Biodiversityindicatorsandthe coverageofthevaluechain
BYCLIMATE&COMPANY,RAEGUENTHER&UNIKASSEL
Authors:
IngmarJuergens(Climate&Company)|ingmar@climcom.org
JohannesFranke(RaeGuenther)| franke@rae-guenther.de
LisaKnob(UniKassel)|lisa.knob@uni-kassel.de
LiyanaNayan(Climate&Company)|liyana@climcom.org
LouiseSimon(Climate&Company)| louise@climcom.org
MaxTetteroo(Climate&Company)| max@climcom.org
July2023
DisclosureRegulation’s(SFDR)Disclosure DelegatedRegulation
EXECUTIVESUMMARY:OURKEYMESSAGES
This policy brief reviews the biodiversity, deforestation and value chain aspects of the Disclosure Delegated Regulation of the Sustainable Finance Disclosure Regulation (SFDR), currently being drafted by the European SupervisoryAuthorities(ESAs).
Message 1: The list of principal adverse impact (PAI) indicators is not informative about the impact of investments on biodiversity throughout the entire value chain Financial institutions (FIs) critically need access to comparable, reliable and quantifiable data for their financing and investment decisions. For high biodiversity-risksectors,suchasthemanufacturingoffoodandbeverages, thebulk of environmental impacts occursupstreaminthesupplychain.Thelackofsupplychaindisclosuresmeansthattheseimpactsareunlikely to be considered by financial market participants (FMPs) and therefore will remain unaddressed. This has serious implications for the financial risks faced by FMPs, which will be severely undermined if only the operationsoftheirdirectinvesteecompaniesareconsidered
Werecommend:Eachindicatoranditscorrespondingformulaneedtobereformulatedtoexplicitlyrefertothe valuechainofinvestees.Theyshouldrefertowell-establishedframeworksthatdescribethestepsandrelevant benchmarks needed to develop concrete and effective policies, such as the EU Deforestation-free Products Regulation (EUDR) for deforestation and the European Sustainability Reporting Standard (ESRS) E4 for biodiversityreporting.
Message 2: Reliance on readily available information disclosed in the CSRD means that the EU CommissioncannotdelayandweakentheESRS.
Relianceonreadilyavailableinformationincreasestheriskthat(expected)delaysanddilutionsoftheESRSwill spilloverintotheSFDR.TheEUCommission’slatestdraftDelegatedActoftheESRShassubjectedthereporting requirementsforthetopicalstandardstoamaterialityassessment. Inaddition,thereareconcernsthattheEU Commission might pursue a climate-first approach, delaying the adoption of other topical standards (such as biodiversity)tolateaftertheEUelections Furthermore,theCSRDonlyrequiressustainabilityreportingfor listed SMEs. Information on the impacts of high-risk sectors dominated by non-listed SMEs (such as agriculture and construction)willthuslikelynotbereadilyavailable.
We recommend: The according need for greater transparency of impacts of companies to be facilitated by ambitiousbutfeasibleESRS.Inourlatestanalysis,weoutlinedindetailhow.
Message 3: Policy coherence needs to be improved by linking the “Do No Significant Harm” (DNSH) principleoftheTaxonomyRegulationandtheSFDR.
We agree with the ESAs’ assessment that the scope for interpretation of the SFDR’s definition of sustainable investmentleadsto significantrisksofgreenwashing DuetothereferencetoPAI indicatorsinthe SFDRDNSH and the sector-specific approach of the Taxonomy’s DNSH, alignment between the two is complex. However, more transparency on the thresholds used and on the linkages between the two frameworks would make the disclosures both easier to use and understand. The provision of a ‘safe harbour’ for taxonomy-aligned investmentstoautomaticallyqualifyas‘sustainableinvestments’undertheSFDRisproposedbytheESAsand isusedbytheEUCommissioninguidelinesontheusabilityoftheTaxonomy.Thisoptionrightlyrecognizesthat FIsneedtomakeuseofthedataalreadyprovidedbyotherregulatorymeasures.
