The new framework addresses information asymmetries: investors shall have access to more and better information, allowing them to understand and evaluate the environmental and social sustainability of their investments.
Harmonized disclosure framework is introduced both for product-specific disclosure to investors as well as general disclosure to the public. Special labels (e.g. the EU ECO label) will be introduced. These measures together aim at re-channeling capital flow towards sustainable investments.
Sustainability as an Incentive
The new regime does not establish an obligation to conduct business in a sustainable manner. It does however create strong incentives to do so.
The Taxonomy Regulation sets the criteria for determining if and to what extent an economic activity qualifies as environmentally sustainable. The aim is to prevent the distribution of a financial product as environmentally friendly where such product does not meet environmental standards (greenwashing).
The European Union and its Member States will determine the areas of law to which the qualification of economic sustainability under the Taxonomy Regulation shall apply. Currently, this will be the upcoming EU Green Bond Standard and the EU Eco Label. Financial products in line with the Taxonomy Regulation will also qualify as sustainable investments under Art. 9 Disclosure Regulation.
The new framework will not provide for one single uniform definition of sustainability but for different levels. While the Taxonomy Regulation addresses environmental sustainability, only, the Disclosure Regulation deals with both environmental and social sustainability. The latter applies to sustainable and non-sustainable financial products, addressing different levels of sustainability.
“Sustainability risk” measures the probability of a loss on an investment – it does not measure whether an economic activity is actually "green" or "social". Global warming, for example, is a sustainability risk for the agricultural industry where a lower yield is expected as a result of climate change-related droughts. If a farm grows plants in a sustainable manner, that is a completely different question.
Under the Taxonomy Regulation, an economic activity shall qualify as environmentally sustainable where that economic activity contributes substantially to one or more of the environmental objectives, does not significantly harm any of the environmental objectives, is carried out in compliance with the minimum safeguards, and complies with technical screening criteria.
The following environmental objectives have been identified by the Taxonomy Regulation:
- climate change mitigation
- climate change adaptation
- the sustainable use and protection of water and marine resources
- the transition to a circular economy
- pollution prevention and control
- the protection and restoration of biodiversity and ecosystems.
The Taxonomy Regulation prevents greenwashing by setting not only qualitative but also quantitative criteria. It also provides minimum safeguards.
The Disclosure Regulation (Sustainable Finance Disclosure Regulation – SFDR) addresses the financial industry, including the insurance sector. It applies to financial market participants and financial advisors when distributing financial products. Its aim is not to cover all kinds of financial instruments and all forms of distribution. Unlike the Taxonomy Regulation, the Disclosure Regulation does also not apply to industrial firms.
Under the Disclosure Regulation, a complex regime of disclosure obligations is established. Disclosure requirements apply both at the product level and at the company level. At company level, disclosure is usually uploaded on the company’s website. For product disclosure, pre-contractual information is used. Disclosure requirements will cover, e.g., sustainability risk policies, adverse sustainability impacts, and remuneration policies.
The Disclosure Regulation applies to sustainable and non-sustainable financial products, establishing different categories: products that only promote environmental or social characteristics (Art. 8 Disclosure Regulation), sustainable investments (Art. 9 Disclosure Regulation), and other financial products.
The impact of the Disclosure and Taxonomy Regulation must not be underestimated. The new sustainability framework will significantly influence not only the financial industry but also the real economy – across the whole value chain.
Since March 2021, the Disclosure Regulation applies with certain exceptions relating to provisions referring to the Taxonomy Regulation. Those rules and the Taxonomy Regulation will apply from 2022 for the environmental objectives of climate change mitigation and climate change adaptation. From 2023 onwards, the taxonomy regulation will fully apply.
The application of the RTS on the disclosure regulation have been further deferred to 1 January 2023. On 8 July 2021, the European Commission announced that all RTS relating to the Disclosure Regulation will be consolidated and only apply from 1 July 2022 onwards. On 25 November 2021, the European Commission further announced that the entry into force of those RTS shall be deferred to 1 January 2023. On those grounds, the European Commission clarified that disclosure requirements under Art. 4 Disclosure Regulation (if applicable) on principal adverse impacts (PAI) only need to be complied with by 30 June 2023, i.e. the first reference period under the regulatory technical standards will be 1 January 2022 to 31 December 2022.