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In order to achieve the objectives set by the EuropeanGreen Deal, the European Union is producing more and more ESG-related legislation. This makes navigating the ESG legal landscape almost as complex as financial legislation. This makes sense, since the main aim of the Green Deal is to bring these two aspects together in order to put in place a " new growth strategy aimed at transforming the EU into a fair and prosperous society, with a modern, resource-efficient and competitive economy "(Communication from the European Commission - The Green Deal for Europe).
The Corporate Sustainability Reporting Directive(CSRD) is one of the main instruments for implementing this strategy, as it sets high standards for sustainability reporting, so that companies can be compared on their ESG performance, in addition to their financial performance. But how does the CSRD fit in with other ESG legislation, such as the CSDDD, the European climate law or the SFDR?
This article explains how the CSRD relates to the following legislation:
- European Climate Law
- SFDR
- Pillar 3
- Reference Index Regulations
- Sustainable taxonomy
- CSDDD
European climate law: the cornerstone of the Green Pact
The European Climate Act is a regulation adopted in 2019, the main aim of which is to establish a "binding objective of climate neutrality in the Union by 2050" (Article 1, §2 of the European Climate Act). It is therefore a particularly important text for the European Union in its sustainable development strategy.
A number of levers have been identified to achieve this objective:
- The contribution of all economic sectors
- The transition to a safe, sustainable, affordable and secure energy system
- Digital transformation, technological innovation and R&D
- Carbon sinks, particularly in the agriculture, forestry and land use sectors
The European Union and its member states encourage (or oblige) economic players to contribute both through their regulatory frameworks and through their environmentally sustainable investments. The CSRD is part of this regulatory framework, as it requires companies to publish information on their climate strategy.
The ESRS are directly linked to the European Climate Act, since ESRS 2 stipulates that companies must include in their report "a table of all data points that derive from other EU legislation (including the European Climate Act), specifying where they appear in the sustainability statement and including those that it considers, after assessment, not to be material, indicating, in this case, 'not material' in the table" (ESRS 2, IRO-2, §56).
Two European climate law data points are mapped in Appendix B of ESRS 2:
- ESRS E1-1 (§14) Transition plan to achieve climate neutrality by 2050
- ESRS E1-7 (§ 56) GHG absorptions and carbon credits
SFDR, Pillar 3, benchmark regulation: several pieces of legislation for more sustainable finance
These three pieces of legislation all concern the financial sector and have different objectives. In addition to the European Climate Act, these are the three other pieces of legislation that are mapped with the ESRS and are part of the requirements on the data point table that derive from other EU legislative acts (IRO-2 publication requirement).
1 - SFDR
The Sustainable Finance Disclosure Regulation (SFDR) "establishes harmonized rules for financial market participants and financial advisors on transparency with regard to the integration of sustainability risks and the consideration of negative sustainability impacts in their processes, as well as the provision of sustainability information with regard to financial products" (Article 1).
This regulation establishes three types of funds on which financial players must disclose specific information in their pre-contractual disclosures:
- Article 6 funds that do not promote specific sustainable objectives
- Article 8" funds that promote environmental or social characteristics
- Article 9" funds, which are investments considered to be sustainable
According to the SFDR, market players must publish information on how their financial products take into account the main negative impacts in terms of sustainability. To this end, in 2022 the Commission published a delegated regulation which defines certain indicators that market players must consider when estimating the main negative impacts in terms of sustainability linked to the companies in which their products aim to invest.
These indicators include environmental and social metrics that are often mandatory under the SFDR (see ESRS 2 mapping, Appendix B). Therefore, the table of CSRD-related data points that companies will disclose under ESRS 2 IRO-2, as mentioned above, will be particularly useful for market players to collect the information needed to calculate the negative impacts of their investments.
2 - Pillar 3 regulations
The Pillar 3 regulation sets out prudential requirements for institutions, financial holding companies and mixed financial holding companies. Prudential requirements aim to make the financial sector more stable, while ensuring that it is able to support households, businesses and other end-users of financial services.
These prudential requirements are very broad. They include disclosure of the environmental, social and governance risks of institutions that have issued shares admitted to trading on regulated markets in a member state. As these institutions are often involved in CSRD, the related disclosures are mapped in Appendix B of ESRS 2. Most of these requirements are linked to ESRS E1 on climate change.