We recommend: The ESAs and the EU Commission should consider how the two DNSH processes can be further aligned to avoid confusion and the risk of greenwashing We recommend requiring the FMPs’ DNSH assessmenttobebasedonsounddataprovidedbycompaniesintheCSRD,particularlythetopicalstandards
2
LISTOFACRONYMS:
CSDDD:CorporateSustainabilityDueDiligenceDirective
CSRD:CorporateSustainabilityReportingDirective
DCF:deforestation-andconversion-free
DNSH:DoNoSignificantHarm
EFRAG:EuropeanFinancialReportingAdvisoryGroup
ESAs:EuropeanSupervisorAuthorities
ESRS:EuropeanSustainabilityReportingStandards
EUDR:EUDeforestation-freeProductsRegulation
FIs:financialinstitutions
FMPs:financialmarketparticipants
GHG:greenhousegases
PAI:principaladverseimpact
SFDR:SustainableFinanceDisclosureRegulation
SMEs:smallandmediumenterprises
RTS:RegulatoryTechnicalStandards
TSC:TechnicalScreeningCriteria
3
POLICYCONTEXT&BACKGROUNDINFORMATION
ESAs’publicconsultationonthereviewoftheSustainableFinanceDisclosure Regulation(SFDR)’sDisclosureDelegatedRegulation.
The Sustainable Finance Disclosure Regulation (EU) 2019/2088 (SFDR) aims to increase the transparency of sustainability-related impacts in the financial services sector. The Regulation requires entity-level (organisational)disclosuresandfinancialproduct-leveldisclosuresforfinancialmarketparticipants(FMPs)and financialadvisors
The EU Commission has mandated the Joint Committee of the European Supervisory Authorities (ESAs) to review and revise the Regulatory Technical Standards (RTS) of the Delegated Regulation (EU) 2022/1288 (hereinafter the Disclosure Delegated Regulation) supplementing the SFDR. The Disclosure Delegated Regulation specifies the content and presentation of the disclosures required of FMPs The ESAs have proposed numerous amendments1 to the Disclosure Delegated Regulation and have also launched a public consultationontheiramendmentsonthe12th ofApril2023.Thedeadlineforcontributiontotheconsultation wasthe4th July2023
ThisreviewisakeyopportunitytoraiseawarenessofandaddresstheshortcomingsoftheDisclosureDelegated Regulation regardingitsusabilityand meaningfulness.Policycoherencewith otherpiecesof legislationwithin the EU Sustainable Finance Framework could also be improved The SFDR and its Disclosure Delegated Regulation should be informative about the impact of FMPs’ investments throughout the value chain, while being feasible to comply with In this context, the sustainability disclosures required by the Corporate Sustainability Reporting Directive (CSRD) through the European Sustainability Reporting Standards (ESRS) are key.ThedisclosureandduediligencerequirementsofFMPswouldbegreatlyfacilitatedbythetimelyadoption ofmandatoryESRS Particularlyforbiodiversityanddeforestation,mandatorydisclosureofimpactsthroughout the value chain is crucial for FIs to understand what kind of impacts are occurring where, and to take the necessaryactionstomitigatethesenegativeimpactsandtheresultingfinancialrisksthattheyface.
This policy brief aims to capture the main concerns and key messages that our teams at Climate & Company, Rae Guenther and Uni Kassel have compiled from our analysis of the amendments proposed by the ESAs regarding principal adverse impact (PAI) indicators (focusing on biodiversity and deforestation) and the considerationofthevaluechain
Theimportanceofunderstandingandaddressingbiodiversity(andparticularly deforestation)impactsinsustainabilityimpactandriskmanagement
Assessingbiodiversity-relatedmetricsiskeytounderstandingtheenvironmental(includingclimate)impactsof investments. The concept of “twin crises” captures the intertwining of climate change and biodiversity: one cannot be solved without the other.2 The financial incentives that the financial sector can provide to “shift the trillions”arethusneededonbothfronts.WhileclimatechangetendstoreceivemoreattentioninEUlegislation because it is easier to measure, this policy brief focuses on biodiversity impacts and the role of financial institutions(FIs)inaddressingthem.
Particularly,onespecifickeybiodiversityareawherethefinancialsectorhassignificantimpactisdeforestation
Thefinancialsectorcontributesindirectlytodeforestation,forexamplebyfinancinginvestmentsinagricultural expansionattheexpenseofforestsorbypromotingconsumptionpatternsthatleadtodeforestation.
