E.U. ENVIRONMENTAL SOCIAL GOVERNANCE (ESG) REGULATIONS GUIDE - By Barrie C. Ingman FactSet Regulatory Solutions
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www.factset.com E .U. E N V I R O N M E N TA L SOCIAL GOVERNANCE (ESG) R E G U L AT I O N S G U I D E By Barrie C. Ingman FactSet Regulatory Solutions
Contents
Acronyms .............................................................................................................................................................................. 3
1 Overview ........................................................................................................................................................................... 4
1.1 Introduction ................................................................................................................................................................................... 5
1.2 Background ................................................................................................................................................................................... 6
1.3 The Proliferation of ESG Standards .............................................................................................................................................. 7
1.4 The ESG Regulations ................................................................................................................................................................... 8
1.5 Timeline – Key Compliance Dates ................................................................................................................................................ 9
1.6 The Regulatory Framework ........................................................................................................................................................ 10
1.7 High-Level Overview ................................................................................................................................................................... 11
1.8 Practical Consequences for Investment Firms ........................................................................................................................... 12
1.9 Terminology ................................................................................................................................................................................ 13
1.10 Future Developments ............................................................................................................................................................... 16
1.11 Delegated Legislation .............................................................................................................................................................. 17
2 The Taxonomy Regulation ............................................................................................................................................. 20
2.1 Introduction ................................................................................................................................................................................. 21
2.2 The Taxonomy Framework ........................................................................................................................................................ 23
2.3 Taxonomy Regulation - The Environmental Objectives ............................................................................................................. 24
2.4 Taxonomy Regulation - Significant Harm to Environmental Objectives ..................................................................................... 31
2.5 Taxonomy Regulation - Minimum Social Safeguards ................................................................................................................ 32
2.6 Taxonomy Regulation - Technical Screening Criteria ................................................................................................................. 33
2.7. Taxonomy Regulation – Legislative Reviews ............................................................................................................................ 35
3 The Disclosure Regulation ............................................................................................................................................. 36
3.1 The Legal Framework ................................................................................................................................................................. 37
3.2 Overview of the Disclosures ...................................................................................................................................................... 44
3.3 Disclosure Type 1 - Risks from Sustainability Issues ............................................................................................................... 46
3.4 Disclosure Type 2 – Risks to Sustainability Issues .................................................................................................................... 48
3.5 Disclosure Type 3 – Product-Specific Disclosures .................................................................................................................... 51
3.6 Ancillary Matters ........................................................................................................................................................................ 55
4 The Climate Benchmarks Regulation ............................................................................................................................. 56
4.1 Introduction ................................................................................................................................................................................ 57
4.2 General ESG Disclosures .......................................................................................................................................................... 59
4.3 Climate Benchmarks Overview .................................................................................................................................................. 60
4.4 Climate Transition Benchmarks ................................................................................................................................................. 61
4.5 Paris-Aligned Benchmarks ......................................................................................................................................................... 64
4.6 Ancillary Matters ........................................................................................................................................................................ 65
1
5 Green Finance and the Green Bond Standard .............................................................................................................. 66
5.1 Introduction ................................................................................................................................................................................ 67
5.2 The Proposed EU Green Bond Standard .................................................................................................................................. 68
5.3 Related Green Finance Initiatives .............................................................................................................................................. 70
5.4 The EU Ecolabel ........................................................................................................................................................................ 71
6 The Shareholder Rights Directive II ............................................................................................................................... 72
6.1 Introduction ................................................................................................................................................................................ 73
6.2 Engagement Policy & Disclosures ............................................................................................................................................. 74
6.3 Institutional Investor Arrangements with Asset Managers ......................................................................................................... 75
6.4 Asset Manager Disclosures and Reporting................................................................................................................................ 76
7 The Non-Financial Reporting Directive .......................................................................................................................... 77
7.1 The Non-Financial Reporting Directive ...................................................................................................................................... 78
7.2 The NFRD Review ..................................................................................................................................................................... 79
8 Prudential Measures....................................................................................................................................................... 80