For related data points, establishments that must meet the disclosure requirements for their environmental, social and governance risks in accordance with the Pillar 3 regulation, have the option, in their CSRD sustainability report, of incorporating this information by reference to the Pillar 3 disclosures if they ensure that the consolidation scopes are the same for both reports.
3 - Benchmark regulations
The benchmark regulation "establishes a common framework to ensure the accuracy and integrity of indices used as benchmarks in financial instruments and contracts, or to measure the performance of investment funds in the Union" (Article 1).
This regulation is linked to the CSRD, as the administrators of financial benchmarks must explain how ESG factors are reflected in each of their indices or index families. For example, administrators of EU "climate transition" and "Paris agreements" benchmark indices are encouraged to increase the share of issuers of constituent securities that set and publish greenhouse gas emission reduction targets in their indices.
Sustainable taxonomy: a tool for defining sustainable economic activities
The Sustainable Taxonomy (also known as the Green Taxonomy or the European Taxonomy) establishes a classification system with clear definitions of what constitutes an environmentally sustainable activity, with the aim of helping investors and companies to make informed investment decisions.
Through technical criteria applying to specific sectors of activity, it is possible to determine whether an activity contributes to one or more of the following environmental objectives:
- Climate change mitigation
- Adapting to climate change
- Sustainable use and protection of aquatic and marine resources
- Transition to a circular economy
- Pollution prevention and reduction
- Protecting and restoring biodiversity and ecosystems
To meet the requirements of the sustainable taxonomy regulation, companies must disclose certain KPIs:
- The proportion of their sales generated by products or services associated with economic activities that can be considered environmentally sustainable
- The portion of their CaPex linked to assets or processes associated with economic activities that can be considered environmentally sustainable
- The share of their OpEx linked to assets or processes associated with economic activities that can be considered environmentally sustainable
Under ESRS 1, these taxonomy disclosure obligations must be included in the CSRD sustainability report in a separate section:
There are several other additional references to the sustainable taxonomy in the environmental ESRS. For example, publication requirement E1-1 (Climate Change Mitigation Transition Plan) requires companies with economic activities covered by the taxonomy to disclose "an explanation of any objectives or plans (CapEX, CapEx plans, OpEX) that the company has set to align its economic activities (revenues, CapEx, OpEX) with the criteria set out in the regulations" on the taxonomy.
There is also a link between taxonomy and SFDR . Indeed, when a financial product invests in an economic activity that contributes to environmental objectives, information on the criteria of the taxonomy must be included in the pre-contractual information.
CSDDD, a duty of care to be disclosed in the CSRD sustainability report
Finally, the Corporate Sustainability Due Diligence Directive is the latest major piece of ESG legislation adopted by the European Union. It concerns very large companies only, so its scope is narrower than that of the CSRD.
While the CSRD establishes an obligation to disclose information, the CSDDD establishes an obligation to take action by :
- due diligence on human rights and environmental risks
- the adoption and implementation of a climate transition plan to ensure that the company takes the necessary steps to align its business model and strategy with the objective of limiting global warming to 1.5°C, and with the climate neutrality target set by European climate legislation
Penalties are based on companies' worldwide sales. The percentage will be defined by member states, and may be as high as 5% of sales. In addition, if due diligence obligations are not complied with and harm is caused to a natural or legal person, companies may be held civilly liable and will be required to pay compensation.
Many people believe that the CSDDD establishes new disclosure requirements. However, "to avoid duplicating reporting obligations", the CSDDD states that the directive "should not introduce new reporting obligations in addition to those provided for in Directive 2013/34/EU (CSRD)". Therefore, a company that is subject to the CSRD in addition to the CSDDD will have to disclose information on how it meets the CSDDD requirements in its sustainability report under the CSRD .
As the ESRS were adopted before the CSDDD, they do not mention this legislation. Nevertheless, there are many publication requirements that are relevant to disclosing how companies are implementing the CSDDD. With regard to due diligence, section 4 of ESRS 1 is dedicated to this and maps the essential elements of due diligence to the publication requirements of ESRS 2 and, in some cases, those of the thematic ESRSs. Lastly, the climate transition plan required by the CSDD will be disclosed under publication requirement E1-1 (Climate change mitigation transition plan).