1 ESAs’Jointconsultationpaper(12th April2023),link 2 EuropeanCommission(2021),Climatechangeandbiodiversitylossshouldbetackledtogether,link Corlett,R.(2020),Safeguarding ourfuturebyprotectingbiodiversity,PlantDiversityVol42,issue4,link
4
Between1990and2020,anestimated420millionhectaresofforest(representingmorethan10%oftotalforest area) were lost due to conversion to other land uses. 3 With at least two-thirds of the earth’s terrestrial biodiversity concentrated in tropical forests, the loss of primary forests results in the extinction of numerous species.Hometomanyindigenousandforestcommunities,deforestationalsothreatenstheirtraditionalforest use, which are an integral part of their culture and livelihoods. The depletion of forests, which are crucial CO2 sinks, reduces carbon absorption capacity and contributes to overall greenhouse gases (GHG) emissions. Deforestationalsoaffectsclimaticconditionssuchasrainfall,whichinturnaffectsrain-fedagriculture.Climate changeadditionallyincreasesvulnerabilitytofire,pests,anddrought.
Notonlycandeforestationcausemassivedamagetotheenvironment,itcanalsoleadtomajorfinancialrisks: forests harbour a significant share of terrestrial biodiversity, and as they disappear, so is the availability of ecosystem services on which many economic activities depend. In terms of the reputational risks, the Dutch Central Bank reports that Dutch FIs alone have a total of EUR 97 billion to businesses with heightened reputationalrisksduetoproductsoractivitieslinkedtodeforestation.4 ThenewEUDeforestation-freeProducts Regulation (EUDR), which entered into force on 29th June 2023, introduces mandatory due diligence rules for companies wishing to place high deforestation-risk commodities and related products on the EU market, makingdeforestationfinanciallymaterial TheEUDRwillalsoincreasereputationalandtransitionrisksforFIs financingcompaniestradingthesecommodities.
Thecriticality ofdeforestationimpactsandrisks underpins theneedfor deforestation tobe coveredby disclosurestandards.Empiricalevidenceshowsthatmandatorysustainabilitydisclosurescanleadtopositive effects for sustainable development, such as higher mine safety 5 , significant improvements in carbon performance6 and reduced industrial wastewater and sulphur dioxide (SO2) emission in cities.7 Investors are becoming increasinglyawareofthemassiveeconomicimportanceofnatureandecosystemservices,butthey need transparency on the impact of economic activities, companies and assets have on deforestation. As the GlasgowCommitmentLetter of 33investorsand theveryrecentdeclarationinSharmEl-Sheikh bymajorfood companiesshow,thereisastrongcorporate(financialandnon-financial)commitmenttohaltingdeforestation.8 FIsnowcriticallyneedaccesstocomparable,reliableandquantifiabledatatoinformtheirdecisions 9
In this regard, transparency of impacts throughout thevalue chain is crucial. For high biodiversity-risk sectors, such as the manufacturing of food and beverage, and construction and materials, the bulk of environmental impact is hidden in the supply chain (98% and 70-72% respectively) 10 The lack of disclosure on supply chain impactsmeansthattheseimpactsarelikelytobeunaccountedforbyFMPsandthereforeleftunaddressed This has serious implications for the financial risks faced by FMPs. Even when assessed from a double materiality perspective (i.e., from an “outside-in” or financial materiality perspective and an ‘inside-out” or stakeholder/impact materiality perspective), these will be severely undermined by looking only at the operationsoftheirdirectinvesteecompanies 11
The SFDR, as part of the broader EU Sustainable Finance Framework, plays a key role in painting a comprehensive picture of the deforestation and wider biodiversity impacts of investments. However, the PAI indicators insufficiently address these information needs. We highlight the shortcomings of the Disclosure DelegatedRegulationbothintermsofdefinitionsandindicatorsused.
3 FAO(2022),Thestateoftheworld’sforests,link
4 DNB&PBL(2020),Indebtedtonature:ExploringbiodiversityrisksfortheDutchfinancialsector,p.12,link
5 Christensenetal.(2017),Therealeffectsofmandatedinformationonsocialresponsibilityinfinancialreports:Evidencefromminesafetyrecords,link
6 Baucklohetal.(2022),UnderPressure?TheLinkBetweenMandatoryClimateReportingandFirms’CarbonPerformance,link
7 Chenetal.(2018),TheeffectofmandatoryCSRdisclosureonfirmprofitabilityandsocialexternalities:EvidencefromChina,link
8 FinancialSectorCommitmentLetteronEliminatingCommodity-DrivenDeforestation(2021),link
9 Amel-Zadeh&Serafeim(2018),WhyandHowInvestorsUseESGInformation:EvidencefromaGlobalSurvey,link
10 UNPrinciplesforResponsibleInvestment(2017),ManagingESGriskinthesupplychainsofprivatecompaniesandassets, link
11 OurteamsatClimate&Company,RAeGüntherandGermanwatchwroteapolicybriefon whymandatorysustainabilityduediligence iskeyforfinancialinstitutions,seehere
5
OURKEYISSUESOFCONCERN/MAINMESSAGES
Message1:Thelistofprincipaladverseimpact(PAI)indicatorsisnotinformative abouttheimpactsofinvestmentsonbiodiversitythroughoutthevaluechain
TheamendmentsproposedbytheESAsdonotyet sufficientlyaddressthevaguenessofthecurrentsetof PAI indicators, and the lack of information provided by most indicators on the actual impacts caused by FMPs’ investments.Thefollowingsubsectionsaddressourmainconcernsregardingthebiodiversity-relatedindicators andthegeneralconsiderationofthevaluechainofinvesteecompanies.