8.1 Credit Institutions ....................................................................................................................................................................... 81
8.2 Investment Firms ....................................................................................................................................................................... 82
8.3 Stress Tests ............................................................................................................................................................................... 83
8.4 Future Developments ................................................................................................................................................................. 83
9 Other Measures and Proposals...................................................................................................................................... 84
9.1 Prudential Measures .................................................................................................................................................................. 85
9.2 Conduct Measures ..................................................................................................................................................................... 86
9.3 The European Green Deal ......................................................................................................................................................... 87
9.4 Other Developments .................................................................................................................................................................. 88
10 Legislation and Materials .............................................................................................................................................. 89
10.1 Table 1 International Materials ................................................................................................................................................. 90
10.2 Table 2 EU Regulations ........................................................................................................................................................... 91
10.3 Table 3 EU Directives .............................................................................................................................................................. 92
10.4 Table 4 European Commission Materials ................................................................................................................................ 93
10.5 Table 5 Other Legislation and Materials .................................................................................................................................. 94
10.6 Table 6 ESA Materials ............................................................................................................................................................. 95
2Acronyms
BMR Benchmark Regulation
CBR Climate Benchmarks Regulation
CTB Climate Transition Benchmark
CRD IV Fourth Capital Requirements Directive
CRD V Fifth Capital Requirements Directive
CRR Capital Requirements Regulation
CRR II Second Capital Requirements Regulation
EBA European Banking Authority
EIOPA European Insurance and Occupational Pensions Authority
ESA European Supervisory Authorities
ESAO European Supervisory Authorities Omnibus Regulation
ESG Environmental, Social and Governance Factors
ESMA European Securities and Markets Authority
ESRB European Systemic Risk Board
FSB Financial Stability Board
IBIP Insurance-Based Investment Product
IDD Second Insurance Distribution Directive
IFD Investment Firms Directive
IFR Investment Firms Regulation
IORP II Second Institutions for Occupational Retirement Provision Directive
ITS Implementing Technical Standards
NFRD Non-Financial Reporting Directive
PAB Paris-Aligned Benchmark
PEPP Pan-European Personal Pension Regulation
PRIIPs Packaged Retail & Insurance-Based Investment Products Regulation
RTS Regulatory Technical Standards
SDGs United Nations Sustainable Development Goals
SDR Sustainability Disclosure Regulation
SRD II Second Shareholder Rights Directive
TCFD Task Force on Climate Related Financial Disclosures
TEG Technical Expert Group
31 Overview
1.1 Introduction 5
1.2 Background 6
1.3 The Proliferation of ESG Standards 7
1.4 The ESG Regulations 8
1.5 Timeline – Key Compliance Dates 9
1.6 The Regulatory Framework 10
1.7 High-Level Overview 11
1.8 Practical Consequences for Investment Firms 12
1.9 Terminology 13
1.10 Future Developments 16
1.11 Delegated Legislation 17
41.1 Introduction
Environmental, Social and Governance’ (‘ESG’) considerations have hovered on the periphery of the public conscious
(and the minds of policy drivers and investment managers) for several decades. However, recently their importance has
taken centre stage with the convergence of several related developments, especially:
• A growth in support for Green political parties
• Enhanced social media coverage of ESG topics
• The adoption of ESG based investment strategies to mitigate risk and/ or achieve Alpha
• The emergence of visible evidence of global warming coupled with definitive scientific consensus on the topic
• Global warming-induced environmental catastrophes (e.g marine plastic pollution, wildfires, hurricanes, etc)
• Enhanced transparency of poor labor practices and governance failures, including through highly-profile leaks
• A predilection of a certain demographic for ethical investing (e.g millennials and Generation Z among others)
Many investment firms have sought to capitalise on the popularity of ESG investing that has accompanied the above
phenomena by providing differentiated ‘sustainable’ offerings that have enabled them to retain or even capture market
share, whilst at the same time burnishing (or greenwashing) their ‘Corporate Social Responsibility’ credentials.
This commercial scramble to capture market share in the ever-growing ESG investment segment has (further) fuelled a
proliferation of voluntary non-governmental standards that have filled the vacuum left by an absence of regulation. It has
also led to an entire ESG data and analytics industry springing up to service the needs of the investment community.
These latter developments have led to market fragmentation, opacity and a heterogeneity in quality between and among
the voluntrary standards and associated offerings, which has ultimately led to greenwashing, with investors left
bewildered as to how to distinguish between genuinely sustainable investments and mere marketing puff.
To overcome this fragementation, EU policy drivers have developed a single set of regulatory standards that require
investment firms to demonstrate the provenance of their ESG claims with robust data and analytic disclosures. The
disclosures are designed to facilitate meaningful comparisons between investments therby empowering investors to
make informed decisions, which it is hoped will translate into the channelling of private investment into legitimate
sustainable economic activities. The regulatory measures also seek to address the growing risks ESG factors pose to
investments (and investment firms), and the risks investments present to ESG factors.
This paper provides an introduction to this emerging set of rules, summarises the relevant regulations, sets out timings of
the various measures and provides analysis on how they are likely to impact the investment community serving the EU.
It is hoped that this paper will also be useful for international firms attempting to gauge the nature, magnitude and impact
of ESG regulatory trends emerging in other parts of the world, many of which are, or are expected to follow the regulatory
trail the EU is blazing through the ESG landscape.
51.2 Background
The EU’s nascent ESG regime can trace its origins in large part to the region’s commitment to the United Nations 2030
Agenda for Sustainable Development and, in particular, the 17 Sustainable Development Goals (SDGs) therein. These
official commitments are set out in several official EU-related policy papers and publications and are explicitly referenced
(as policy drivers) in the recitals to most of the ESG-related EU regulations outlined in this paper.
Of the SDGs, the goal of combatting climate change (SDG 13) has been identified by the EU political institutions as the
most pressing, following publication of Council Decision (EU) 2016/1841, which adopts the United Nations Paris Climate
Change Agreement. However, the EU has embraced all of the SDGs within its EU ESG regulatory framework (to varying
degrees), together with the following broader, objectives, which overlap with various aspects of the SDG objectives:
1. To channel investment towards sustainable activities, thereby transforming the economy in a way that benefits
the environment, individuals and society, and promotes good corporate governance. To achieve this objective
requires regulation defining and classifying sustainable and unsustainable activity to enable investors to identify
genuinely sustainable investments.
