Insights

Now that the Christmas turkey has been consumed and digested, and the leftover chocolate logs have been reduced to their very last slice, the time is ripe to turn our attention (however begrudgingly!) to the year ahead. This brief article seeks to shed some light on a few of the major sticking points / expected developments in the world of sustainable finance in 2024. The author intends to expand on some of the contents found herein in subsequent articles and/or updates – so please watch this space.

Updates to the EU Emissions Trading System (ETS)

As has been widely reported in the media in the past couple of weeks, the European Union’s Emissions Trading System (ETS) has, as of January 2024, been extended so as to cover carbon dioxide emissions from all large ships (i.e., of 5,000 gross tonnage and above) entering into any one of the European Union’s ports – regardless of their flag or ownership.

What does this mean? In a nutshell, shipping companies will be expected to purchase and surrender (i.e., use) EU ETS emission allowances for each tonne of carbon dioxide (or carbon dioxide equivalent) emitted by an in-scope vessel. The European Commission has sought to phase in this requirement over the next four years, as follows:

• 2025: covering 40% of emissions reported in 2024;
• 2026: covering 70% of emissions reported in 2025;
• 2027 onwards: covering 100% of emissions reported.

Despite the (predominantly) negative publicity received, at least locally, it will be interesting to see how the extension of the EU ETS will help in achieving the European Union’s objective to reduce the bloc’s greenhouse gas emissions by 62% by 2030, and what effect (if at all) this development will have on the trajectory of ongoing decarbonisation efforts for ageing fleets. The capital markets may very well present ship owners with a golden opportunity in this respect; with the raising of finance via the issuance of sustainable instruments such as green (or blue) bonds constituting a plausible (and likely, more feasible) alternative to traditional bank financing in this sector.

Proposed changes to the Sustainable Finance Disclosures Regulation (SFDR)

Many financial market participants and financial advisers considering (on an entity level) the principal adverse impacts (PAIs) of their investment decisions and/or advice on sustainability factors will have started 2023 in overdrive mode in an effort to prepare for the publication of their very first PAI statement (as emanating from Commission Delegated Regulation (EU) 2022/1288) by the end of June 2023.

Fast forward a couple of months, and on 4 December 2023, the Joint Committee of the European Supervisory Authorities (ESAs) – following a mandate given to it by the European Commission to review several aspects of the abovementioned Commission Delegated Regulation (EU) 2022/1288 –  published its Final Report consisting (yet again) of new, draft regulatory technical standards introducing a number of changes to the ‘Level 2’ disclosures regime. Amongst the more pertinent changes introduced by the Final Report are:

• an extension of the list of mandatory social indicators to be included in one’s PAI statement;
• the refinement of the content of a number of other PAI indicators and their respective definitions, applicable methodologies, metrics and presentation;
• new financial product disclosures pertaining to greenhouse gas (GHG) emissions reduction targets; and
• the revision of the provisions for products with investment options such as multi-option products (MOPs).

The European Commission will now be assessing the ESAs’ Final Report in further detail prior to endorsing same within three months of its publication. As a result, it is envisaged that any changes to Commission Delegated Regulation (EU) 2022/1288 will not come into force until mid-2024, but in-scope financial market participants and financial advisers would be well-advised to prepare for these expected changes in advance.

 CSRD v. CSDDD?

At first glance, one would be forgiven for thinking that the above-captioned acronyms refer to one and the same piece of legislation – but they do not.

Having come into force on 5 January 2023, the Corporate Sustainability Reporting Directive (CSRD) became the talk of the town for a number of months thereafter; requiring in-scope entities to disclose, as part of their management reports, information on a range of sustainability matters which are relevant to their respective business/es. The CSRD has extended the scope of its predecessor – i.e., the Non-Financial Reporting Directive (NFRD) – so as to capture a much larger pool of entities; nearly four times the number of entities falling within the scope of the NFRD (as per the European Commission’s original indications as at the CSRD proposal stage).

The applicability of the CSRD has been staggered across a number of financial years, as follows:

The reader should, however, be reminded that back in December 2023, Commission Delegated Directive (EU) 2023/2775 was published in the Official Journal of the European Union. This piece of legislation amended the Accounting Directive so as to adjust the size criteria for micro, SME and large companies by 25% in order to account for inflation – thereby effectively reducing the extent of application of the CSRD.

In-scope entities will be expected to report in accordance with mandatory European Sustainability Reporting Standards (ESRS); with the first two sector agnostic ESRS issued in the form of Commission Delegated Regulation (EU) 2023/2772 published in December 2023. Other sector specific standards will follow in due course.

The Corporate Sustainability Due Diligence Directive (CSDDD), on the other hand, introduces a separate sustainability due diligence duty on large EU companies and non-EU companies with significant EU activity to identify, prevent, mitigate, bring to an end and account for certain adverse human rights and environmental impacts in their own operations, and that of their subsidiaries and their value chains.

Entities which fall within the scope of the CSDDD include:

• large, EU limited liability companies with more than 500 employees and a net worldwide turnover of over EUR 150 million (known as ‘Group 1’ entities);
• EU limited liability companies which: (a) operate in defined sectors where there is a high risk of human rights breaches or harm to the environment, and (b) do not meet the thresholds to qualify as a ‘Group 1’ entity but have more than 250 employees and a net worldwide turnover of EUR 40 million, if at least EUR 20 million is generated in the aforementioned defined sectors (known as ‘Group 2’ entities); and
• non-EU undertakings that are active in the EU and whose net turnover in the EU exceeds the net turnover thresholds of either Group 1 or Group 2 entities.

Amongst the more interesting requirements put forward in the CSDDD proposal is the introduction of new duties on directors of Group 1 and Group 2 entities to inter alia take into account human rights and the environment as part of their duty to act in the best interests of the company in question. This appears to be the very first concrete indication of a push, at EU level, to re-imagine the traditional fiduciary duties of directors as enshrined in the company law of the respective member states so as to cater for the consideration of sustainability risks. This follows a steadily rising trend of ESG litigation initiated beyond our shores pursuant to which the applicants have sought to argue that the directors’ duty to exercise reasonable care, skill and diligence in the discharge of their obligations vis-à-vis the company ought to include an obligation to ensure that the entity in question is well-positioned to prevent the materialisation of sustainability risks.

The European Council and the European Parliament announced in December 2023 that they reached a provisional, political agreement in relation to the text of the CSDDD. It is now expected that the final form of the CSDDD will be adopted at some point in 2024.

Green Claims Directive

Back in March 2023, the European Commission, in an effort to consolidate its efforts against the proliferation of greenwashing, published a proposal for a Directive pertaining to the substantiation and communication of explicit environmental claims – which has come to be known as the Green Claims Directive. The proposal for a Green Claims Directive inter alia requires businesses to meet minimum standards for the substantiation of any ‘green claim’ made; going so far as to require any such claims to be independently verified by third-party verifiers, as well as controlling the use of environmental labels. The proposal also introduces a sanctioning regime which provides for maximum fines of 4% of annual turnover for organisations which fail to comply with the eventual Directive.

Negotiations for the introduction of this Directive are still at an early stage, with further discussions expected to be held in February – March 2024. Regardless, it will be interesting to see whether the final text of the proposed Directive will have been watered down significantly by the time of its promulgation – particularly given the onerous nature of some of the requirements set forth therein, and the risk that such requirements might actually deter the manufacture of sustainable products.