17.07.2024
In September 2023, an international team of scientists from the Stockholm Resilience Centre provided a detailed outline of planetary resilience by mapping out all nine boundary processes that regulate the stability and resilience of the Earth system[1]. From global warming to deforestation, the team had concluded that six of these boundaries have been transgressed, noting that irreversible environmental harm is imminent unless drastic measures are deployed into practice[2].
In light of these continuous ongoing revelations, as well as the visible deterrent effects that are evident in our current day to day lives, the discussion on Sustainable Finance is relevant, now more than ever.
Sustainable Finance places focus on Environmental, Social and Governance (ESG) factors when making investment decisions, leading to long-term investments in sustainable economic projects. It assesses a company’s business practices together with performance of various sustainability and ethical issues.
In turn, the shift towards sustainable finance and the framework of ESG has incentivised the European Union (EU) to place the environmental and social aspects of businesses at the forefront of its regulatory agenda.
This was discussed at length in Working Town's first annual ‘Terra’ conference on ESG, attended by Dr. Brandon Meli, Associate.
Legislation
Through its Green Deal initiative, the EU has introduced various high profile instruments with the intent to elevate sustainable reporting to the same level of criticality as traditional financial reporting.
High profile legislative instruments include the Sustainable Finance Disclosure Regulation (SFDR)[3], a transparency framework obliging financial market participants to disclose the sustainability of their investments to potential investors, as well as the Corporate Sustainability Reporting Directive (CSRD)[4] (Directive (EU) 2022/2464), effective from 5th January 2023.
In line with the principle of double materiality as originally introduced by the Non-Financial Reporting Directive (NFRD)[5], the CSRD obliges listed businesses to compile an annual comprehensive report detailing how their business affects sustainability and how sustainability issues affect their business and the business’ value chain.
In scope businesses are also required to compile a report on the due diligence processes in place in relation to sustainability, in line with the EU’s Corporate Sustainability Due Diligence Directive, and to disclose their sustainability risk strategies and the compatibility of their business model with the global warming targets of the Paris Agreement.
In relation to the enforcement and sanctions for non-compliance with the CSRD for in scope companies, whilst no sanctioning measures are stipulated, the CSRD provides that effective penalties and procedures related to infringements should be enacted by each Member State.
The European Sustainability Reporting Standards
The CSRD’s raison d'être of harmonising sustainability reporting across Member States is in accordance with the EU Sustainability Reporting Standards (ESRS)[6] that the European Financial Reporting Advisory Group (EFRAG) is devising.
The ESRS architecture envisages three layers of disclosures. The first set of ESRS, which were delivered as an initial draft to the European Commission on November 2022 and were adopted on July 2023, are sector agnostic, and include a comprehensive range of ESG issues, including the governance of business’ conduct and consumers, value chain workers and climate change pollution.
The second set of drafts, which are to be sector specific, and cover sectors such as, inter alia, oil and gas, agriculture, energy production, motor vehicle production and road transportation, are to be adopted in annual batches starting from June 2025.
The third set of drafts will be entity specific and will see the entities themselves making an informed judgment in responding to their particular circumstances.
These sector specific standards complement the sector agnostic disclosures by reducing the necessity of specific disclosures of unstructured entities.
Since the ESRS is mainly targeted for listed and large companies, as part of the EU’s SME Relief Package of September 2023[7], EFRAG are currently devising a voluntary standard for non-listed SMEs and micro companies, which standard being outside of the CSRD mandate, and aims to facilitate the SME’s transition to sustainable economy by providing a simple proportionate tool better suited for smaller companies which will provide guidance on the management of their sustainability matters whilst also reducing the burden of various uncoordinated data requests.
Whilst Member States had until 6th July 2024 to transpose the CSRD provisions into national law, the new reporting requirements will be phased in over time.
Malta’s Position
From a Maltese perspective, whilst the CSRD’s transposition deadline was not reached, there is currently a good working draft, with proposed amendments expected to be implemented to the Maltese Companies Act as well. The draft will follow the usual consultation process and the parliamentary procedure soon after.
Due to the wider scope application of the CSRD, the sector based competent bodies will also be tasked with oversight of the applicability of CSRD in the relevant sector. The Malta Financial Services Authority (MFSA) will be in charge of large licenced and regulated entities, the Malta Gaming Authority (MGA) will be in charge of large gaming companies, the Accountancy Board will be in charge of accounting firms, whilst other companies will be falling under the remit of the Malta Business Registry (MBR).
Funding Opportunities
Due to various climate financing challenges, including the mainstreaming of carbon markets, project origination barriers and the world financing gap, the United Nations Framework Convention on Climate Change (UNFCCC)[8] establishes various financial mechanisms aimed at providing climate financing opportunities, such as the Green Climate Fund (GCF)[9] and the Global Environment Facility (GEF)[10].
The GCF is the world’s largest climate fund, established to assist developing countries realise their Nationally Determined Contributions (NDC) ambitions towards low-emissions, climate-resilient pathways, by providing money in the form of grants, as well as various guarantees.
The GEF comprises a multilateral family of funds targeted at developing countries and is dedicated to combating biodiversity loss, climate change and the protection of land and ocean health.