2. The first objective meets a secondary objective of inhibiting “greenwashing” whereby investors are misled into
investing in activities they believe are sustainable, which are, in fact, not. The risk of greenwashing occurring is
magnified when a multiplicity of voluntary, divergent standards with minimal formal oversight emerge that
confuse investors and allows investments with sub-standard ESG credentials to attract a misleading green
veneer. A single classification taxonomy and standardized set of climate benchmark rules should overcome this.
3. To achieve the above two objectives, disclosures are required that demonstrate the provenance of ESG claims
made and which set out the risks to a product or portfolio from ESG phenomena, and the risks a product or
portfolio presents to ESG factors (the so called ‘double materiality perspective).
4. Linked to the third objective is the aim of ensuring economic resilience in the face of ESG risks by requiring firms
to assess such exposures to the products they manufacture or distribute, the services they provide and also the
exposure of their own firm, through enhanced risk management rules and recalibrated prudential measures.
These four objectives set out the key drivers behind the new suite of measures. In many respects they have been
formulated to counterbalance the perceived excesses arising from the predominance of financial considerations that
govern the world of corporate strategy, corporate governance, finance and accounting. However, the ambitious suite of
new measures are unlikely to prevent profit retaining its primacy in this context, at least in the short term.
Nevertheless, over the longer term, should there be an increase in the type of climate catastrophes witnessed in recent
years or a linked fallout following the COVID-19 pandemic, Milton Friedman’s “shareholder value” centric western
capitalist hegemony may soon be supplanted by a multi-stakeholder approach to corporate governance. Whilst it may
sound somewhat hyperbolic, some commentators view the new ESG rules as the first step in this transition of the
modern western economic model.
For those wanting a 30,000-foot view of the regime before diving into the details in this paper, the European Commission
Factsheet on Sustainable Finance provides a useful pictorial guide to the key measures.
61.3 The Proliferation of ESG Standards
A proliferation of governmental, non-governmental, transnational, and commercial ESG measures over the last decade
has led to significant market fragmentation and an acute dissonance in methodologies and classifications, where a single
corporation can attract “sustainability” scores across the spectrum, from good to bad, depending on the system used.
Such a fragmented landscape serves as an ideal breeding ground for greenwashing; a phenomenon that is threatening
to undermine ESG-related political commitments and especially the goal of channeling private investment into genuinely
sustainable economic activities. Consequently, policy drivers are now seeking to harmonize measures through initiatives
such as the Network for Greening the Financial System (comprised of leading central banks and related institutions).
In the EU, policy drivers have concluded that the fragmentation of the current ecosystem is so problematic that only a
single set of harmonized EU ESG regulatory standards will be sufficient to protect investors, overcome greenwashing,
and achieve sustainability goals. This set of standards comprises the regime set out in this paper.
This regime will supplant in the EU an enourmous body of existing voluntary, cross-sectoral, non-governmental ESG-
related standards, the first of which - the Global Reporting Initiative (GRI) standards - were published in 1997. Other
examples include the Sustainable Accounting Standards Board’s (SASB) Standards and the Climate Disclosure
Standards Board Framework. The non-profit International Integrated Reporting Council have also developed a
Framework for non-financial reporting including ESG factors, and more recently the International Organization for
Standardization (ISO) has commenced developing several ESG / sustainability-related standards and has further drawn
together in a dedicated webpage over 3000 of its existing standards that contribute towards achieving the SDGs.
More recently, in 2017 the Financial Stability Board’s industry-led Task Force on Climate-Related Financial Disclosures
(TCFD) published voluntary recommendations for climate-related financial reporting (and in 2020 the Basel Committee
on Banking Standards (BCBS) announced their own task force, but with a slight different lens: focusing on climate-
related financial risk; fortunately, it has yet to supplement the super-abundance of existing standards with its own set).
Complementing the SDGs, the United Nations Environment Programme Finance Initiative (UNEP-FI) has also sponsored
Principles for Responsible Investment (PRI) and Principles for Responsible Banking (PRB) (the latter accompanied by a
Portfolio Impact Tool) - initiatives that encourage signatories to commit to various SDG and Paris Agreement aligned
practices. In late 2019, the UN also announced the SDG Impact Practice Standards for Private Equity Funds, which
provides a checklist for integrating SDG related impact investing into design and management of Private Equity funds.
Moreover, as the European Commission notes in its 2020 Non-Financial Reporting Directive Consultation Document,
there are even more frameworks and standards that focus on individual or narrower sets of (non-financial) ESG relevant
issues, such as the UN Guiding Principles Reporting Framework on human rights, the CDP questionnaires on carbon
disclosures, the Organization Environmental Footprint (OEF) Guidelines (as set out in Commission Reccomendation
2013/179/EU), reporting under the European Commission Eco-Management and Audit Scheme, and in the ‘Green
Finance’ arena, the International Capital Markets Associations’ (ICMA) Green Bond Principles, the Loan Market
Association’s (LMA) Green Loan Principles, and the LMA Sustainability Linked Loan Principles.
