In our role on capital advisory and debt finance, more and more clients ask us when and how ESG will impact their activity and the way they interact with their banks. This post is the first of three in our attempt to summarize the impact of ESG regulation.

1.   Introduction

Concerns about the future of the natural Environment, prevailing Social conditions, and Governance of private and public institutions inspire today’s ESG movement, also accelerated by the current pandemicESG criteria are becoming increasingly influential among Financial Institutions (FIs) when deciding where to allocate their money. It is a necessity for companies, financial and non-financial alike, to understand the underlying ESG movement and to plan applicable roadmaps and courses of action to stay on top of the upcoming financial reforms. 

The financial sector is under increasing pressure lately from different actors: regulatory bodies, governments and society. New regulatory frameworks are in the pipeline in Europe and will bring major disruptions to how FIs complete their reviewing and reporting activities. Regulations such as the EU Sustainable Finance Disclosure Regulation ‘SFDR’, the EU Green Taxonomy or the GHG Accounting and Reporting Standards will all become mandatory and will overall accentuate the reporting effort expected from FIs. Financiers will pass on these regulatory constrains to companies, who can expect an increase in their reporting on sustainability impact of their product and activities. This reporting is expected to start in the short term, i.e. 2022/23.

The European Central Bank and the European Banking Association have published guides with their expectations on integration of climate and environmental risks in banks risk systems and prudential controls. These will invariably affect interaction and requirement with the banks’ clients.

Besides, the growing ESG movement is at the heart of sustainable finance and very much linked to one of Ernest Partners’ three key values, Durability. As we challenge ourselves to reach solutions that will last through time, we promote sustainable financing opportunities whenever possible. 

This article intends to give a high-level view on the future of the ESG approach and reporting, namely: overall philosophy and ambitions, how ESG scoring works, and how it might affect and influence companies’ access to funding.

2.  Underlying philosophy and ambitions of the ESG approach and reporting

ESG investing was more of an anecdotal and exploratory investment idea and was limited to a small number of players before the 2008 Global Financial Crisis. In the wake of the crisis, the concept of green finance rapidly developed and increasingly impacted the landscape of the financial world. While green finance is a generic term to designate the financing of green assets (infrastructure for low-carbon transition, renewable energy, water management, biodiversity protection, etc.), ESG investing is a more comprehensive term, and is not limited to the environmental challenge, but also encompasses social and governance considerations.

As such, the tools that have been developed for the extra-financial analysis of (mostly listed) companies are relatively recent. The integration of ESG criteria in funds’ investment strategies has evolved from a niche market a few years ago to a mainstream phenomenon today. The trend is now significantly expanding in the passive investment space as well and it is unlikely to slow down with the current crisis.

The ESG’s cornerstone is built on:

  • First, the United Nations’s Sustainable Development Goals (SDGs). The UNs General Assembly defined 17 SDGs in 2015, that each country must implement and achieve by 2030. Every SDG is composed of multiple targets (169 in total), concrete and actionable measures which countries need to implement by the end of the decade.
  • Second, the 2016 Paris Climate Agreement, which aims to limit the temperature increase to 1.5°C. In October 2018, the International Panel of Climate Change released a special report that calls for the limitation of global warming to 1.5°C in order to reduce the occurrence of future extreme risks for human, nature and ecological systems.
  • Third (agreement in principle at EU level), the European Climate Law, with the commitment of achieving carbon neutrality by 2050 and a net greenhouse gas emissions reduction target of at least 55% by 2030 compared to 1990. This target is to be reached through the Commission’s flagship plan, the European Green Deal, including its Green Taxonomy. The European Green Deal provides a roadmap with actions to boost the efficient use of resources by moving to a clean, circular economy and stop climate change, revert biodiversity loss and cut pollution. The Taxonomy inside the Green Deal will serve as a classification tool aimed at investors, companies, and financial institutions. It will define the performance of economic activities making a significant contribution to one of the six following environmental objectives: Climate change mitigation, Climate Change Adaptation, Water and Marine Resources, Circular Economy Transition, Pollution Prevention & Control, Biodiversity & Ecosystem Protection.

Over the next decade, these goals will guide governments, regulatory bodies, FIs and companies alike in preparing for a future that ensures stability, a healthy planet, fair, inclusive and resilient societies and prosperous economies.

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