By Eileen Grace, Partner, Addleshaw Goddard
ESG is a topical and pertinent issue for businesses with increased focus due to new regulation, consumer demands and investor requirements. There is a move from theoretical views to real action at corporate level which is expected to intensify.
The ESG agenda is now being treated less as optional and increasingly more as a critical issue for businesses, as they face increasing ESG requirements to incorporate into their organisations' processes. These businesses must ensure that their ESG reporting and disclosures are accurate and meet investor demands and avoid reputational risks, especially Greenwashing.
As capital and funding become more aligned to demonstrative metrics to indicate an acceptable ESG strategy and compliance level, access to capital markets will be predicated on the quality of the corporate's disclosure. There will likely be an increased cost of capital for those who do not satisfy regulatory obligations.
We suggest the following as important ESG trends, developments and initiatives impacting in Ireland currently;
CSRD is imminent and Irish businesses within its scope must focus on its requirements. There are differences in the scope and extent of CSRD, compared with the Non-Financial Reporting Directive (NFRD). CSRD will apply to:
The implementation schedule for CSRD means that corganisations already the subject of NFRD, will have to include disclosure requirements in their report for financial year 2024. Other large companies will have to report for 2025, and thereafter some listed SMEs and other small and non-complex credit institutions and captive insurance undertakings will be required to report in financial year 2026, with the remaining companies under scope including non-EU undertakings with net turnover over €150 million (if they have any subsidiary or branch in the EU) being required to report by financial year 2028.
Information required to be reported on must be adequate to provide an understanding of the business' impact on sustainability matters, and also to understand how sustainability matters affect its development, performance and position – referred to as "double materiality" reporting. It is anticipated that by 30 June 2023, the European Commission will specify the information that undertakings are required to report upon.
The anticipated information to be reported will involve the following on a breakdown of ESG components:
The new format for CSRD reporting will be in a single economic reporting format. Critically, there will be new requirements for external audit assurance and reporting standards.
It is anticipated that the new CSRD disclosures will be of particular interest to the investor and asset management community who have to date expressed difficulties with gathering consistent information required by them for their underlying investments in order to comply with their own obligations under the Sustainable Finance Disclosure Regulations (SFDR). Reports and survey findings have consistently shown that investment and other managers want greater information on sustainability claims by companies, and generally express a view that there is a lack of consistency and/or accuracy in available data. CSRD is a response to the demand for better sustainable reporting and accountability for impact, particularly as regards avoiding greenwashing. The disclosures created under CSRD should better enable investors to take account of sustainable related risks and opportunities and relieve the data concerns about inadequacies to date.
The CSRD must be transposed into Irish law by 6 July 2024.
Other EU ESG Legislation re Improved Disclosures
In recent years there have been new directives and initiatives from the EU aimed at providing greater harmonisation of ESG and protection of the environment and human rights. In addition to CSRD, these include the Corporate Sustainability Due Diligence Directive (CSDDD) and the EU Taxonomy Regulation.
The CSDDD was adopted by the EU Commission in February 2022 and though it does not have the same scope as CSRD, it aims to foster sustainable and responsible corporate behaviour and centre human rights and environmental considerations in companies' operations and corporate governance. Although implementation is not expected until later this decade, consideration is already being given to its implications.
The EU Taxonomy applies to companies subject to NFDR and sustainable activities and is a classification system to clarify what investments are environmentally sustainable in the context of the European Green Deal. It does this by setting four overarching conditions that an economic activity must meet to qualify as environmentally sustainable. Its aim is to prevent greenwashing and to help investors make greener choices. It is considered a main element in the drive to redirect capital to lower carbon economies.
Through all applicable EU regulations, ESG is becoming codified into Irish law with the effect that this increased legislative requirement, coupled with investor pressure and market development, is resulting in greater incentivisation of corporates to improve the quality of ESG disclosures. Trends indicate that corporates are electing to make voluntary disclosures against frameworks not required of them.
Without doubt, greenwashing is a trending issue.
The SFDR regime will apply new disclosure requirements to many financial companies with the specific aim of preventing greenwashing and ensure a consistency of data standardisation and standardise transparency on sustainability in financial markets. It is particularly focused on how funds are described relative to sustainability. Within scope firms must explain ESG performance across 14 mandatory Principle Adverse Impact data points and two further optional metrics. The SFDR sets strict new disclosure standards for setting up funds.
Three EU supervisory authorities, EBA, EIOPA and ESMA, have published a Call for Evidence on greenwashing with the process commenced in November 2022. The aim of the process is to obtain a greater understanding of greenwashing which will then help inform policy makers and help foster the reliability of sustainability related claims. This demonstrates an increased focus by regulators on greenwashing activity and claims. Separately, in Ireland the Central Bank of Ireland has commenced a thematic review in respect of funds domiciled in Ireland with a stated focus of the review being to identify greenwashing activities, particularly in the classification of Article 6 Funds.
As already mentioned, the EU Taxonomy regulation aims to prevent greenwashing.
However, a critical issue at the centre of the greenwashing concern is the simple question of how to define greenwashing. There are increasing calls for a common understanding of it from institutions such as the ESAs and the UK's FCA.
It is anticipated that 2023 will see continued momentum in the creation of green finance products. Green finance is any structured financial activity that is created to achieve a better environmental outcome, and can include green bonds, green mortgages and credit cards, as well as renewable energy credits and renewable and sustainable equity.
The desired transition to a greener, more circular, and sustainable economy requires funding as does the new infrastructure to be powered by renewable energy and used renewable energy products and creation of zero waste products. All of this increases the demand for green finance. It is suggested that 2023 sees a second wave of green products and innovation.
Greater Focus On Social Component Of ESG
There has been a raft of new legislation focused on the social component of ESG and this legislation will impact businesses. During 2022, new legislation included Protected Disclosures (Amendment) Act 2022, Sick Leave Act 2022, European Union (Transparent and Predictable Working Conditions) Regulations 2022, Payment of Wages (Amendment) (Tips and Gratuities) Act 2022 and Gender Pay Gap Information Act 2021. Moreover, there is current EU legislation in process relevant to the social component of ESG. Notable among these are:
According to the European Banking Authority, businesses who fail to comply with ESG related requirements in respect of employment law, will be exposed to market, operational, reputational, liquidity and funding risks. Employers who do not meet the minimum ESG standards may also struggle with recruitment and retention of employees and risk legal and regulatory action.
In summary, 2023 is anticipated as a year of action rather than talk on ESG issues with particular focus on information integrity and reducing greenwashing. CSRD is very significant and organisations are gearing up to prepare for compliance therewith. The ESG Social component is getting attention with new legislation proposals.
Eileen is a Partner with the firm, specialising in corporate Law with particular focus on corporate governance. Eileen has written numerous articles relating to corporate governance, directors' duties and shareholders' issues as well as ESG trends and implications.