EU reporting simplification will result in less information and introduce distortions in the sustainable finance market
This piece was first published on Bruegel’s website and is available at: Streamlining or hollowing out? The implications of the Omnibus package for sustainable finance
The European Commission’s so-called first Omnibus package, published 26 February, has as its objective “unprecedented simplification” while keeping to the goals of the European Green Deal – the European Union’s net-zero plan – “enabling companies to access sustainable finance for their clean transition”. This is a complex trade-off. If adopted, the package could create risks for the underlying policy objectives of the European Green Deal and disrupt sustainable finance in two important ways.
First, the package weakens reporting requirements across three major EU sustainability reporting rules: the Corporate Sustainability Reporting Directive (CSRD), the Corporate Sustainability Due Diligence Directive (CSDDD) and the Taxonomy Regulation. The proposed changes would massively reduce data availability. The CSRD applies to about 50,000 EU firms, for which investors could expect comparable and high-quality sustainability disclosures. But the Omnibus would limit CSRD reporting obligations to only 20% of those firms. It would also delay reporting and make it shallower. Meanwhile, a weakened CSDDD will reduce transparency in the value chains of large firms.
Investors had thought that disclosures mandated by the CSRD would ultimately replace the third-party corporate environmental, social and governance (ESG) ratings that are widely used as proxies for sustainability, despite recognised flaws. ESG ratings providers do not always incorporate double materiality – or a company’s external impacts plus the impact of external factors– in their ratings. For sustainability-minded investors, access to data incorporating this approach remains essential. If this is no longer available under the CSRD, the Commission should consider stricter requirements for ESG ratings sold in the EU.
Second, the changes in taxonomy reporting requirements have the potential to exacerbate some of the taxonomy’s flaws. The Commission recognises that the real economy is not yet well-aligned with the taxonomy, with only 16% of capex of EU companies taxonomy-aligned, against a much higher share of eligible capex. The gap is especially large for transitioning sectors including transport, construction, infrastructure, real estate and chemicals, which struggle to demonstrate that core activities do not significantly harm environmental objectives.
The Omnibus introduces the option to report “partial Taxonomy-alignment” for activities that fulfil only some Taxonomy Regulation requirements. This may improve usability of the taxonomy as a framework for transition finance. But the increased flexibility is trumped by a cut in scope, which would make taxonomy reporting mandatory only for companies with more than 1,000 employees and net turnover exceeding €450 million.
This downsizing directly impacts sustainable finance. As fewer companies report on the alignment of their activities, the taxonomy alignment of financial products (which financial-market participants must report under another EU law, the Sustainable Finance Disclosure Regulation (SFDR)) will likely drop. In many cases, this would be ‘artificial’ – because of reduced data availability rather than changes in underlying portfolios – but it would still be detrimental for final consumers of financial products, making reported datapoints less meaningful and difficult to interpret.
Financial-market participants will likely be even more hesitant than currently to commit to taxonomy-aligned investments, because they will have less data to prove fulfilment of such commitments. As fewer companies are required to report on alignment, issuance of taxonomy-linked corporate funding instruments may also shrink, shrinking an already tiny niche in the sustainable finance market.
On the bright side, cuts to reporting obligations create an opportunity for companies electing to report voluntarily on sustainability metrics in line with CSRD standards. Accurate reporting will have a much greater value for sustainability-minded investors in a world in which disclosure is no longer required. This could result in a ‘greenium’, or sustainability premium, for companies that make the effort. Before the Omnibus, many companies not subject to the CSRD already intended to partially or fully align their sustainability disclosures with it.
Lastly, the changes introduced by the Omnibus make the upcoming revision of the SFDR crucial. In an EU consultation, 82% of respondents requested more clarity on the nebulous SFDR concept of ‘sustainable investment’. Clarity will be even more important in the context of diminished sustainability reporting. The taxonomy seemed set to become the default framework for defining sustainable investment, but the Omnibus’s downsizing of taxonomy reporting obligations will make an activity-based approach to sustainable investment highly problematic.
An alternative approach based on a top-down/entity-level assessment of alignment with Green Deal objectives would have the benefit of being applicable to all companies (even in an environment with less disclosure) and neutral across capital-market instruments. It would help make the EU sustainable finance framework more easily operational and effective in delivering the desired alignment of incentives across the real economy and the financial sector. At a time when sustainable finance is under fire politically, this is essential to ensure that regulatory simplification does not lead to a hollowing out of underlying EU climate goals.
Silvia Merler, Head of ESG & Policy Research (Algebris Investments)
