EU Taxonomy Regulation disclosure – ESMA consults

In a nutshell...

ESMA's consultation paper contains draft Level 2 measures which specify the content, methodology and presentation of the key performance indicators (KPIs) that non-financial undertakings and asset managers which fall within the scope of the Non-Financial Reporting Directive (NFRD) must disclose under Article 8 of the Taxonomy - or Framework - Regulation (the Regulation).

The key draft proposals for consultation address the following aspects:

• for asset managers, the advice proposes:

  • a KPI calculation model based on eligible investments; and
  • advice on how this KPI should be calculated and presented so uniform disclosure is given on how the activities are directed at funding environmentally sustainable economic activities.

• for non-financial undertakings, the advice covers the content of the three KPIs (ie, the proportion of turnover, and capital and operating expenditure related to environmentally sustainable activities which must be disclosed) and sets out specific considerations in relation to how these must be prepared and presented.

The consultation period closes on 4 December 2020.

ESMA will deliver its final advice to the Commission by 28 February 2021.

The Commission must adopt a delegated act by 1 June 2021.

These new reporting obligations will not, however, automatically apply in the UK since they will not come into force until after the UK's transition period has ended. It remains to be seen whether the UK will implement them.

By way of background:

Article 8 of the Regulation requires undertakings covered by the NFRD to publish information on how and to what extent their activities are associated with economic activities that qualify as environmentally sustainable under the Regulation.

• What do I need to know about the NFRD?

  The NFRD covers large Public-Interest Entities (for the definition, see below) with more than 500 employees and requires them to include a non-financial statement as part of their annual public reporting obligations.

  It identifies a number of sustainability issues, (environment, social and employee issues, respect for human rights, and anti-corruption and bribery matters).  In respect of each of these, companies must disclose information about their business model, policies (including implemented due diligence processes), outcomes, risks and risk management, and KPIs relevant to the business.

  In-scope companies must disclose information "to the extent necessary for an understanding of the development, performance, position and impact of [the company's] activities."

  This means that a company should disclose not only how sustainability issues may affect it but also how it, the company, affects society and the environment (the so-called 'double materiality perspective').

• What about the Taxonomy Regulation?

  The Regulation establishes an EU-wide classification system or taxonomy which is intended to provide a common language that businesses and investors can use to identify the degree to which given economic activities can be considered to be environmentally sustainable.

Who does the consultation paper apply to?

Overall, the NFRD requirement to disclose non-financial information applies to a Large Undertaking which:

• is a Public-interest Entity; and
• has, on average, more than 500 employees during the financial year.

A Large Undertaking is defined in the Accounting Directive as one which, on its balance sheet date, exceeds at least two of the three following criteria: (a) a balance sheet total of €20,000,000; (b) a net turnover of €40,000,000; (c) an average of 250 employees during the financial year.

Public-interest Entities are defined in the Accounting Directive as being: (a) EU companies listed on an EU regulated market; (b) credit institutions; (c) insurance undertakings; or (d) entities designated as such by a Member State (eg, those that are of significant public relevance because of the nature of their business, their size or the number of their employees).

I'm an asset manager - will the consultation paper affect me?

On the above definitions, the answer at the moment is 'probably not' - although it could (if not now, then in the future).

ESMA concedes that currently "very few" asset managers will be directly affected, though more could be indirectly captured as part of a subsidiary of a public interest entity (usually a bank or an insurance company).

However, the NFRD is being reviewed and the Commission's consultation saw 'significant support' for expanding the Directive's scope - in time, ESMA believes, more asset managers could be brought into scope.

What should the KPIs for asset managers contain?

Bearing in mind that few asset managers currently report under the NFRD and that this would be a new reporting requirement, ESMA accepts that reporting quantitative information would not be straightforward.

It is, then, seeking feedback on its proposal for a 'simple model', which requires disclosure in terms of a ratio of eligible investments that are Taxonomy-aligned.

The numerator would consist of:

• the value of green bonds complying with the EU Green Bond Standard; and
• a weighted average of the value of investments invested in Taxonomy-aligned activities of investee companies.

The denominator would consist of the value of the total eligible set of investments in investee companies held by the asset manager's funds, where eligible investments are equity and fixed income assets of eligible investee entities.

What methodology should asset managers use for preparing the KPIs?

ESMA recognises that the absence of reported data is a significant issue that needs to be addressed by the Level 2 measures. While its proposals require accurate reporting by investee companies of their Taxonomy-aligned activities, the EU Taxonomy currently covers only two of the six environmental objectives in the Taxonomy Regulation, so the extent of reportable Taxonomy-aligned activities will not immediately be very extensive.

ESMA seeks feedback from respondents as to how investments falling outside the scope of the NFDR should be treated, where these cannot be treated Taxonomy-aligned (eg, if they are issued by entities not reporting under the NFRD, the extent of their activities' association with Taxonomy activities may not be known).

• On the issue of investee companies carrying on activities which contribute to multiple environmental objective: ESMA believes these companies would normally assign activities to one such objective and that this would avoid double counting and other challenges.

• On netting: ESMA considers that, in order to mirror the commitment approach that funds typically use to calculate net leverage, reporting should take place after netting potential hedges and offsets, regardless of the instrument used (derivatives, repurchases, short positions...). ESMA also suggests that the methodology for calculating net short positions under the Short Selling Regulation could be used as a reference for the netting methodology.

• On derivatives: ESMA proposes that the KPI calculation for asset managers to use should not cover derivatives.

How should the KPIs be presented?

The consultation paper proposes that disclosures made under Article 8(2) of the Regulation should be set out following the template style set out in Annex IV of the consultation paper.

The way in which the disclosure is presented should identify which environmental objectives the investments contribute to. Where possible, the activities invested in should be identified for each environmental objective.

Appropriate accompanying information should be presented close to the standard table, with a link, if relevant, to disclosures on the principal adverse impacts of investment decisions on sustainability factors under Article 4 of the SFDR.