Leaders, policy makers and legislators are increasingly relying on the role of entrepreneurs and investors to face global challenges, made even more impelling by COVID-19. At the same time, the private sector is experiencing a certain degree of legal uncertainty on how to carry on activities, following recent regulatory developments demanding compliance with ESG factors and sustainable standards.

EU sustainable finance

At the EU level, the COVID-19 outbreak has made even clearer that the scale of societal challenges is beyond the capacity of the public sector alone and that the private sector has a key role to play in meeting those commitments undertaken under the UN 2030 agenda and sustainable development goals, as well the Paris climate agreement.

In order to re-orient investments towards more sustainable technologies and businesses, with a long-term vision, the EU policy agenda put at its core the action plan on financing sustainable growth and the development of a renewed sustainable finance strategy.

Such action plan is the result of several recent initiatives set up by the European Commission, which initially established in December 2016 a High-level expert group on sustainable finance (HLEG). The HLEG published an interim report in July 2017 and delivered its final report in January 2018. The HLEG’s recommendations subsequently formed the basis of the action plan on sustainable finance adopted by the Commission in March 2018.

Shortly after, in July 2018, the Commission set up the Technical expert group (TEG) on sustainable finance - whose mandate has been recently extended until 30 September 2020 - with the objective to assist it notably “in the development of a unified classification system for sustainable economic activities, an EU green bond standard, methodologies for low-carbon indices, and metrics for climate-related disclosure”. On 9 March 2020, the TEG published its final report on EU taxonomy, a technical annex and excel tools to help users of the Taxonomy in implementing it in their own activities.

Alongside the action plan, the Commission announced on 11 December 2019 the European Green Deal and on 14 January 2020 the European green deal investment plan, with the goal to make Europe the first climate neutral continent by 2050. At least €1 trillion of sustainable investments will be mobilized over the next decade, in a transition to a climate-neutral, green, competitive, more inclusive and circular economy.

Under the EU action plan, the 3 main areas covered by the 10 actions are:

  1. Reorienting capital flows towards a more sustainable economy
  2. Mainstreaming sustainability into risk management
  3. Fostering transparency and long-termism

EU Regulation 2019/2088: mainstreaming sustainability into risk management

In dealing with the second area, specifically with action n. 7 (“Clarifying asset managers' and institutional investors' duties regarding sustainability”), on 27 November 2019 the EU Parliament and Council have adopted Regulation 2019/2088 “on sustainabilityrelated disclosures in the financial services sector, entered into force on 29 December 2019.

Under Article 2, the EU Regulation gives a first definition of asustainable investment, namely:

  1. “an investment in an economic activity that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy”; or
  2. an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or an investment in human capital or economically or socially disadvantaged communities”;

As a further condition, the sustainable investment shall not significantly harm any of the above-mentioned objectives and the investee companies shall follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance (“principle of do no significant harm”). Regulatory technical standards will be adopted by the EU Commission to specify the details of the content and presentation of the information in relation to such principle.

Furthermore, the EU Regulation provides financial market participants and financial advisers with specific transparency obligations. Under its Article 3, such recipients shall publish on their websites information about their policies on the integration of sustainability risks in, respectively, their investment decision‐making process or investment/insurance advice.

In this regard, the Regulation defines “sustainability risk” as “an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment”.

Moreover, under Article 4 financial market participants and financial advisers shall be transparent also on their adverse sustainability impacts at entity level. In particular, they shall publish weather or not they consider principal adverse impacts of investment decisions, or investment/insurance advice, on sustainability factors - or in case, the reason why they do not consider such impacts. It shall be noted that the consideration of such adverse sustainability impacts will become an obligation, from 30 June 2021, for those financial market participants (which alone or in-group) exceed on their balance sheet dates the criterion of the average number of 500 employees during the financial year.

At this purpose, the Regulation defines “sustainability factors” as “environmental, social and employee matters, respect for human rights, anticorruption and antibribery matters”.

By 30 December 2020, regulatory technical standards will be drafted on the content, methodologies and presentation of information referred to Article 4, in respect of the sustainability indicators in relation to adverse impacts on the climate and other environment‐related adverse impacts. Similar regulatory technical standards will be drafted by 30 December 2021 in the field of social and employee matters, respect for human rights, anti‐corruption and anti‐bribery matters.

Under Article 5, recipients shall be also transparent with respect to the remuneration policies, which shall include information on how those policies are consistent with the integration of sustainability risks, and shall publish such information on their websites.

On the side of precontractual disclosures, under Article 6 financial market participants and financial advisers shall include descriptions on the manner in which sustainability risks are integrated into investment decisions or investment/insurance advice; as well as on the results of the assessment of the likely impacts of sustainability risks on the returns of the financial products.

At financial product level, if it promotes environmental or social characteristics and/or has sustainable investment as its objective, Articles 8 and 9 respectively provides for precontractual disclosures obligations, in accordance with regulatory technical standards that will be drafted by 30 December 2020. Similarly, Article 7 mandates transparency on adverse sustainability impacts, but with entry into force postponed to 30 December 2022.

Articles 10 and 11 provide for specific obligations on transparency on websites and in periodic reports when financial markets make available financial products that, respectively, promotes environmental or social characteristics and/or have sustainable investment as objective.

In accordance with Article 13, any marketing communications of financial market participants and financial advisers shall not contradict the information disclosed pursuant to the Regulation.

