.
As highlighted by the Draghi Report, there are a number of challenges for SMEs operating across Europe. One of these is that SMEs will need access to capital in order to decarbonise and innovate. The LMA is looking closely at how it can support greater liquidity in relation to the flow of sustainable finance to SMEs. The LMA will be looking to start work on a dedicated project in this area in 2025. Please contact Gemma Lawrence-Pardew if you are interested in finding out more about this project.
FCA: Four month extension on “naming and marketing” sustainability rules
On 9 September 2024, the FCA offered firms limited temporary flexibility until 2 April 2025 to comply with the “naming and marketing” rules under the SDR regime. As is widely reported, firms have been busily preparing themselves for compliance with the “naming and marketing” and disclosure rules which will come into force from 2 December 2024.
In its statement, the FCA refers to the “good progress” made by firms and the “strong pipeline” of applications for labels, however acknowledges that firms are struggling to meet the required changes – particularly in meeting the disclosure standards relating to investment labels or when changing the name of products.
Recognising these challenges, the FCA is offering limited temporary flexibility until 2 April 2025 for firms to comply with the naming and marketing rules (ESG 4.3.2R to ESG 4.38R of the ESG sourcebook) in relation to a sustainability product which is an authorised investment fund. The extension only applies in “exceptional circumstances” i.e. where the firm (i) has submitted a completed application form for approval of amended disclosures in line with ESG 5.3.2R by 5pm on 1 October 2024; and (ii) is currently using one of the terms “sustainable”, “sustainability” or “impact” (or a variation of those terms) as part of the name of the fund and is either intending to use a label, or change the name of the relevant fund.
Firms should note that:
- the temporary measures do not apply to funds which are using any other sustainability-related terms;
- notwithstanding the temporary flexibility, firms are expected to comply with the naming and marketing rule as soon as they can;
- firms should comply with all other relevant rules including the anti-greenwashing rule; and
- firms should already be complying with the FCA’s pre-SDR guiding principles.
Further information and analysis in respect of these rules can be found in Horizons01 and Horizons02.
ESMA: Guidelines on Funds’ Names
On 21 August, the European Securities and Markets Authority (ESMA) published their translations in official languages of the “Guidelines on funds’ names using ESG or sustainability-related terms” (the Guidelines). The aim is to protect investors against unsubstantiated or exaggerated sustainability claims in fund names whilst also clarifying the criteria that asset managers should consider when considering the use of specific terms in fund names.
Firms should note that the Guidelines apply from 21 November 2024 and national competent authorities have two months from this date to notify ESMA whether they (i) comply, (ii) do not comply but intend to comply, or (iii) do not comply and do not intend to comply. The transitional period for funds existing before the application date will be six months after that date (i.e. 21 May 2025) and any new funds created on or after 21 November 2024 will need to apply the Guidelines immediately.
For further information and analysis please see Horizons01 and Horizons02.
ESMA: Updated Consolidated Q&A on the Sustainable Finance Disclosure Regulation (SFDR)
In July, ESMA published an updated consolidated Q&A in relation to the SFDR and SFDR RTS which includes Q&A relating to Principal Adverse Impact, calculations relating to sustainable investments and scoping.
The SFDR has also featured in a number of regulatory updates and reports this quarter including (i) ESMA’s opinion aimed at improving the usability and coherence of the EU Sustainable Finance regulatory framework – which included recommendations to phase out the concept of ‘sustainable investments’, (ii) the additional guidance published by the Taskforce for Nature-Related Financial Disclosures (TNFD) which maps the SFDR Principal Adverse Impact Metrics to TNFD core metrics, and (iii) the Commission’s FAQ relating to the Corporate Sustainability Reporting Directive which clarifies certain provisions of SFDR (see below for additional details).
These developments, whilst welcome, also illustrate the challenge highlighted in the Draghi Report and emphasise the need to improve usability and understanding of the SFDR in an efficient and comprehensive way. With uncertainty remaining over the future of the SFDR (see Horizons01), market participants continue to grapple with challenge of scoping and implementing SFDR.
Further information and analysis in respect of SFDR can be found in Horizons01 and Horizons02.
Spotlight on the “S”
The “S” in ESG or social factors are often lower on the agenda for market participants and companies, with reasons cited including the lack of regulatory focus, lack of quality/disaggregated data and information and the absence of relevant benchmarks and standards. In the loan market, this perception has not prevented large number of sustainability-linked loans from including a social KPI (often a gender-related KPI) and for increasing social loan issuance with a gender lens. The LMA, together with 2X Global and Sukhvir Basran at King & Spalding are working on the “Gender Lens Guidelines” for the loan market. These guidelines aim to bring the breadth and experience of 2X Global (including their recently launched 2X Certification) to the private sector in order to support the integration of gender lens terms and KPIs in sustainable loan products. We would be delighted to hear your views. Please feel free to reach out if you would like to be part of the reviewing group.
In the wider market:
- The Draghi Report (see above) emphasises the need for a just transition recognising that policymakers must not repeat past mistakes in being insensitive to the social consequences of growth and innovation. The report highlights the crucial need for the transition to increase growth and innovation whilst also ensuring social inclusion. This includes the need for increased public services, housing, education and training as well as childcare during the transition and stakeholders must be aware of the unintended social consequences of innovation and automation. As programmes are developed there is also a need to be inclusive across regions and cities with a focus on cohesive policies.
- In July 2024, the World Benchmarking Alliance (WBA) launched the 2024 Social Benchmark Insights Report. The 2024 Social Benchmark assesses the SDG2000 – companies identified by the WBA as 2000 of the world’s most influential companies. The 2024 Social Benchmark focuses on performance by these companies in respect of human rights, providing decent work and ethics. The WBA’s report sets out 18 indicators which aim to assess the extent to which a company is effectively contributing to a just transition and overall highlights the gap between current corporate practices and expectations for the creation of a just and equitable transition to a sustainable future.
- The European Banking Authority has published a report on the application of gender-neutral remuneration policies by institutions and investment firms. The review looks at the gender pay-gap and the monitoring of indicators in the area of equal pay and opportunities.
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