In addition to the above, a host of regulatory measures outside of the EU have also emerged over recent years, with one
study by the Institute of International Finance (the “IIF”) identifying over 2000 ESG regulatory developments since 2016,
with a trend of exponential growth. Moreover, a number of state ESG ‘labels’ and ‘schemes’ have emerged, which, in
Europe include the French Greenfin, Nordic Swan, LuxFLAG, and FNG Seal schemes, among others. Furthermore, the
European Commission’s Joint Research Centre Second Technical Report details several competing ESG taxonomy
frameworks. Together, all of the above developments are in addition to the abundance of overlapping commercial
measures on the market, including ESG ‘standards’, ‘scores’, and analytical ‘methodologies’.
71.4 The ESG Regulations
The object of this paper is to provide an overview of the entire EU ESG regulatory regime as it currently stands—as a
snapshot in time—since a definitive guide will not be possible until the entire suite of rules crystallizes, which is not
anticipated to occur anytime within the next decade. Instead, the idea is to give the reader a grounding in the basic
foundations, concepts and key rules and legislative texts that comprise the existing regime.
As with the broader EU financial regulatory landscape, the ESG regime uses the Lamfalussy Architecture, and as of Q1
2020, all but one of the main level 1 texts have been published in the EU’s Official Journal, each of which contain various
“application dates” phased in over the next one to five years.
Work on the level 2 documents started in earnest in 2020 and a steady stream will trickle out over the coming years with
the first batch expected in Q4 2020. These will in turn be supplemented by level 3 measures at various points in time.
In terms of level 1 ESG-related texts, the following have so far been published in the EU Official Journal:
• Directive (EU) 2014/95 NFRD The Non-Financial Reporting Directive
• Directive (EU) 2017/828 SRD II The Second Shareholder Rights Directive
• Regulation (EU) 2019/876 CRR II TheSecond Capital Requirements Regulation
• Regulation (EU) 2019/2088 SDR The Sustainability Disclosure Regulation
• Regulation (EU) 2019/2089 CBR The Climate Benchmarks Regulation
• Regulation (EU) 2019/2033 IFR The Investment Firms Regulation
• Directive (EU) 2019/2034 IFD The Investment Firms Directive
• Regulation (EU) 2019/2175 ESAO The "ESA Omnibus" Regulation
Some of the texts already apply (such as the NFRD and SRD II), while others will be phased in over the coming years.
Some of the texts are dedicated exclusively to ESG matters such as the CBR and SDR, whereas others are focused on
different issues, with ESG obligations comprising just a small part of a much broader suite of obligations. For instance,
the CRR II, IFD, and IFR principally concern the solvency of financial institutions and ESG considerations are just one of
many risk factors that need to be analyzed and mitigated within this broader context.
Of the “dedicated” ESG texts still to be published, the following are due for release imminently or within the next couple
of years:
• Pending Taxonomy Regulation On Sustainability Definitions and Requirements
• Proposed Green Bond Standard On Proposed Green Bond Labelling Measures
• Proposed Ecolabel Measures On an Ecolablel for Financial Services
At the time of writing, the pending Taxonomy Regulation had passed all relevant procedural hurdles and is only waiting
formal approval in the European Parliament before publication in the EU Official Journal. The text is expected to be
published in the Official Journal in early Q2, absent any last minute political obstacles.
Note, the focus of this paper is principally on regulatory measures impacting investment firms. For ESG-related
regulatory developments affecting the insurance sector, see the EIOPA Sustainability Webpage.
81.5 Timeline – Key Compliance Dates
Below are the key compliance dates for the main ESG-related rules. At present, a complete, definitive list of all commencement dates is not
possible, since, among other reasons, many are contingent on the publication of yet-to-be-drafted delegated legislation.
Note, the NFRD went live in 2017 with the first reports published in 2018.
91.6 The Regulatory Framework
The ESG regulations ultimately all stem from the European Council’s Sustainable Finance Policy, which sets out the
high-level policy ambitions of the EU’s political elite. This Policy is complemented by a suite of corresponding European
Commission Green Finance Initiatives, the most immediate of which is the Sustainable Finance Action Plan, which has
four key elements:
• The Pending Taxonomy Regulation
• The Sustainability Disclosure Regulation
• The Climate Benchmarks Regulation
• A Proposed Green Bond Standard
These measures constitute the principal “ESG” regulations that have recently been published in the EU’s Official Journal
or are shortly due to be. These measures are in turn complemented by several pre-existing legislative texts that while not
dedicated solely to ESG matters, nevertheless incorporate ESG-related obligations.
Specifically, the Second Shareholder Rights Directive (SRD II), which went live on June 10, 2019, introduces ESG
investment strategy, corporate engagement, and disclosure obligations on certain buy-side firms, while the Non-Financial
Reporting Directive (NFRD) has, since January 1, 2017, required large corporates—including in-scope financial services
firms—to publish annual ESG related disclosures.
In addition to these conduct-based rules, several ESG risk-related measures have been inserted into the EU’s prudential
regimes for credit institutions and investment firms.