Lastly, the Regulation shall apply from 10 March 2021, except for those articles applicable from 29 December 2019 regarding the adoption by the Commission of those specific regulatory technical standards necessary for the implementation of the Regulation. As a further derogation, Article 11(1) to (3), on periodic reports obligations, shall apply from 1 January 2022.

Regulation 2020/852: EU green taxonomy

In dealing with the first area of the action plan (“Reorienting capital flows towards a more sustainable economy”) and with action n.1 (“Establishing a clear and detailed EU taxonomy, a classification system for sustainable activities”), on 18 June 2020 the EU Parliament and Council have adopted Regulation 2020/852 “on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, entered into force on 12 July 2020.

The recipients of the regulation are financial market participants that make available environmentally sustainable financial products; those undertakings subject to the obligation to publish a non-financial statement or a consolidated non-financial statement pursuant to Directive 2013/34/EU.

In particular, EU Regulation 2020/852 establishes the criteria for determining whether an economic activity qualifies as environmentally sustainable for the purpose of establishing the degree to which an investment is environmentally sustainable. Under Article 3, an economic activity is environmentally sustainable if:

  1. contributes substantially to one or more of the environmental objectives;
  2. does not significantly harm any of the environmental objectives;
  3. is carried out in compliance with the minimum safeguards laid down in article 18 (see below);
  4. complies with technical screening criteria established by the EU Commission in accordance with Article 19.

The environmental objectives are:

  1. Climate change mitigation and adaptation
  2. Sustainable use and protection of water and marine resources
  3. Transition to a circular economy, including waste prevention and increasing the uptake of secondary raw materials
  4. Pollution prevention and control
  5. Protection and restoration of biodiversity and ecosystems
  6. Boosting green investments

The mechanism of “minimum safeguards” under Article 3 requires an environmentally sustainable investment to comply not only with environmental profiles but also with those essential principles explicitly recalled by Article 18. Indeed, by the term “minimum safeguards” the Regulation refers to those “procedures implemented by an undertaking that is carrying out an economic activity to ensure the alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights”. Moreover, when implementing such procedures, undertakings shall adhere to the “principle of do no significant harm”, as described above in the analysis of EU Regulation 2019/2088.

Furthermore, the Regulation provides for specific transparency rules in case of environmentally sustainable investments, supplementing and amending the above-mentioned EU Regulation 2019/2088on sustainabilityrelated disclosures in the financial services sector”.

In particular, Articles 5, 6 and 7 set specific transparency rules in order to inform on the environmentally sustainability of financial products. The information to be disclosed regards, for instance, the environmental objective pursued and how and to what extent the investments underlying the financial product are in economic activities that qualify as environmentally sustainable. Such information shall be included among those already mandatory under Regulation 2019/2088 in pre-contractual disclosures and periodic reports.

Article 8 set specific transparency rules for those undertakings subject to non financial reporting. These entities shall disclose on:

  1. the proportion of their turnover derived from products or services associated with economic activities that qualify as environmentally sustainable;
  2. the proportion of their capital expenditure and the proportion of their operating expenditure related to assets or processes associated with economic activities that qualify as environmentally sustainable.

The methodology, content and procedure of such disclosure will be further regulated by the EU Commission by 1 June 2021.

As specified in Article 19, the Regulation tasks the Commission with establishing, through delegated acts, the actual list of environmentally sustainable activities by defining technical screening criteria for each environmental objective.

Under Article 22, Member States shall lay down the rules on measures and penalties applicable to infringements of Articles 5, 6 and 7.

Lastly, the Regulation shall apply from 12 July 2020, except for those rules under Articles 4, 5, 6 and 7 and Article 8(1), (2) and (3) which shall apply from 1 January 2022 or 1 January 2023, depending on whether they relate to the environmentally objectives set out, respectively, in letter a) and b) or c), d), e) and f) of Article 9.

In other words, the taxonomy for climate change mitigation and climate change adaptation should be applied from 1 January 2022. For the four other environmental objectives, the taxonomy should be applied from 1 January 2023.

Further development of the EU taxonomy will take place via a new Platform on sustainable finance which is expected to be operating by autumn 2020 in accordance with Article 20 of the Regulation. The platform will be an advisory body composed of experts from the private and public sector and will advise the EU Commission on the technical screening criteria and sustainable finance more broadly. In addition, the platform will monitor and report on capital flows towards sustainable investments.

The Commission is also coordinating international efforts through its International platform on sustainable finance.

Upcoming: EU social taxonomy

As declared under EU Regulation 2020/852, further guidance is upcoming on “activities that contribute to other sustainability objectives, including social objectives”.

In particular, under its Article 26, it is provided that “by 31 December 2021, the Commission shall publish a report describing the provisions that would be required to extend the scope of this Regulation beyond environmentally sustainable economic activities and describing the provisions that would be required to cover […] other sustainability objectives, such as social objectives”.

The Pandemic has made even more urgent the establishing of a clear and detailed EU taxonomy and classification system for sustainable activities regarding the “S” of the well-known ESG factors. In this sense, EU Regulation 2020/852 represents a clear model that must inspire this process, indispensable for an economic recovery that rather than simply "build it back" is oriented towards "build it better" - in line with the global trend of a new “impact economy” (see i.e the recent open letter of the Fourth Sector Group).

In this regard, it will be also relevant to see the result of the consultation for a renewed sustainable finance strategy launched by the EU Commission on April 8 2020, and recently concluded on 15 July 2020, in a context of recovery from the impact of the COVID-19 outbreak.