CONSIDERATION OF THE VALUE CHAIN IN DESCRIPTION OF INDICATORS AND FORMULAS (ANNEX 1)
OurfirstgeneralconcernrelatestotheconsiderationofthevaluechainwithinPAIindicators Whilewewelcome theESAs’proposedadditioninArticle6(5)ofinformationonthevaluechainswhenmadeavailablethroughthe reportingrequirementsoftheCSRDandwhenreadilyavailable,thisisnotsufficient. Most of the PAI indicators do not, in their current form, provide for a clear indication of the need to considerthevaluechainofinvesteecompanies TheneedtoreportonScope1-3GHGemissionsshowsthat, at least in terms of climate impacts, the supply chain of investee companies must be taken into account. However,theinclusionofthevaluechainisincompleteanddependsonthespecificsustainabilityfactorlisted in Annex I of the Disclosure Delegated Regulation. Even if the EU Commission accepts the amendments introduced by the ESAs to add the value chain within the PAI calculation (Q13), the list of indicators and their correspondingformulawillneedtobeadjusted. Ourtakeawaysandrecommendations:
• 6 of 9 mandatory environmental PAI indicators do not explicitly refer to the valuechain of investee companies
o We recommend reformulating each indicator and its formula to include the value chain of investeecompanies
• The PAI indicator on Biodiversity (Annex 1, Table 1, indicator 7) currently considers “Share of investments in investee companies with sites/operations located in or near to biodiversity-sensitive areas where activities of those investee companies negatively affect those areas”
o Thelimitationtoinvesteecompanies’directoperationsmeansthatthebulkofadverseimpacts on biodiversity, usually happening upstream in the supply chain, will not be covered by the indicator
o We thus recommend reformulating it into “Share of investments in investee companies with sites/operations located in or near to biodiversity-sensitive areas and sourcing from third-party producers with sites/operations located in or near to biodiversity sensitive areas where the activities of those investee companies and their value chain suppliers negatively affect those areas”.
• ThePAIindicatoron“Naturalspeciesandprotectedareas”(Annex1,Table2,indicator14)currently covers “a) Share of investments in investee companies whose operations affect threatened species b) Share of investments in investee companies without a biodiversity protection policy covering operational sites owned, leased, managed in, or adjacent to, a protected area or an area of high biodiversity value outside protected areas”.