This paper summarises each of of the measures outlined above in turn, together with related regultory developments.
101.7 High-Level Overview
In terms of the overall structure of the EU ESG regime, the Taxonomy Regulation and the NFRD can be seen to sit at the
centre, with the NFRD providing the raw ESG data (at least, from large EU corporates) and the taxonomy providing the
official ESG classifications and associated technical criteria.
Gravitating around these two core texts are several issue-specific ESG regulatory measures, most of which either rely
on, or are somehow linked to the Taxonomy Regulation and/ or the NFRD. The issue-specific topics include climate
indices (the CBR), financial risk management (the prudential measures), investor protection, risk analysis, disclosures
and marketing issues (the SDR and EU Ecolabel), investment strategies and corporate engagement (SRD II) and green
finance (the EU Green Bond Standard – ‘EU GBS’)).
From a buy-side perspective, it is tempting to see a linear progression to the application of these measures in practice,
starting with portfolio (and prudential) risk analyses based on the NFRD data, followed by disclosures (SDR/ EcoLabel)
and portfolio evaluation and performance measurement against climate benchmarks, which feed back into the
concluding part of the process: evaluation of the investment strategy and corporate engagement under SRD II.
Whilst superficially useful, this model belies the complexity of the measures, each of which overlap with various aspects
of the other legislative texts, whilst having their own standalone objectives, focus and even definitions. As such, it might
be more accurate to describe the landscape as a series of regimes. Nevertheles, in practice they are regarded as part of
one broader overarching initiative to weave sustainability into the fabric of the EU’s economic and financial landscape.
Taxonomy
Regulation
_______________
Non-Financial
Reporting Directive
111.8 Practical Consequences for Investment Firms
The regime can be broken down into several high-level key tasks that investment firms will have to integrate into their
existing processes. The tasks start with data collection, which must be analysed to calculate the risks ESG factors pose
to a portfolio (and to the firm from a prudential perspective), and in turn, to evaluate the risks a portfolio poses to ESG
factors. Suitable ESG-related (and regime-compliant) indices should be selected for portfolio analysis, performance
benchmarking, reporting, and disclosures especially for products promoted on their ESG credentials.
The data collected and analysis undertaken must also inform a broad set of disclosures and also the firm’s investment
strategies and engagement activity, which, in addition to financial considerations, must factor in the long-term interests of
investors together with the interests of a broad set of other stakeholders. Firms must also report on their engagement
activity (including and especially proxy voting), which should align with clients’ long-term strategic objectives.
1.
Data
Collection
5. 2.
Corporate Risk & Performance
Engagement Analytics
4. 3.
Strategy Reporting
Formulation & Disclosures
Outside of the portfolio management cycle, large investment firms will also need to report on the ESG impact of their
firm’s operations for the purposes of the NFRD. Furthermore, new prudential rules will require firms to analyze their
balance sheet and exposures—not just client portfolios—to ensure they are adequately protected from ESG risk in the
same way that they need to mitigate market, credit, liquidity and other operational risks.
In practical terms, investment firms will need to procure new datasets and analytical capabilities, establish new reporting
processes and reformulate policies, procedures, systems and controls to accommodate the integration of these new
requirements. Given the phased-in nature of the measures, this will be a multi-year, ongoing process that should have
already commenced and which will need to ramp-up rapidly in the coming years as more and more measures enter into
force. For firms with existing ESG business, regulatory change management processes will need to be engaged to adapt
and expand existing arrangements to meet the requirements of the new regime.
Finally, it is worth nothing that the changes are not likely be confined to operational matters: with ESG funds starting to
outperform the market (at least at the time of writing), those firms that rely on an ESG based strategy to achieve alpha
will need to stretch their existing capabilities as the rest of the market is forced by the regulation to catch up with them in
terms of intergration of new ESG datasets, analytics and reporting capabilities.
121.9 Terminology
Before exploring the regulations in detail, the inconsistent use and conflation of the terms “ESG” and “Sustainability”
need to be addressed.
Historically, and in a narrow sense today, the terms “sustainable” and “sustainability” were/ are used to describe
practices that have a neutral or positive environmental impact and which do not further deplete scarce natural resources.
However, a broader sense of the term has also emerged over recent years that expands the concept to cover non-
environmental matters such as the impact of corporate practices (and corporate governance arrangements) on
individuals, communities, societies, and vulnerable groups.
It is this broader sense of “sustainability” that is employed in the regulatory texts and in a way that is synonymous with
the term “ESG factors.” Indeed, these terms are used interchangeably throughout the texts, but not always consistently.
The following section explores these inconsistencies to avoid confusion arising later.
1.9.1 The Pending Taxonomy Regulation
The pending “Regulation of the European Parliament and of the Council on the Establishment of a Framework to
Facilitate Sustainable Investment” refered to as the “Taxonomy Regulation”, establishes a clasiification system to define
“economic activities” that may be classified as “environmentally sustainable,” to enable the identification of
“environmentally sustainable investments.”
Whilst the term ‘sustainability’ is used rather than ‘ESG’, Recital 2 makes it clear that the terms are largely synonyms,
stating that the ‘three dimensions of sustainability[are]: economic, social and environmental'.
