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To achieve the goals set by the European Green Deal (Green Deal), the European Union is producing an increasing number of ESG-related regulations. It is becoming difficult to navigate the ESG legal landscape, which is now almost as complex as financial legislation. This makes sense, as the main objective of the Green Deal is to address both aspects together in order to implement a " new growth strategy aimed(at) transforming the EU into a fair and prosperous society, with a modern, resource-efficient and competitive economy " (European Commission Communication - The European Green Deal). This roadmap is part of the 2015 Paris Agreement ratified by the EU, which aims to limit global warming to below 2°C compared to pre-industrial levels.
The Corporate Sustainability Reporting Directive (CSRD) is one of the main instruments for implementing this strategy, as it sets high standards for sustainability reporting, allowing companies to be compared on their ESG performance in addition to their financial performance. But how does the CSRD fit in with other ESG regulations such as the CSDDD, the European Climate Law, or the SFDR?
This article explains how the CSRD is linked to the following regulations:
- European Climate Law
- SFDR
- Pillar 3
- Benchmarks Regulation
- Sustainable Taxonomy
- CSDDD
The European Climate Law: the cornerstone of the Green Deal
The European Climate Law is a regulation adopted in 2019 with the primary goal of establishing a “binding climate neutrality objective in the Union by 2050” (Article 1, §2 of the European Climate Law). It is therefore a particularly significant text for the European Union in its sustainable development strategy.
To achieve this goal, several levers have been identified, such as:
- The contribution of all economic sectors
- The transition to a safe, sustainable, affordable, and secure energy system
- Digital transformation, technological innovation, and research and development
- Carbon sinks, particularly in the agriculture, forestry, and land-use sectors
The European Union and its Member States encourage (or mandate) economic actors to contribute both through their regulatory framework and through environmentally sustainable investments. The CSRD is part of this regulatory framework, as it requires companies to disclose information regarding their climate strategy.
The ESRS are directly linked to the European Climate Law, given that ESRS 2 stipulates that companies must include in their report“a table of all data points that derive from other EU legislative acts (including the European Climate Law) specifying where they appear in the sustainability statement and including those it considers, after assessment, to be immaterial, in which case it should indicate "immaterial" in the table” (ESRS 2, IRO-2, §56).
Two data points from the European Climate Law are mapped in Appendix B of ESRS 2:
- ESRS E1-1 (§14) Transition plan for climate change mitigation
- ESRS E1-7 (§ 56) GHG removals and carbon credits
Its link to sustainable finance legislation
The SFDR, the Pillar 3 regulation, and the Benchmarks Regulation are three pieces of legislation that all concern the financial sector and have different objectives. In addition to the European Climate Law, these are the three other pieces of legislation mapped to the ESRS and included in the requirements for the table of data points derived from other EU legislative acts (disclosure requirement IRO-2).
1 - The SFDR
The Sustainable Finance Disclosure Regulation (SFDR) “establishes harmonized rules for financial market participants and financial advisers regarding transparency with regard to the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes, as well as the provision of sustainability-related information with regard to financial products” (Article 1).
This regulation establishes three types of funds for which financial market participants must disclose specific information in their pre-contractual disclosures:
- “Article 6” funds that do not promote specific sustainable objectives
- “Article 8” funds that promote environmental or social characteristics
- “Article 9” funds that are considered sustainable investments
Under the SFDR, market participants must publish information on how their financial products take into account principal adverse impacts on sustainability. To this end, the Commission published a delegated regulation in 2022 that defines certain indicators that market participants must consider when estimating the principal adverse sustainability impacts related to the companies in which their products aim to invest.
These indicators include environmental and social metrics that are often mandatory under the CSRD (see ESRS 2 mapping, Appendix B). Consequently, the table of SFDR-related data points that companies will disclose under ESRS 2 IRO-2, as mentioned previously, will be particularly useful for market participants to collect the information needed to calculate the adverse impacts of their investments.
2 - The Pillar 3 Regulation
The Pillar 3 Regulation establishes prudential requirements for institutions, financial holding companies, and mixed financial holding companies. Prudential requirements aim to make the financial sector more stable, while ensuring it is able to support households, businesses, and other end-users of financial services.
These prudential requirements are very broad. They include the disclosure of environmental, social, and governance risks for institutions that have issued shares admitted to trading on a regulated market of a Member State. Given that these institutions are often subject to the CSRD, the related disclosures are mapped in Appendix B of ESRS 2. Most of these requirements are linked to ESRS E1 on climate change.