o It does not explicitly state whether indirect operational effects (through the investee companies’ value chain) are included, hence would leave the negative impacts through sourcing,production,transportation,anddistributionoutofthereporting
6
o Westronglyrecommendincludingoperationsthatarealsoaffectingspeciesacrossbroaderrisk categories, according to the nine risk categories stipulated by the IUCN Red List12, so that proactiverisk-aversionmeasurescanbetakentoprotectspeciesthatarevulnerableandnearthreatened. For consistency with the biodiversity and ecosystem change impact metrics outlinedintheESRSE413,theassessmentofmaterialimpactsonspeciesshouldalsoconsider thepopulationsizeandrangeoftheecosystemsaffectedbyinvesteecompanies
ALIGNMENT OF DEFINITIONS AND INDICATORS ON DEFORESTATION AND BIODIVERSITY WITH OTHER FILES
Thedefinitionofan“activitynegativelyaffectingbiodiversity-sensitiveareas”(Annex1(8))referstothree Directives and their equivalent at national or international level, for which none of the conclusions, mitigation measures, or impact assessments adopted have been implemented. Our concerns and recommendations regardingthisdefinitioninclude:
• The first issue with this definition is the threshold for “no action”, which indicates that the implementationofinsignificantorsmall-scalemitigationmeasuresorothertypesofactionissufficient to consider an activity as not adversely affecting biodiversity-sensitive areas. Biodiversity impacts should be reported regardless of whether actions have been taken to mitigate the damage caused. Mitigation actions would be reported on an annual basis in column 6 ("Actions taken, and actions planned and targets set for the next reference period”) and should hopefully lead to results to be reportedincolumn3(”Impact[yearn]”)
• An improvement to this definition would be to include a reference to the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct14, which were very recently updated. The SFDR already refers to the OECD Guidelines in its due diligence requirements15, so the updated version should now be referenced instead. Furthermore, the updated Guidelines include clearer expectations for companies to carry out risk-based due diligence to assess and address adverse environmentalimpacts,particularlypointingatbiodiversityloss,degradationoflandanddeforestation, among others. The draft ESRS 1 from the European Financial Reporting Advisory Group (EFRAG) also refertotheOECDGuidelinesfortheirduediligenceprocess.16
• Furthermore, the definitiondoes not make reference to the upcoming Corporate Sustainability Due DiligenceDirective(CSDDD),wherefinancialandnon-financialcorporateswould(notyetadopted)be required to take actions to mitigate impact on biological resources (as part of one of the violations of theAnnexIpartIIoftheCSDDD17).Lackofmeasurestomitigatenegativeimpactsontheuseofbiological resourceswillbemadetransparentundertheCSDDDandshouldthereforebeusedbyinvestors.Adding theCSDDDasaDirectiveunderthisdefinitionwouldimprovepolicycoherence.
• TheESRSE4onBiodiversity,althoughproposedintheEUCommission’sdraftDelegatedAct(ofJune 2023)asavoluntarystandardsubjecttoamaterialityassessment,wouldbeahighlyrelevantreference frameworkfordisclosureofbiodiversity-relatedmetrics.Inparticularly,thebiodiversitytransitionplans includedinESRSE4couldinformFMPsaboutthespecificactionsthatcompanieswilltaketotransition to more sustainable activities. However, the EU Commission has decided in its draft Delegated Act to makebiodiversitytransitionplansvoluntary.Thiswouldallowforgreenwashing,disincentivizeinvestor from considering impacts, and threaten data quality and comparability. It is therefore crucial that the EU Commission takes EFRAG’s technical advice into account in this context, particularly in light of the relianceofFMPsonsustainabilityinformationfromtheirinvesteecompanies.
12 IUCNRedListofThreatenedSpecies(link)
13 EFRAG(November2022),DraftEuropeanSustainabilityReportingStandardsESRS4:Biodiversityandecosystems(link)
14 OECD(2023),OECDGuidelinesforMultinationalEnterprisesonResponsibleBusinessConduct,updated8th June2023,link
15 Recital(18)oftheSFDRandArticle22(a)(ii),Article26(2)(b)oftheDisclosureDelegatedRegulation.
16 EFRAG(November2022),DraftESRS1GeneralRequirements,link
17 EuropeanCommission(2022),AnnextotheproposalforaDirectiveonCorporateSustainabilitydueDiligence,link
7
Regarding other biodiversity-relevant definitions, we support the reference to the ESRS E4 for the definitions of“landdegradation”and“desertification”,whichisahelpfulapproachtoincreasingcoherencebetweenthe SFDRandCSRD/ESRS.
Thedefinitionof‘deforestation’ forboth ESRSandSFDR(outlinedinAnnex1oftheconsultationdocument) are aligned to mean ‘temporary or permanent human-induced conversion of forested land to non-forested land’ reflecting the UN’s Food and Agriculture Organisation’s definition. However, no reference is made to the definitionofdeforestationintheEUDeforestation-freeProductsRegulation(EUDR),themoststringentpiece of EU legislation on deforestation where considerable thoughts have gone into deciding the definition of deforestation” This is a missed opportunity to increase policy coherence and to allow for more comparability of information The EUDR covers the most important forest-risk commodities Furthermore, the EUDR will be subjecttovariousreviewstopotentiallyextentthescopeoflands,ecosystemsandcommoditiescoveredbythe requirements of the Regulation. So, an explicit reference to this evolving Regulation will hopefully enable a broader scope of ecosystems to be covered by the disclosure requirements of the SFDR. The disclosure requirements ESRS E4 already address ecosystem conversion in a broader sense (beyond deforestation) The conceptofecosystemconversionisnotcoveredintheSFDRyet.IntheinterestoffurtheralignmentbetweenEU disclosurepolicies,werecommendtheESAstoaddthisconceptinthescopeofPAIoftheSFDR. Lastly, the indicator on deforestation (“Share of investments in companies without a policy to address deforestation”, Annex 1, Table 2, indicator 15) is not informative An indication of whether a company has a deforestation policy in place or not, does not provide useful and accurate information about the quality and impactofthosepolicies.