Moreover, to be classified as “environmentally sustainable,” an “economic activity” must comply with an extensive suite
of social and governance “safeguards” set out in Article 18, which cross-references Article 2(17) of the Sustainability
Disclosure Regulation (SDR), and specifically the “do no harm” to other related objectives principle contained therein,
which has the effect of reinforcing the link between the terms “sustainability” and “ESG”.
1.9.2 The Climate Benchmark Regulation
The CBR is formally entitled ‘Regulation (EU) 2019/2089 of the European Parliament and Council of 27 November 2019
on amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks
and sustainability-related disclosures for benchmarks’. Whilst the term ‘sustainability’ appears in the title of the
Regulation and throughout the text, there are also numerous references to ‘ESG’ in a manner synonymous with the term
sustainability. Once again, the two terms are used synonymously within the same text, albeit without an explicit indication
that this is the case.
131.9.3 The Disclosure Regulation
As its title suggests, “Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019
on sustainability‐related disclosures in the financial services sector” opts for the term “sustainability” over “ESG.”
However, while not defined, the constituent components of ESG—social, environmental, and governance—are used
throughout, on a standalone basis, in conjunction with each other, and critically within the three sustainability definitions
in the text. In several places, the umbrella term “environmental, social, and governance” (though not the acronym ESG)
is also used. Moreover, the regulation cross-references, and is cross-referenced, by other ESG legislative texts that use
both terms synonymously and interchangeably.
1.9.4. The Non-financial Reporting Directive
As neatly summarized in the European Commission Consultation Document on Directive (EU) 2014/95 (the “NFRD”):
“The NFRD identifies four sustainability issues (environment, social and employee issues, human rights, and bribery and
corruption).” This definition diverges from the definitions and terms used in the other regulatory texts, but in practice is
likely to be regarded as equivalent. This position is supported by the Background Document to the NFRD consultion,
which makes an explicit link between the data published under the NFRD and the obligations of financial services firms
under the Sustainability Disclosure Regulation.
1.9.5. Green
While the term “Green” is used in numerous ESG-related EU initiatives such as the European Green Deal and the
proposals for a European Green Bond Standard, (the latter of which originates from the same suite of initiatives as the
Disclosure Regulation), Green is not formally used in any of the existing ESG-related legislative texts. In the European
Green Deal and related materials, green generally refers to products and practices that have a net neutral or positive
environmental impact and as such the term is broadly equivalent to how the term “environmental” is used in the
Disclosure Regulation.
The term “Green” is also used in Section 2 of the Commission’s Sustainable Financing Action Plan and also in the
Technical Expert Group EU Green Bond Standard Report, published in response to the Action Plan (and in the later TEG
EU Green Bond Standard - Usability Guide). In the Report, the TEG proposes a definition of “Green Bonds,” which in
turn is dependent on the definition of “Green Projects,” which are defined as projects that i) contribute substantially to at
least one of the six Environmental Objectives in the pending Taxonomy Regulation, while (ii) not significantly harming
any of the other objectives therein, and (iii) complying with minimum social safeguards. The report further notes that the
taxonomy “will provide detailed guidance to issuers and investors on green metrics and eligibility.”
1.9.6. Socially Responsible Investing
“Socially Responsible Investing” or “SRI” is another term used by the industry as a synonym for ESG and sustainability
from an investing perspective. However, whereas the object of ESG investing could be to have a neutral or a positive
outcome on specified measures, SRI is seen as aimed at having more than a neutral impact.
141.9.7. Impact Investing
Finally, “impact investing” (another synonym for ESG) is more typically used for measures that go beyond mere ESG and
even SRI investing to achieve specific ethical outcomes as further explained in the SDG Impact Practice Standards for
Private Equity Funds for instance. The United Nations Positive Impact Initiative (PII) is a sub-initiative within the broader
United Nations Environment Programme Finance Initiative (UNEP-FI), and focuses on impact investing as a means to
finance the UN’s SDGs, as summarised in its dedicated webpage that is accompanied by several tools to assist banks in
analysing how their portfolio of consumer and commercial loans contribute to the SDGs.
1.9.8 Conclusion
While not set out expressly, it appears that sustainability and ESG factors are used as synonyms within the various ESG-
related EU regulatory texts, while the term “Green” is used broadly as a synonym for the E in ESG. However, there are
subtleties in certain places in the texts, especially in relation to the three “sustainability-related” terms in the Disclosure
Regulation, which require specific attention.
For those who are still struggling with the concepts outlined in this section, the Background Section of the EBA’s Action
Plan on Sustainable Finance provides a useful potted overview of the terms used in plain accessible language, while
EIOPA’s Opinion on IORP supervision and ESG risks references the useful ESG definitions provided in the UN
Principles for Responsible Investment (as endorsed in Recital 58 of IORP II).
In this paper, the specific term used in the text under discussion will be used. For general references to the broader
concept, the term ESG rather than sustainability will be used.
151.10 Future Developments
The taxonomy is designed to expand overtime, targeting more and more sectors (‘economic activities’) with detailed,
science-based analysis to inform the discipline of identifying sustainable activities or, conversely, those activities that
present risks to ESG factors.