For related data points, institutions that must meet disclosure requirements for their environmental, social, and governance risks in accordance with the Pillar 3 Regulation have the option, in their CSRD sustainability report, to incorporate this information by reference to the Pillar 3 disclosures, provided they ensure that the consolidation scopes are the same for both reports.
3 - The Benchmarks Regulation
The Benchmarks Regulation “establishes a common framework to ensure the accuracy and integrity of indices used as benchmarks in financial instruments and financial contracts, or to measure the performance of investment funds in the Union” (Article 1).
This regulation is linked to the CSRD given that administrators of financial benchmarks must explain how ESG factors are reflected in each of their indices or families of indices. For example, administrators of EU Climate Transition and EU Paris-aligned benchmarks are encouraged to increase the share of constituent issuers that set and publish greenhouse gas emission reduction targets in their indices.
The link between the European Climate Law and the Sustainable Taxonomy
The Sustainable Taxonomy (also known as the green taxonomy or EU taxonomy) establishes a classification system with clear definitions that determine what constitutes an environmentally sustainable activity with the goal of helping investors and companies make informed investment decisions.
Through technical criteria applicable to specific business sectors, it is possible to determine whether an activity contributes to one or more of the following environmental objectives:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems
To meet the requirements of the Sustainable Taxonomy Regulation, companies must disclose certain KPIs:
- The proportion of their turnover derived from products or services associated with economic activities that can be considered environmentally sustainable
- The proportion of their CapEx related to assets or processes associated with economic activities that can be considered environmentally sustainable
- The proportion of their OpEx related to assets or processes associated with economic activities that can be considered environmentally sustainable
Under ESRS 1, these taxonomy disclosure obligations must be included in the CSRD sustainability report in a separate section:
There are several other additional references to the sustainable taxonomy in the environmental ESRS. For example, disclosure requirement E1-1 (Transition plan for climate change mitigation) requires companies with taxonomy-eligible economic activities to disclose “an explanation of any targets or plans (CapEx, CapEx plans, OpEx) that the company has set to align its economic activities (revenue, CapEx, OpEx) with the criteria established in the regulation” on the taxonomy.
Furthermore, there is a link between the taxonomy and the SFDR. When a financial product invests in an economic activity that contributes to environmental objectives, information regarding taxonomy criteria must be included in pre-contractual disclosures.
Its links to the CSDDD and CSRD sustainability reporting
Its links to the CSDDD and CSRD sustainability reporting
Finally, the Corporate Sustainability Due Diligence Directive is the latest major ESG legislation adopted by the European Union. It applies only to very large companies, so its scope is more limited than that of the CSRD.
While the CSRD establishes an obligation to disclose information, the CSDDD establishes an obligation to take action through:
- the implementation of due diligence regarding risks related to human rights and the environment
- the adoption and implementation of a climate transition plan to ensure that the company is dedicating the necessary resources to align its business model and strategy with limiting global warming to 1.5°C and with the climate neutrality objective set by the European Climate Law
Sanctions are based on the companies' global turnover. The percentage will be defined by Member States and may reach a maximum of 5% of turnover. Furthermore, if due diligence obligations are not met and harm is caused to a natural or legal person, companies may be held civilly liable and required to pay damages.
Many people believe that the CSDDD establishes new disclosure requirements. However, “to avoid duplicating reporting obligations”, the CSDDD provides that the directive “should not introduce new reporting obligations in addition to those provided for by Directive 2013/34/EU (CSRD)”. Therefore, a company subject to both the CSRD and the CSDDD will need to disclose information on how it meets CSDDD requirements within its CSRD sustainability report.
Given that the ESRS were adopted before the CSDDD, they do not mention this legislation. Nevertheless, there are numerous disclosure requirements that are relevant for reporting on how companies implement the CSDDD. Regarding due diligence, section 4 of ESRS 1 is dedicated to this and establishes a mapping between essential due diligence elements and the disclosure requirements of ESRS 2 and, in some cases, those of the topical ESRS. Regarding climate objectives, the climate transition plan required by the CSDDD will be disclosed under disclosure requirement E1-1 (Transition plan for climate change mitigation).
In conclusion, the European Climate Law aims to accelerate the European Union's green transition while enabling it to profoundly transform its economy, notably by becoming a global leader in the green industry. By relying on increased transparency, the mobilization of private funds, and a European recovery plan, it aims to support companies in this transition while creating new economic opportunities and fostering the development of green jobs.