In addition to providing guidance to the GEF and the GCF, Parties to the UNFCC have set up two special funds—the Special Climate Change Fund (SCCF)[11] and the Least Developed Countries Fund (LDCF)[12], both managed by the GEF—as well as the Adaptation Fund (AF)[13], established under the Kyoto Protocol[14], which finances climate change adaptation activities in developing countries.
On a local level, the recently launched fund by Malta Enterprise[15] aims to encourage SMEs to produce an ESG report, whilst partly refunding the costs incurred through the consultants. Under this fund, SMEs may cover €3,000 in relation to the first ESG Report, capped at a total of 75% of the costs incurred, and €1,000 yearly for the following two years when submitting a report each year, which will be capped at 50% of the consultancy costs.
Also in line with the Commission’s assistance framework for Member States, the European Investment Bank has also launched the European Local ENergy Assistance (ELENA)[16] funding programme, which provides technical guidance for energy efficiency and renewable energy investments targeting buildings and innovative urban transport.
Automation in ESG Data Collection
With the increasing CSRD and SFDR regulatory obligations imposed on in scope business, an evident challenge is the copious amount of data and compliance that is required to be collected as well as how this data is to be presented.
ESG data provides information about the environment, social and governance attributes of an organisation or investment, which data would be paramount and also utilised by investors, analysts companies as well as policy makers.
Although ESG data is usually collated manually from a variety of satellite systems and data silos, there are evident issues surrounding consistency, standardisation, normalisation and the inherent human error, which may lead to incorrect our outdated data and in turn, non-compliance with the legislative obligations imposed on in scope businesses.
Businesses might be interested to know that a solution to this challenge could be by exploiting modern technologies such as the Robotic Process Automation (RPA)[17], which automation mimics human behaviour and automates repetitive and rule based tasks. When combined with the already available AI tools, such technologies may assist businesses in their reporting and compliance obligations.
Way Forward
In light of the increasing importance of Sustainable Finance, an inside out perspective is needed, whereby businesses should not only monitor what is being done internally, but also how what is being done internally is affecting the society and the environment at large. Accordingly, a shift from the traditional investment ideology, which focuses on increasing financial results, to a more impact investment mentality, which seeks to balance financial and philanthropic goals, is needed.
Such a shift is being made across the globe as is evident by the rising ESG obligations imposed on businesses through the EU’s regulatory framework, such as the CSRD, which extended the scope of sustainability reporting requirements, and in scope businesses should, now more than ever, consider these implications whilst devising a business model that ensures compliance with the reporting requirements as we move closer and closer to the directive’s transposition into national law.
Whilst Malta continues the necessary transposition exercise of the CSRD together with the gradual adoption of the new European Sustainability Reporting Standards, consultations continue to be held between the regulators, local businesses and stakeholders to ensure that the Maltese legislative instruments reach the intended objectives of safeguarding the environment for current and future generations in a proportionate and objective manner.
Author: Dr. Brandon Meli
Dingli & Dingli continues to monitor the ESG developments and interested clients seeking to ensure compliance with the growing regulatory requirements are invited to reach out.
[1] Stockholm Resilience Centre, 'Planetary boundaries' (Stockholm Resilience Centre - Stockholm University, 2023) <https://www.stockholmresilience.org/research/planetary-boundaries.html> accessed 11 July 2024
[2] Stockholm Resilience Centre, 'Planetary boundaries - All planetary boundaries mapped out for the first time, six of nine crossed' (Stockholm Resilience Centre - Stockholm University, 2023) <https://www.stockholmresilience.org/research/research-news/2023-09-13-all-planetary-boundaries-mapped-out-for-the-first-time-six-of-nine-crossed.html> accessed 11 July 2024
[3] Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector
[4] Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting
[5] Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups
[6] European Commission , 'The Commission adopts the European Sustainability Reporting Standards' (EUR-Lex, 31 July 2023) <https://finance.ec.europa.eu/news/commission-adopts-european-sustainability-reporting-standards-2023-07-31_en> accessed 15 July 2024
[7] Directorate-General for Internal Market, Industry, Entrepreneurship and SMEs, 'Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions - SME Relief Package' (European Commission , 12 September 2023) <https://single-market-economy.ec.europa.eu/publications/sme-relief-package_en> accessed 15th July 2024
[8] UNFCCC, 1992: United Nations Framework Convention On Climate Change. United Nations, FCCC/INFORMAL/84 GE. 05-62220 (E) 200705, Secretariat of the United Nations Framework Convention on Climate Change
[9] https://www.greenclimate.fund/
[10] https://www.thegef.org/
[11] https://unfccc.int/topics/climate-finance/resources/reports-of-the-special-climate-change-fund
[12] https://www.thegef.org/what-we-do/topics/least-developed-countries-fund-ldcf
[13] https://www.adaptation-fund.org/
[14] Kyoto Protocol to the United Nations Framework Convention on Climate Change, Dec. 10, 1997, 2303 U.N.T.S. 162
[15] Exereco, 'ESG Grant by Malta Enterprise' <https://www.exereco.com/post/esg-grant-by-malta-enterprise> accessed 15 July 2024
[16] https://www.eib.org/en/products/advisory-services/elena/index
[17]https://www.ibm.com/topics/rpa#:~:text=What%20is%20RPA%3F,forms%2C%20moving%20files%20and%20more.