There are also several other prudential, disclosure, risk, advice-related, and portfolio management-related rules under
consideration within the EU, including proposals focused on mitigating the impacts of short-termism on corporates and
measures on integrating sustainability considerations into suitability assessments. These are summarised in Section 9 of
this paper.
At the end of 2019, a European Commission Communication set out the European Green Deal that lays out a further
suite of economic and social policies strategically centered around a core of environmental initiatives that commit the EU
to the following (as summarized in the EU Green Deal Factsheet):
1. To become climate-neutral by 2050
2. To protect human life, animals, and plants by cutting pollution
3. To help companies become world leaders in clean products and technologies
4. To help ensure a just and inclusive transition
These broad policy objectives will be transformed into more granular black-letter law in due course. In the meantime, the
European Commission’s 2020 Work Programme, its proposed Climate Neutrality Regulation, ESMA’s recent Sustainable
Finance Strategy, and the EBA’s Action Plan on Sustainable Finance have all placed ESG considerations at the core of
their current agenda.
ESG measures also continue to proliferate in other non-EU jurisdictions, albeit in a much less systematic fashion.
Meanwhile, at the internaltional level, the trend towards integrating ESG factors into financial regulation continues to gain
momentum. Together, these developments mean that the standard categorization of financial regulatory measures, as
set out below, is likely to need modification:
1. Prudential Rules
2. Conduct Rules
3. Financial Crime Rules; or
4. Payments or Market Structure Rules
It is anticipated by many that the current pipeline of regulations and proposed initiatives may lead to ESG becoming the
fifth pillar of financial regulation.
161.11 Delegated Legislation
As set out in the rest of this paper, the EU is currently only at the stage of publishing (Lamfalussy Architecture) level 1
framework legislative texts that establish the key principles of the regime.
The practical details will be fleshed out at level 2 through delegated legislation and by way of level 3 materials such as
European Supervisory Authority (ESA) guidelines, as mandated by various provisions of the level 1 texts.
For ease of reference, these measures and provisions are set out at the beginning of this paper, in the tables below.
Table 1 The Taxonomy Regulation
Reference Article Description of Delegated Act Commission Adoption Deadline
Article 8(4) Specificities of NFRD Taxonomy Related Disclosures Jun 01, 2021
10 (3), 19, and 23 Technical Screening Criteria for Environmental Objective 1 Dec 31, 2020
11 (3), 19, and 23 Technical Screening Criteria for Environmental Objective 2 Dec 31, 2020
12 (2), 19, and 23 Technical Screening Criteria for Environmental Objective 3 Dec 31, 2021
13 (2), 19, and 23 Technical Screening Criteria for Environmental Objective 4 Dec 31, 2021
14 (2), 19, and 23 Technical Screening Criteria for Environmental Objective 5 Dec 31, 2021
15 (2), 19, and 23 Technical Screening Criteria for Environmental Objective 6 Dec 31, 2021
The Articles 10(3) to 15(2) Delegated Acts are to apply a year after Commission adoption.
17Table 2 The Sustainability Disclosure Regulation
SDR Commission
Reference Description of Delegated Measures Submission
Article Deadline
RTS on the presentation and content of information on the principle of “do not significantly
Article 2a Dec 30, 2020
harm” in Article 2(17). (Article 2a Inserted by pending Taxonomy Regulation)
RTS on the methodologies and information on sustainability indicators in relation to adverse
Article 4(6) Dec 30, 2020
impacts on climate and other environment‐related adverse impacts.
RTS on methodologies and information on sustainability indicators in relation to adverse
Article 4(7) impacts in the field of social and employee matters, respect for human rights, anti‐corruption, Dec 30, 2021
and anti‐bribery matters.
RTS on the presentation and content of social and environmental related pre-contractual
Article 8(3) Dec 30, 2020
disclosures.
RTS specifying details of the presentation and content of Article8 (2a) information. For June 1, 2021 /
Article 8(4) Environmental Objectives 1 and 2, the submission deadline is June 1, 2021, and for the other
objectives the deadline is a year later. (Inserted by pending Taxonomy Regulation) June 1, 2022
RTS on the presentation and content of sustainable investment related pre-contractual
Article 9(5) Dec 30, 2020
disclosures.
RTS on the presentation and content of information referred to in Article 9 (2a). For June 1, 2021 /
Article 9(6) Environmental Objectives 1 and 2, the submission deadline is June 1, 2021, for the other
objectives it is a year later. (Inserted by pending Taxonomy Regulation) June 1, 2022
RTS on the presentation and content of disclosures relating to the environmental or social
Article 10(2) Dec 30, 2020
characteristics of products and of sustainable investments to be disclosed on websites.
RTS on the information relating to environmental or social characteristics and of sustainable
Article 11(4) Dec 30, 2020
investments to be disclosed in periodic reports.
RTS on the details of the presentation and content of the information referred to in Article
11(1)(c) and (d). For environmental objectives 1 and 2, the submission deadline is June 1, June 1, 2021 /
Article 11(5)
2021, for the other objectives it is one year later. (Inserted by the pending Taxonomy June 1, 2022
Regulation)
ITS on the standard presentation of information on the promotion of environmental or social
Article 13(2) Optional
characteristics and sustainable investments in marketing communications.