• Therefore, we recommend including the EUDR as an explicit reference in the indicator on deforestationasfollows:“Share of investments in investee companies trading commodities subject to the EUDR fulfilling all compliance requirements AND share of investments in investee companies that voluntary disclose on all (material) disclosure requirements of ESRS E4”.
o AlldisclosurerequirementsoftheESRSE4arenotonlyaboutdeforestationbutrelatedtoit.We recommend the SFDR to provide several incentives through different indicators to require biodiversity disclosures through the ESRS E4 for the purpose of reinforcing the “Do No SignificantHarm”(DNSH)assessment(seebelowunder“Error!Referencesourcenotfound.”)a ndtheuseofthevoluntaryESRSE4
• This recommendation is aligned with other established international metrics, such as the indicator recommendedbytheAccountabilityFrameworkInitiative(AFi)Coalitionforallcompanies:“proportion ofdeforestation-andconversion-free(DCF)commodityvolumesinthesupplychains”.18
Message2:RelianceonreadilyavailableinformationdisclosedwithintheCSRD meansthattheEUCommissioncannotdelayandweakentheESRS.
TheESAs’suggestedtoincludeprecisionsontheuseofvaluechaindatawhenavailable19 Weareworriedthat focusingonlyonreadilyavailableinformationcouldcausetwomainblindspots:
First,theCSRD isintendedtoserveas thedatafoundationforFMPs'reportingundertheSFDR.So,reliance on readily available information increases the risk that (expected) delays and dilutions of the ESRS spill over intotheSFDR TheEuropeanCommission’slatestdraftDelegatedAct20 hassubjectedthemandatoryreporting requirementsonthetopicalstandards(includingbiodiversity)toamaterialityassessment,withquestionsabout the assurance that this assessment is well-executed. There is a danger that this change (from mandatory to
18 AccountabilityFrameworkInitiative(2023),TheAFiCoalitioncallsoncompaniestodiscloseprogresstowardsdeforestation-and conversion-freesupplychains,link
19 “FMPs shall include information on the value chains of other investee companies where that information is readily available”
20 EuropeanCommission(2023),draftDelegatedActforcross-cuttingstandardsandstandardsforthedisclosureofenvironmental, socialandgovernanceinformation,link
8
voluntary assessment) leads to huge data gaps for the obligatory reporting of the PAI under the SFDR Additionally,therearestillconcernsthattheEuropeanCommissionmightpursueaclimate-firstapproachwith thisDelegatedAct,inwhichcasethenon-climatetopicalstandards(includingbiodiversity)willnotbeincluded, and their finalisation will be significantly postponed until late after the elections. Both risks have been introducedaftertheESAsprovidedtheiramendmentstotheSFDR,thereforeincreasingtheimportanceoftheir consideration
Second, the impact of sectors that are dominated by SMEs still fall outside the scope of the CSRD, and thereforetheirinformationisunlikelytobereadilyavailable TheESAssuggestusinginformationthatisreadily available,“for example by third party data providers”(Recital(3)).Thisisnotenoughtoensurethevaluechainis sufficiently covered. Agriculture is a good example of a sector dominated by SMEs outside of the scope of the CSRD,anditisunlikelytheirvaluechains’informationisreadilyavailable. TheEuropeanCommission’sdraftDelegatedActforthecross-cuttingandtopicalESRSprovidesmoreguidance and direction to what can be done if the undertaking cannot collect value chain information, making an estimation “using all reasonable and supportable information that is available to the undertaking at the reportingdatewithoutunduecostoreffort”(ESRSE1 AR17(p.27)).Thiswouldnotyetsolvetheissuesabove, butaligningwiththiswouldbeapotentialintermediatesolution(intermsofpolicycoherence).
