The convergence of EU sustainable finance regulations

By Francesco Cavallini, Head of Sustainable Finance, Continental Europe

In this article, we examine the evolving landscape of sustainable finance regulations in the European Union (EU). We explore key directives such as the Sustainable Finance Disclosure Regulation (SFDR), Corporate Sustainability Reporting Directive  (CSRD) and Corporate Sustainability Due Diligence Directive (CSDDD), their interconnections, and their potential impact on the financial industry and businesses. Our goal is to provide a clear understanding of these complex regulations and their implications for various stakeholders.

Since 2014, the EU has been steadily developing a regulatory framework to promote sustainable finance and corporate responsibility. This evolution reflects growing political and social pressures to address climate change and other sustainability challenges. We’ll explore the following key regulations that are shaping this landscape and their potential impacts on the financial industry and businesses:

• Non-Financial Reporting Directive (NFRD)
• Sustainable Finance Disclosure Regulation (SFDR)
• European Taxonomy Regulation
• Corporate Sustainability Reporting Directive (CSRD)
• Corporate Sustainability Due Diligence Directive (CSDDD)

Sustainable finance regulations

1. Sustainable Finance Disclosure Regulation

SFDR’s purpose is mainly to improve transparency in the financial market regarding sustainability risks and their impacts.

Key requirements:

Financial market participants and advisors must disclose:

• If and how they integrate sustainability risks into investment decisions
• Any potential impacts of sustainability risks on investment returns
• How their products consider adverse sustainability impacts

SFDR will eventually help investors make more informed decisions about sustainable investments.

2. Corporate Sustainability Reporting Directive

The main purpose of CSRD is to enhance and standardise sustainability reporting by companies.

Key features:

• CSRD expands the scope of companies required to report compared to the NFRD (starting with large companies, eventually including SMEs)
• It introduces more detailed reporting requirements on environmental, social and governance (ESG) factors
• It mandates third-party auditing of reported information
• It requires digital, machine-readable reporting formats

Relationship with SFDR:

CSRD complements SFDR by ensuring that companies provide the data needed for financial market participants to meet their SFDR disclosure obligations. It’s therefore an essential step forward to complete the transparency requirements of limited partners (LPs).

3. Corporate Sustainability Due Diligence Directive

CSDDD’s goal is to ensure companies address human rights and environmental impacts in their operations and supply chains.

Key requirements:

• Companies must conduct human rights and environmental due diligence
• Companies must develop and implement a climate change transition plan
• Companies must engage with stakeholders and communicate publicly about due diligence efforts

Broader impact:

CSDDD extends the focus beyond just reporting, requiring companies to actively manage and mitigate their sustainability impacts.

The interconnected system

These regulations, built on the common language of the EU Taxonomy, create a comprehensive system affecting most economic activities in the EU:

1. CSRD ensures companies report detailed sustainability information
2. SFDR requires financial market participants to use this information in their disclosures and decision-making
3. CSDDD mandates that companies actively manage their sustainability impacts

This interconnected approach aims to:

• Increase transparency in corporate and financial markets
• Standardise disclosure rules across the EU
• Address information gaps between companies and stakeholders
• Redirect capital flows towards sustainable investments
• Manage financial risks related to sustainability issues

The future of sustainable finance in the EU

As these regulations take effect and evolve, we can expect several developments.

1. Refinement of regulations: Based on implementation experiences, regulators are likely to refine and adjust these directives over time
2. Expansion of scope: The regulatory framework may expand to cover additional aspects of sustainability or include more types of companies and financial products
3. Technological advancements: We may see rapid development in sustainability data management and reporting technologies to meet the new regulatory requirements
4. Market transformation: As sustainability becomes more integrated into financial decision-making, we could see significant shifts in capital allocation towards more sustainable companies and projects
5. Global influence: The EU’s approach may influence similar regulatory developments in other regions, potentially leading to more global alignment on sustainable finance standards

Conclusion

The convergence of SFDR, CSRD, CSDDD, and related regulations represents a shift in how sustainability is integrated into the European financial system and corporate governance. While the implementation of these regulations poses significant challenges, it also offers substantial opportunities for creating a more transparent, responsible and sustainable economic landscape.

For all stakeholders – from investors and companies to regulators and service providers – staying informed and proactive in addressing these new requirements will be crucial. As the sustainable finance landscape continues to evolve, those who can effectively navigate these changes will be well-positioned to thrive in the new regulatory environment and contribute to a more sustainable future.