EIOPA Guidelines specifying how investment decisions and risk assessments by IORPs
Recital 25 Not Specified
must consider ESG risks under Directive (EU) 2016/2341.
18Table 3 The Climate Benchmarks Regulation
BMR Reference
Articles Description of Delegated Measures Commission Adoption Deadline
Delegated Act on content and format requirements for the
13(2a) descriptions of the key elements of the benchmark methodology in None Specified
Article 13(1) and how they reflect ESG factors.
Delegated Act on CTB and PAB selection criteria and methodology
19a (2) None Specified
requirements.
Delegated Act on sectors excluded from Paris-Aligned Benchmarks
that do not have measurable carbon emission reduction targets with
19c (1) January 01, 2021
specific deadlines aligned with the objectives of the Paris
Agreement.
Delegated Act on content and format requirements of ESG factors
27 (2b) None Specified
within Benchmark Statements.
Table 4 Prudential Regulation – Delegated Materials
Commission Submission
Articles Description
Deadline
CRR II EBA to develop implementing technical standards for CRR II Part 8
Jun 28, 2020
Article 434a Disclosures, including CRR II Article 449a ESG Risks.
CRD IV EBA Report and, where appropriate, guidelines on the inclusion of ESG
risks in the supervisory review and evaluation process (Requirement Jun 28, 2021
Article 98(8) Inserted by CRD V).
EBA Report on exposures to ESG risks, and where appropriate, Guidelines
Investment
introducing ESG risk criteria for the supervisory review and evaluation Dec 26, 2021
Firms Directive
process.
192 The Taxonomy Regulation
2.1 Introduction 21
2.2 The Taxonomy Framework 23
2.3 The Environmental Objectives 25
2.4 Significant Harm to The Environmental Objectives 31
2.5 Minimum Social and Governance Safeguards 32
2.6 Technical Screening Criteria 33
2.7 Legislative Reviews 35
202.1 Introduction
2.1.1 Background
On April 16, 2020, the European Council published the latest version of a regulation on “the establishment of a
framework to facilitate sustainable investment, amending Regulation 2019/2088” otherwise known as the “Taxonomy
Regulation” (or “Green List” as the Commission Taxonomy Q&A also refers to it).
The pending Taxonomy Regulation is driven by the EU’s commitment to become climate neutral by 2050 and achieve
the United Nations’ Paris Agreement's 2030 targets. To meet these commitments will require enormous funding, which
the public sector cannot achieve on its own, with the European Commission currently calculating an annual funding gap
of around €180 billion a year.
The pending taxonomy is designed to plug this gap by enabling investors to identify and re-orient their investments
towards more sustainable businesses. The taxonomy is a unified classification system designed to identify “economic
activities” that can genuinely be classified as “environmentally sustainable” on a measurable and empirical basis. The
system will replace the existing panoply of market-based and non-governmental initiatives and national arrangements
that together confound investors and prevent meaningful comparisons between products, thereby ultimately facilitating
greenwashing and deterring sustainable investment.
More formally, Article 1(1) of the pending regulation states that the purpose of the taxonomy is to establish “the criteria
for determining whether an economic activity qualifies as environmentally sustainable for the purposes of establishing the
degree to which an investment is environmentally sustainable.”
Rather than a standalone initiative, the taxonomy is designed to facilitate measures in several other EU ESG regulations
and initatives including the SDR (and by association the CBR - see Article 9(1) SDR for instance), the EU-Green Bond
Standard initative, the EU Ecolabel proposals for financial services, the NFRD, and several prudential measures.
Since the Taxonomy Regulation has yet to be published in the Official Jounral, references to its articles and recitals in
this paper are to those in the latest agreed text (at the time of writing). Given that it currently sits at the final stage of the
legislative process, the text references are not expected to change. Nevertheless, once the regulation is published in the
Official Journal, this paper will be updated, if necessary, to reflect any changes and communicated through the FactSet
Insight monthly regulatory update.
2.1.2 Level 2 Measures
The regulation will provide the Lamfalussy level 1 framework of the taxonomy, while level 2 Commission Delegated Acts
will plug in the details. The initial level 2 material will be drafted in accordance with the Technical Expert Group
Taxonomy Report of March 2020. The TEG report establishes technical screening criteria (for the first 2 of 6 key
environmental objectives within the text) through which to determine the environmental sustainability of an economic
activity. The report also contains recommendations on the overarching design of the taxonomy, as well as guidance on
how users can develop related disclosures. The report is supplemented by a Technical Annex containing a full list of the
screening criteria and methodologies for assessments of 'significant harm to other environmental objectives’. Finally, the
report is supplemented by xls tools that the industry can use to help integrate the measures into their processes.
The Commission will in future be assisted in developing the level 2 materials by an expert panel called the ‘Platform on
Sustainable Finance’ and a ‘Member State Expert Group on Sustainable Finance’, with the Platform essentially taking
takeover from the TEG, once the latter’s mandate expires in September 2020.
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