Message3:Policycoherenceneedstobeimprovedbylinkingthe“DoNo SignificantHarm”(DNSH)principleoftheTaxonomyRegulationandtheSFDR
We agree with the ESAs’ assessment that the room for interpretation regarding the definition of sustainable investmentinthecurrentversionof theSFDRleadsto importantgreenwashingrisks.Weacknowledgethatan alignment between the Taxonomy Regulation, which is sector-specific, and the current sector-agnostic perspectiveoftheSFDRisacomplexissue.
LEVEL 1 – LEVEL 2 AMENDMENTS
The ESAs express the view that Level 1 reform, i.e., reform of the SFDR, is necessary to accomplish coherence betweentheSFDRandtheTaxonomyRegulation.Indeed,Level1reformwillbenecessarytocompletelyresolve inconsistencyissues.However,theSFDRdelegatesconsiderablepowertotheESAsregardingDNSHdisclosure that they can and should use to address as many issues as possible. Art. 2a SFDR, which was added by the TaxonomyRegulation,empowerstheESAstodraftRTStospecifythedetailsofthecontentandpresentationof the information in relation to the DNSH principle referred to in Art. 2 (17) SFDR, consistent with the content, methodologies, and presentation of the PAI indicators. Due to the reference to the PAI indicators, complete alignment with the EU Taxonomy cannot be achieved within the SFDR Delegated Regulation. However, specificationofthe content oftheinformationisexpresslywithintheauthorityoftheESAs.Thisempowerment should be used to promote comparability of DNSH/PAI indicators. This could include, for instance, setting quantitativethresholdsoratleastprescribingmethodologiesfortheDNSHcriteriainsteadofleavingthiscrucial stepcompletelytoFMPs(andonlyobligingthemtoreportontheirrespectivethresholdsandmethodologies). Inthiscontext,itwouldalsobepossibletotakeintoaccountsectoraldifferences,asintheEUTaxonomy,thus promotingcoherence
DISCLOSURE OF QUANTITATIVE THRESHOLDS
WestronglysupporttheESA’srecommendationtomakemandatorydisclosureonthequantitativethresholds FMPsuse.Mandatorydisclosuresonquantitativethresholdsensureahigherdegreeofcomparability,andwhen communicated transparently, can increase the level of ambition in setting the thresholds. Leaving the definition/threshold of DNSH up to FMPs’ discretion raises significant concerns regarding the generation of comparableandaccuratedataacrossinvestmentsandmayleadtogreenwashing.Whilecomparabilitymaybe limited by the fact that many PAI approaches differ in terms of sectors, company size, and other factors, we encourageeffortstoincreasetransparency
9
A “SAFE HARBOUR” FOR TAXONOMY-ALIGNED ACTIVITIES
We welcome the efforts towards the alignment between SFDR and the Taxonomy Regulation As one of their proposals, the ESAs explain the idea of a ‘safe harbour’, through which taxonomy-aligned economic activities willnotberequiredtobesubmittedtoanenvironmentalDNSHassessmentundertheSFDR.Weagreethatwith this alignment, investment instruments focused on environmentally sustainable activities can be boosted. To guidethis,theEuropeanCommissionhasrecentlyreleasedaworkingdocumentonEUTaxonomyusability21 as part of its 2023 Sustainable Finance Package22 , as well as a recent Commission notice on frequently asked questionsonthelinksbetweentheSFDRandTaxonomyRegulation23,both providingguidanceontherulesto provide a ‘safe harbour’ for taxonomy-aligned investment to be automatically qualified as ‘sustainable investment’undertheSFDR.However,weseeariskofmisunderstandingtheconceptofasafeharbourandhow toimplementit,particularlyinparalleltonon-taxonomy-alignedactivities.Furtherclarificationandguidancein the SFDR on the aggregation of DNSH definitions to the financial product level would be highly beneficial for FMPs in implementing this safe harbour option, and for investors in understanding the exact meaning a “sustainablefinancialproduct”
Since Taxonomy-aligned economic activities are separately treated from the SFDR requirements, we see this recourseasanoptionforFMPstotakean“in-betweenstep”totransitioningfullyintoEUTaxonomyalignment. However, caution must be taken so that the DNSH criteria identified by the Platform as inadequate from a usabilityperspective24 are avoided, such as criteria thatrefers only to EU legislation(andhence not applicable outsidethebloc)and‘stateambitions’thathavenocleardefinition.WhileitischallengingtocomparetheDNSH criteriaofthetwofilesconsideringthetaxonomyDNSHisattheactivitylevelandthePAIsofSFDRisatthefirm level,weencouragethecontinuousimprovementstowardstransparencyinlightofimperfectdata
