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      ESG Talk: progress but still timing mismatch in EU plans on ESG disclosure
      MONDAY, 27/06/2022 - Scope ESG Analysis GmbH
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      ESG Talk: progress but still timing mismatch in EU plans on ESG disclosure

      Inadequate corporate data remains the bugbear in improving disclosure for investors on greenhouse-gas emissions and other sustainability factors which EU regulatory initiatives are making only partial headway in addressing.

      Bernhard Bartels, executive director at Scope ESG Analysis explains why in this interview with Dierk Brandenburg, head of credit and ESG research at Scope Ratings.

      Dierk Brandenburg: The EU Council and Parliament have finally agreed on a proposal for corporate non-financial reporting. What does it mean for financial markets?

      Bernhard Bartels: The agreement on the Corporate Sustainability Reporting Directive (CSRD) is an important step towards standardising ESG reporting and minimising greenwashing. However, there is still a problem of timing. Larger corporates start reporting only in 2025 on their 2024 figures while asset managers are due to start ESG reporting on their investments from next year when the EU’s Sustainable Finance Disclosure Regulation (SFDR) comes into force.

      DB: From an investor perspective, what are the main cornerstones of the SFDR?

      Bernhard Bartels: The SFDR is targeting financial market participants and asking them to disclose more information related to the sustainability characteristics of funds and financial products in general. From next year, financial products in the EU have to include information on the so-called Principal Adverse Indicators (PAIs) at the corporate level. The PAIs range widely from greenhouse gases to water pollution, working conditions and other precise environment, social, and governance indicators, i.e. a change from rather broad, often voluntary disclosure requirements to very specific ones, some of which will be compulsory.

      DB: The source of much of the confusion over ESG-related disclosure centres a lack of uniformly high-quality corporate data. Where is the biggest gap?

      For us, the biggest gap is the availability of so-called scope-3 greenhouse gas emissions (GHG) for a company’s entire value chain – raw materials through to final products – for several reasons. First, GHG disclosure is required across multiple PAIs such as carbon emissions or fossil fuel exposure. Secondly, the scope-3 emissions are central to assessing a company’s carbon footprint and net-zero strategy because they often dominate the footprint. And thirdly, so far, companies themselves do not disclose much of this information, and if they do, it is not consistent, which makes it hard for fund managers to generate the necessary reporting. This is a major challenge which is yet to be resolved.

      DB: We know there are a lot of other initiatives on the way, notably in Europe? How are they all linked, given their ambitious deadlines, and can one proceed without the other?

      The CSRD will replace the existing Non-Financial Reporting Directive by 2024 for large corporates. The goal is to ensure larger companies carry out mandatory audits and standardised disclosures of PAIs. In addition, companies have started reporting on their alignment with the EU Taxonomy which allows asset managers to select taxonomy-aligned activities for their sustainable investment products.

      DB: Can you explain the link between the taxonomy and corporate and funds reporting?

      The EU Taxonomy directly links to the SFDR. The issue the EC faces is that taxonomy alignment at the corporate level is still reported rarely, while the degree of alignment is low and will remain so given how ambitious the framework is. This automatically restricts the availability of funds that can include taxonomy-aligned investments. The EC has now clarified that funds can use the PAI indicators to measure the environmental or social characteristics or the overall sustainable impact of the financial product, for example, by showing improvements in the investments against those indicators over time.

      DB: Is this a function of necessity, pragmatism or a dilution of original goals?

      It is not a dilution. The taxonomy for now addresses climate change – mitigation and adaptation – two specific environmental issues rather than the wider issue of sustainability.  We will have to wait for an extended version of the taxonomy. The PAIs can help investors in avoiding assets with harmful ESG impacts. However, a focus only on taxonomy-alignment and PAIs also narrows the options for investors eager to promote sustainability. We need a broader definition.

      DB: This neatly brings us to scope-3 impacts and those downstream and upstream linkages. Will investors get a realistic view of where those emissions are?

      I have two answers. With limited corporate disclosure, we are left looking at sector and regional exposure to scope-3 emissions where we do have reliable industry and country data. This is what we at Scope ESG are doing. However, we cannot rely only on this macro data. We need company-level information based on standardised scope-3 reporting. The recently created International Sustainability Standards Board (ISSB) and the European Financial Reporting Group have made it clear that this methodology needs to be written. Of course, some argue that it is so difficult to identify the indirect responsibility of companies for emissions that we should focus only on direct responsibility in ESG assessments using scope-1 and scope-2 definitions.

      DB: That sounds a pragmatic way of addressing the current reality, but why do we need to take the scope-3 emissions into account?

      The companies that produce most of emissions – oil and gas companies, cement producers – produce little of the value added whereas the companies which produce most of the value added – technology, consumer goods, services – have little in the way of direct emissions. But Russia’s war in Ukraine has shown that companies have difficulty producing that extra value without access to cheap energy.

      We need to have this link across sectors to incentivise companies to lower emissions even if it involves multiple counting of emissions – something which some people do not like.

      DB: If you had to invest political capital today in a breakthrough, where would you put it?

      What is crucial is this increase in transparency, primarily corporate reporting and ultimately financial market reporting. We need to better understand where negative impacts and positive contributions occur to make meaningful judgements and policy. If we do not know where we import emissions from, say in the form of Chinese electronics, there is no point creating a regime which does not take them into account. Transparency is the goal that needs to be met – and the quicker the better.

       

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