ESG dreams come true
The ESG (Environmental, Social and Corporate Governance) agenda is moving dynamically up the regulatory, political and social framework.
It should be stressed that the creation of the ESG legal framework is a long-term process which naturally must be divided into several stages and involves constant collaboration between entities and demands continuous improvement of the adapted strategies due to the fluent modifications.
Bearing in mind the above, lessons to be learned from the past is that the regulatory framework should not be seen only as obligations imposed, but as an opportunity to ameliorate the company’s competitive advantage, especially taking into account Joe Biden’s declaration concerning the US rejoining of the Paris Agreement on the first day of his presidency which may have a significant impact on the trajectory of international competition for setting the sustainable development standards.
Therefore, after providing a general overview in our first publication on what the term sustainability actually means and refers to, we would like to provide general insight on the EU legal acts which have already had a significant impact on the day-to-day business reality of entrepreneurs.
It should be noted that there are few general “landmark” EU legal acts pertaining to sustainable development and providing the basis for the ESG-related operation of companies which should be distinguished:
1) the Non-Financial Reporting Directive (i.e. Directive 2014/95/EU amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups) aimed at imposing a non-financial reporting obligation,next to financial reporting, on particular entities,
2) the Disclosure Regulation (i.e. Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector) aimed at achieving more transparency on how financial market participants and advisers integrate and consider sustainability risks in their decision making or investment advice processes, and
3) the EU Taxonomy (i.e. Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088), i.e. the classification tool for activities considered as sustainable ("green") intended primarily for investors, companies and financial institutions to define environmental performance of economic activities across all sectors.
In this publication, we will focus on non-financial reporting (sometimes referred to as environment, social and governance (ESG) reporting) in accordance with the chronology of development of the aforementioned legal acts, whereby in the publications to come we will direct the attention towards two other regulations resulting from the European’s Commission’s Action Plan on Financing Sustainable Growth published in March 2018 subject to further development under the European Green Deal announced in December 2019 which defined a new set of ambitious goals to be achieved by the EU and is currently the driving force behind change.
First and foremost, market players started to acknowledge that non-financial factors are becoming the cornerstone of business decisions.
Since 2018, under the Non-Financial Reporting Directive, the EU law requires large undertakings which are public-interest entities with more than 500 employees to disclose non-financial information on the impact of their business activities, including but not limited to environmental or social matters (whereas, if companies do not have a policy on one of these areas, the non-financial statement should explain the reason behind such omission).
Hence, the Non-Financial Reporting Directive requires the aforementioned companies to disclose relevant non-financial information to provide investors and other stakeholders with a more complete picture of the impact of their business activities. The Non-Financial Reporting Directive is considered as a good starting point in providing a clearer picture of the company’s sustainability performance and plays a vital role in boosting action in the private sector.
Even though the companies and financial institutions are used to reporting on financial issues, non-financial reporting is still considered as not standardized enough to achieve comparable results. The development of standardized ESG reporting standards is the key to moving forward as it is crucial that the companies and financial institutions improve the disclosure of non-financial information and report consistent and verified data allowing the investors to make informed decisions. It will also help to prevent the risk of “greenwashing” which is considered as the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly (i.e. making people believe that the given entity is doing more to protect the environment than it really is).
It should be noted that under the European Green Deal, the European Commision committed to review the Non-Financial Reporting Directive as part of the strategy to strengthen the foundations for sustainable investment. There are two following objectives of such a review: (i) improving disclosure of climate and environmental data by companies to better inform investors about the sustainability of their investments, and (ii) to implement changes required under the Disclosure Regulation and the EU Taxonomy. The amendment to the Non-Financial Reporting Directive is expected to be adopted by the European Commision in the first quarter of 2021 after the appropriate feedback had already been gathered in this regard and public consultation is now closed.
Although non-financial reporting imposes obligations only on particular entities, it has a direct impact on other entrepreneurs. The leading economic players play a vital role in the moving forward of corporate sustainability and sustainable investing.
Leaving the regulatory environment aside, the change in the approach towards sustainability metrics is clearly visible among the actions of numerous market players. Global leaders in financial services are currently stressing that ESG-focused data is essential to understand a company’s growth potential and their investment decisions will be more and more ESG-driven.
In addition, we observe the increasing number of declarations of leading institutions in the capital markets concerning sustainable finance commitments to support global climate transition and inclusive growth strategies.
Taking all of the above into account, sustainability should no longer be perceived as an aspirational idea, but it is widely believed that it has rather evolved to be a long-term strategy aimed at value creation.
In this series of publications we navigate through topics related to sustainability as we believe that they are the basis for functioning in the world of tomorrow, not only business one. We will focus on practical aspects for business as we strongly believe that this multidimensional initiative of sustainable development takes on extremely practical and beneficial dimensions, including but not limited to better rates of return on invested capital or higher corporate income.