ALIGNMENT BETWEEN TAXONOMY DNSH AND SFDR DNSH IN THE LONG TERM
We support ESA’s longer-term view on the merging of two parallel sustainability concepts, SFDR (SFDR Article 2(17) and Taxonomy Regulation, and that the EU Taxonomy’s Technical Screening Criteria (TSC) should also form the basis of the DNSH assessment for the SFDR. The Technical Screening Criteria of the Taxonomy Regulation provide activity-level criteria based on scientific evidence that are specific to economic activities undertaken by investee companies This approach facilitates the identification of more detailed sustainability risksandimpactsassociatedwiththeinvestmentsofFMPs
REQUIREMENT TO BASE DNSH ASSESSMENT ON DISCLOSURES FROM THE CSRD
TheCSRDanditsESRSarecrucialsourcesofinformationfortheassessmentofwhetherfinancialproducts“do nosignificantharm”.WhilesomeofthePAIindicatorsalreadyrefertodefinitionsusedintheESRS(seeabove), werecommendrequiringFMPstobasetheirDNSHassessmentundertheSFDRoninformation reportedinthe topical standards of the ESRS This requirement would reinforce the DNSH assessment and ensure that it is based on information reported under concrete guidelines, as well as boost the disclosures of non-financial companies under the different topical standards. Creating an incentivize for non-financial companies to disclose information according to the ESRS will address substantial challenges that a voluntary approach to disclosure standards will pose on FMPs. It is imperative that the Commission recognizes the importance of maintaining consistency within the reporting framework and upholds the CSRD provisions to ensure that sustainabilitystandardsencompasstheinformationessentialforcompliancewithSFDR.
• For example, for the DNSH criteria of the biodiversity-related PAI indicators (in both Table 1 and 2 of AnnexII)tobefulfilled,FMPsshouldbasetheirassessmentondatadisclosedinESRSE4onBiodiversity.
21 EuropeanCommission(2023),COMMISSIONSTAFFWORKINGDOCUMENT,EnhancingtheusabilityoftheEUTaxonomyandthe overallEUsustainablefinanceframework,link
22 EuropeanCommission(2023),SustainableFinancePackage,link
23 EuropeanCommission(2023),CommissionnoticeontheinterpretationandimplementationofcertainlegalprovisionsoftheEU TaxonomyRegulationandlinkstotheSustainableFinanceDisclosureRegulation, link
24 EuropeanplatfromonSustainableFinance(Oct.2022),PlatformRecommendationsonDataandUsability,link
10
CONCLUSION
The implementation of the SFDR would greatly benefit from a strong revision of its Disclosure Delegated Regulation, which sets out the specific disclosure requirements. It is crucial that the reported data provide concrete information on the actual environmental impact of investments and close the door to any greenwashing opportunities. We recommend that the ESAs revise the PAI indicators in this direction, avoiding indications of whether any policies to mitigate impacts are in place, but rather referring to established frameworksthatprescribestepstobuildaneffectivepolicyTransparencyoftheentirevaluechainisneededto accurately depict environmental impacts (such as on biodiversity and deforestation). This information is not currentlyavailablefromallnon-financialcompanies.TheEUCommissionmustthusensurethattheCSRDand the ESRS foreseen for its implementation provide an enabling framework for both financial and non-financial companies to understand which sustainability issues to assess and how. By weakening of the standards comparedtoEFRAG’sproposal,itwillbemoredifficultandburdensome forFIstounderstandwhycompanies report on certain sustainability topics and not others, in addition to the massive data gaps they face for their ownreportingobligations
11
PUBLICATIONDETAILS
FUNDEDBY
TheGordonandBettyMooreFoundation,moreinformationontheprojectpage.
CREATEDBY
Climate&Company-TheBerlinInstituteforClimateTrainingandResearchgGmbH
IngmarJuergens,LiyanaNayan,LouiseSimon,LouisavonEssen&MaxTetteroo
Ahornallee2|12623Berlin
www.climateandcompany.com|hello@climcom.org
RechtsanwälteGünther
Dr.JohannesFranke
Mittelweg150|20148Hamburg
www.rae-guenther.de|post@rae-guenther.de
UniversitätKassel-FachbereichWirtschaftswissenschaften-FachgebietNachhaltigeFinanzwirtschaft
LisaKnob
Mönchebergstraße19|34125Kassel
www.uni-kassel.de|poststelle@uni-kassel.de
12
