By Dr Marcin Krzemień, associate in the Energy and Infrastructure practice, CMS
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The first sustainability reports required under the Corporate Sustainability Reporting Directive (CSRD) will be published in 2025. However, sustainability reporting requirements have already started to influence EU market practice.

CSRD disclosures require a great deal of preparation from reporting entities. In fact, many voluntary ESG reports (based on market standards such as the GRI) have appeared on the market in recent years, in anticipation of the upcoming regulatory changes.

To meet the requirements of European Sustainability Reporting Standards (ESRS; reporting standards approved as a delegated regulation to the CSRD), reporting entities need to carry out significant due diligence. They need to prepare a gap analysis to establish what data required under the ESRS they lack. They also need to execute a double materiality analysis – that is, to consider, how they impact ESG factors (environment, local communities) as well as the opportunities and risks ESG factors generate for their business operations. Reporting entities should also review their corporate policies and strategies. ESRS requires them to show, for example, how ESG considerations feature in an entity’s strategy, business model and risk management function.

Entities reporting under CSRD need to analyse their value chain – upstream and downstream (direct or indirect) business relationships – to identify issues that may generate ESG impacts, risks and opportunities. Issues which may be material in the value chain area include energy sourcing, greenhouse gas emissions in supply chains, labour practices of subcontractors, and waste management practices of suppliers.

On 31 May 2024 EFRAG—the EU’s reporting standard setter—approved new guidelines relating to value-chain analyses under CSRD and clarified that all material ESG impacts, risks and opportunities occurring in the value chain area should be reported. EFRAG guidelines provide that value-chain analyses of financial institutions must include their investment and lending activities. As explained under ESRS 1 (AR 12), if a loan results in the contamination of the area of the borrower’s operations, such negative impact is connected to the reporting undertaking by way of the relationship created by the loan agreement. This means that financial institutions reporting under CSRD should analyse the impacts of their investment and lending activities and review their portfolios – the companies and projects they finance.

Other ESG reporting requirements and their impact on financing

Since 2022, there have also been reporting requirements in place regarding the compliance of large corporates with the EU Taxonomy (the taxonomy of environmentally sustainable activities set out in EU Regulation 2020/852 and delegated acts), which also apply to financial institutions and which survive under the CSRD reporting regime. Companies have to disclose on the alignment of their activities with the Taxonomy. For banks, insurers and investment firms, this means reporting on the share of their lending and investment activities aligned with the EU Taxonomy and what is eligible for such alignment in the future. This also requires the review and monitoring of the portfolio companies. 

Apart from CSRD, specific reporting obligations for the financial sector concerning investment and advisory activities, based on the SFDR Regulation (2019/2088), are already in effect. Since 2023, banks and investment firms offering portfolio management services, and insurers offering insurance-based investment products employing more than 500 people have been mandated to report their due diligence policies, considering any principal adverse impacts of their investment decisions on sustainability factors. In these reports, they should disclose information on various ESG KPIs of their portfolio companies such as energy efficiency, greenhouse gas emissions, water usage, waste management and recycling practices, pollution and labour-related accidents (as well as others, depending on the scope of the portfolio). There is also increasing regulatory pressure on financial institutions to consider long-term ESG risks in their activities and to prevent greenwashing. New guidelines on combatting greenwashing were published by the EU financial sector regulators (ESMA, EBA, EIOPA) on 5 June 2024.

This is why, when assessing the bankability of a project – the possibility of obtaining debt financing for its development – there’s an increasing need to examine the project for its compliance with ‘hard’ environmental protection laws, as well as with ESG standards such as the Taxonomy and the ESRS, and measure its performance against ESG KPIs such as energy efficiency, greenhouse gas emissions, resource use and labour policies. Clauses concerning a project’s alignment with the Taxonomy are becoming increasingly commonplace in market practice, especially in the construction sector.

EU funds are becoming more and more ‘green’

ESG requirements have also started to influence the expenditure of public funds. For example, funds from the Recovery and Resilience Facility (established by EU Regulation 2021/241) must be spent in accordance with the ‘do no significant harm’ principle described in Taxonomy Regulation 2020/852. This means that projects financed from this facility cannot harm the environmental objectives specified in the regulation (these objectives include climate change mitigation and adaptation, and the transition to a circular economy), according to the technical criteria set by the EC. Entities wishing to implement projects financed from these funds must be prepared for the possibility of similar requirements being imposed on them, which might be verified during project implementation.

Additionally, dedicated monies from EU funds are sometimes allocated to projects with a beneficial impact on ESG factors, particularly climate and the environment. For example, the EU’s initiatives to increase energy efficiency in buildings are funded through programmes like InvestEU (Regulation 2021/523), and should be spent in line with the Taxonomy. Hence, the implementation and financing of such projects will certainly require verification of their actual environmental impact.

For all the above reasons, issuers, financiers and investors alike may become more interested in green-finance instruments, such as green or sustainability-linked bonds. It is yet to be seen how successful will be the EU’s newest idea for a sustainable financial instrument, the European Green Bonds, the proceeds of which have to finance EU Taxonomy-aligned projects, when the standard starts to function at the end of 2024.