European Union’s ESG standards for financial institutions: final draft looks weaker

February 12, 2021

Reading Time: 3 min

ESG standards for financial institutions: hotly anticipated

Many people in the financial activism community have been following with interest the developments around the European Union’s sustainable financial disclosure regulation (SFDR). It would define what sustainable finance means for European financial institutions in practice. It would be a standard measurement of their Environmental, Social and Governance (ESG) impact.

And so last week we saw the publication of the final report on DRTS by the European Supervisory Authorities. The consensus seems to be that the final version looks considerably watered down compared to the last one, proposed in April 2020. Some ascribe this to extensive industry lobbying during the consultation period.

EU’s sustainable financial disclosure regulation – details

What immediately attracts attention is that the number of mandatory indicators has been more than halved, from 32 to 14. Most of the removed ones relate to social factors. Examples include CEO pay ratio, human trafficking and corruption. Only five social factors are now mandatory.

Climate indicators fare better, but are still not sufficient. The ones that remain (carbon emissions, carbon footprint, carbon intensity) are not really enough to measure meaningfully contribution to Paris Agreement objectives. Another huge gap is the absence of forward-looking indicators among the proposed key performance indicators; those would have provided clear guidance regarding the climate alignment of financial market participants.

No data, really?

The first draft of the document was unwieldy in parts, and it would have been difficult to compile data on all the factors it proposed, currently impossible in some cases. Even certain sustainable investment groups had reservations in this regard, and that was one of the key complaints during the consultation process.

But with the forthcoming review of the Non-Financial Reporting Directive and the legislative initiative on mandatory due diligence for companies more data will become available anyway. The fact that data is not there is, moreover, the problem of the financial institutions themselves – in some cases, they don’t want to have it. They could easily have their investee companies produce it and their data providers supply it. A broken car speedometer doesn’t allow you to ignore speed limits – it’s on you to get it fixed.

Next frontier: Non-financial reporting directive (NFRD)

The narrative on SFDR, even among the critics, is a congratulatory one. “A welcome first step,” is what one reads over and over. We at the Altruist League advise our members to go far beyond that first step on their own initiative, by thinking about the ESG issues holistically, from both a regulatory and a moral standpoint. Superficial compliance with watered down ESG regulation won’t convince shareholders, clients or employees, whose awareness of these matters has grown exponentially over the past year alone.