Transformational framework
From obligation to opportunity
Marie Ahlgren
Riccardo Traverso
Mandatory frameworks are transforming the target setting and business strategy
New mandatory legal frameworks, such as the EU's Corporate Sustainability Reporting Directive (CSRD), the EU Taxonomy, and the Sustainable Finance Disclosure Regulation (SFDR), are compelling companies to adopt more rigorous sustainability goals, specific measurable targets and extensive reporting practices on their organisations and supply chains. The effort to comply is not only a matter of legal duty but is also viewed as a strategic necessity to match the wider aims of the EU’s green deal.
The significant amount of resources, in terms of new Environmental and Social Governance (ESG) competences and investments, needed to achieve these goals highlights the magnitude of the expected change in business that is now required. Sustainability is no longer optional, but essential for every business and should be central to their strategy. The key question is not how to meet the standards, but how will companies leverage the regulations to generate value for business and stakeholders.
The EU is in the front seat pushing sustainable change through tough regulations. However, this is not a solitary journey: several geographies are initiating a development of their own measures to contribute to the global sustainability agenda. China's national emissions trading scheme and California's renewable portfolio standard (RPS) are diverse in their approach but share
the common goal of reducing environmental impact and promoting sustainable growth.
Pressure from financial institutions and investors
A recent report published by the 'Platform on Sustainable Finance' highlights the growing utilisation of the European Union's sustainable finance framework tools, notably in reshaping financial structures and integrating the EU Taxonomy into key strategic documents, including financial planning. This shift indicates a significant movement toward sustainable finance practices, encompassing both financial and non-financial entities, with a diversification across various financial products such as green and sustainability-linked bonds, loans, and investment funds.
The EU sustainable-finance tools are growing in importance among financial players, driven by better sustainability reporting and new standards like the European Sustainability Reporting Standards (ESRS) and the EU Green Bond Standard. These efforts aim to align financial products with the EU's environmental goals, bolstering green finance's effectiveness and integrity.
Performance vs. purpose
In the landscape of green finance, two primary approaches cater to distinct corporate aspirations: performance-based financing and purpose-based thematic funding.
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Performance-based financing, also known as sustainability-linked financing, is designed to facilitate a company's progress towards its sustainability objectives. This model is inherently flexible, allowing for the incorporation of various metrics, such as improvements in ESG ratings, adherence to external benchmarks like the science based targets initiative, or the achievement of specific internal goals, including carbon reduction, enhanced recycling rates, or sustainable procurement practices. The primary allure of this approach is its adaptability enabling companies to tailor financing mechanisms to their unique sustainability journey and goals.
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Purpose-based thematic funding directly supports projects or assets with a clear sustainability mission, such as reducing CO2 emissions, augmenting the use of recycled materials, or minimising energy consumption. This funding is more targeted, channelling capital into specific, tangible projects that have a direct impact on sustainability outcomes. It suits entities seeking to finance discrete projects or investments that contribute to broader environmental objectives.
Companies choose performance-based finance for broad sustainability improvements or purpose-based finance for specific environmental projects, depending on their strategic goals and sustainability stage.
A transition process
Setting and achieving sustainability targets is a dynamic and comprehensive process that requires a strategic approach grounded in a thorough understanding of a company's impact on ESG aspects. This process is not only about selecting goals but also about embedding the goals into the core functions of the organisation, thereby making sustainability an integral part of its operations and decision-making.
A meaningful sustainability strategy starts with a robust materiality assessment, identifying key impacts and issues from both sustainability and financial viewpoints.
As Double Materiality Assessment (DMA) includes your company’s external impact as well as the impact of the changing environment on your business, there is a risk of drowning in important aspects. It is wise to prioritise the very most material aspects at the start, setting clear targets for these and mobilising the organisation to meet them. Later on, more aspects may be added.
This prioritisation aligns sustainability targets with strategic objectives and stakeholder expectations, ensuring that resources are focused effectively. Implementing sustainability targets demands integrating ESG considerations into a company's operational framework, ensuring accurate ESG data management, tracking progress, and facilitating informed decision-making through effective internal and external reporting mechanisms.
Key components
Integrating ESG criteria into corporate strategy is crucial for mitigating operational and legal risks, driving efficiency, and opening new pathways for credits and sustainable business opportunities. By doing this, companies can not only navigate the complexities of regulatory compliance and reduce exposure to environmental liabilities but also capitalise on the growing demand for sustainable practices. This strategic alignment with ESG principles positions companies advantageously for innovation and collaboration in green ventures, ensuring long-term resilience and competitiveness in a rapidly evolving business landscape.
Frameworks of disclosures and tools to scale up sustainable investments
To reach the European green deal targets, the EU will need to scale up its investments by two thirds (about EUR 620 billion more each year until 2030), relative to average levels over the 2011 2020 period. Private entities will be responsible for raising most of the funding.
The EU's action plan on sustainable finance revolves around three objectives – transparency risk management and supporting capital reallocation.
The framework of disclosures and tools has been established to assist investors (corporations and
financial entities) to better identify and assess operations and projects that can make a positive
environmental impact:
— EU Taxonomy,
— Corporate Sustainability Reporting Directive (CSRD)
— Corporate Sustainability Due Diligence Directive (CSDDD)
— Capital Requirements Regulation (CRR)
— Sustainable Finance Disclosure Regulation (SFDR)
— EU Green Bond Regulation (EUGB).
The timeline for the new mandatory disclosures is listed in the figure below. A European Single Access Point (ESAP) will create a unique data source that will allow for automated, centralised access to all ESG disclosures in a machine-readable format.
The ESAP platform is expected to become available from mid-2027.
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