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How the black box of ESG disclosures and ratings is being blown open

Written by Garth Watson
on May 24, 2022

ESG disclosures now require sharing of confidential compliance data

Confidential compliance information relating to sustainability is now required for sustainability disclosures. Significantly this is required for financial service providers to market certain financial products as environmentally sustainable. 

Not many companies have this information at their fingertips and neither do ESG ratings agencies. 

This means that a lot of innovation is going to be required in order for financial market participants to get their hands on reliable sustainability compliance data in order to be confident that the financial products they market as sustainable, do in fact meet the legal requirements for such products.

The legal requirements in question are those that are coming out thick and fast in terms of the European Union Green Deal. At the center of things are the EU Taxonomy Regulations, SFDR (the EU’s Sustainable Finance Disclosure Regulations) and NFDR (Non-financial Reporting Directive). At a very high level, SFRD applies to financial market participants, while NFRD applies to large companies. The Taxonomy Regulations apply to both financial market participants and large companies and inform certain requirements set out in the SFDR and NFRD. For more information on this, here is a concise explanation of the application and relationship between SFDR, NFRD and the Taxonomy Regulations. It's worth noting too that the the upcoming CSRD (Corporate Sustainability Reporting Directive) will cast apply to a much larger number of large companies and is the successor to the NFRD.

A 3 prong transformation 

The Taxonomy Regulations lead a transformative three prong transition for ESG data. 

Firstly, the Taxonomy Regulations will move industries and financial markets away from ESG lip service to actual sustainability through operations and flows of capital towards material economic activities that make the world sustainable. 

Secondly, they envisage a radical redefinition of ESG data or Sustainability data. To date, ESG data has been publicly available or relatively easily disclosable by companies and collectable by ESG ratings agencies. The Taxonomy Regulations now make information relating to regulatory compliance (that has to date been confidential) into information that must be disclosed and reported. 

And thirdly, the Taxonomy Regulations are also set to change the way ESG data is collected. Many companies do not have the granular mechanisms and systems in place to assess compliance with the technical requirements set out in the Taxonomy Regulations (see details below), let alone report and disclose such data. All of this is set to change.

It’s either environmentally sustainable, or it’s not

The Taxonomy Regulations provide a very robust classification for what economic activities may be classified as an environmentally sustainable economic activity for the purpose of disclosures in terms of SFDR and NFRD. 

In short, to be classified as environmentally sustainable, an economic activity must contribute substantially  to one or more of the environmental objectives which are:

  1. climate change mitigation
  2. climate change adaptation
  3. the sustainable use and protection of water and marine resources; 
  4. the transition to a circular economy; 
  5. pollution prevention and control;
  6. the protection and restoration of biodiversity and ecosystems.

Then, the economic activity in question must also do no significant harm to any of the other environmental objectives.  Basically, this criterion says that you can’t save the world and stuff it up simultaneously. For example, if the economic activity is the operation of an offshore wind farm, the wind farm must, amongst other things, not undermine the protection and restoration of biodiversity and ecosystems.

Then there are a whole host of minimum safeguards that are set out. These include the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.

The crowning glory of the Taxonomy Regulations are the technical screening criteria which so far are in force only for the climate change mitigation and adaptation environmental objectives, but which are coming soon for the others. Basically, what the technical screening criteria do is add a whole lot of detail and specificity to the substantial contribution, do no significant harm and minimum safeguard criteria for what is required for an economic activity to be screened as economically sustainable. The draft technical screening criteria are about 1000 pages long, and incorporate by reference, the need to comply with a host of other existing EU EHS regulations and directives. Some of these are listed below. What this effectively means is that whether an economic activity is screened as environmentally sustainable or not is a matter of regulatory compliance, and regulatory compliance with a host of very technical and granular environmental regulations. I’ll give some examples from the wind power economic activity.

Sustainability regulatory “bookkeeping” technology, help please!

One of a plethora of screening requirements for an economic activity that is being screened as environmentally sustainable on grounds that it generates electricity from wind is that it does not adversely affect biodiversity.  Health warning. These action items / screening requirements are based on a tiny excerpt from the technical screening requirements and other regulations incorporated by reference in the technical screening requirements of the Taxonomy Regulations. Don’t read all of them, but do get a sense for the scale of what may be thought of sustainability regulatory data bookkeeping. Ok, get a sense of the challenge from one small corner of the Taxonomy Regulations, but scroll quickly once you’ve done that. I’ll see you on the other side of this small sample of screening criteria.

  • An Environmental Impact Assessment (EIA) or screening has been completed
  • Where an EIA has been carried out, the required mitigation and compensation measures for protecting the environment are implemented.
  • The feasibility of using equipment and components of high durability and recyclability and that are easy to dismantle and refurbish has been assessed.
  • Where feasible, equipment and components of high durability and recyclability and that are easy to dismantle and refurbish is used.
  • The activity has been screened to identify which physical climate risks from the list in Section II of this Appendix may affect the performance of the economic activity during its expected lifetime
  • The quality and occurrence of habitats and the distribution and abundance of species are in line with prevailing physiographic, geographic and climatic conditions.
  • Non-indigenous species introduced by human activities are at levels that do not adversely alter the ecosystems.
  • Populations of all commercially exploited fish and shellfish are within safe biological limits, exhibiting a population age and size distribution that is indicative of a healthy stock.
  • All elements of the marine food webs, to the extent that they are known, occur at normal abundance and diversity and levels capable of ensuring the long-term abundance of the species and the retention of their full reproductive capacity.
  • Human-induced eutrophication is minimised, especially adverse effects thereof, such as losses in biodiversity, ecosystem degradation, harmful algae blooms and oxygen deficiency in bottom waters.
  • Sea-floor integrity is at a level that ensures that the structure and functions of the ecosystems are safeguarded and benthic ecosystems, in particular, are not adversely affected.
  • Permanent alteration of hydrographical conditions does not adversely affect marine ecosystems.
  • Concentrations of contaminants are at levels not giving rise to pollution effects.
  • Contaminants in fish and other seafood for human consumption do not exceed levels established by Community legislation or other relevant standards.
  • Properties and quantities of marine litter do not cause harm to the coastal and marine environment.
  • Introduction of energy, including underwater noise, is at levels that do not adversely affect the marine environment.
  • The spatial distribution, temporal extent, and levels of anthropogenic impulsive sound sources do not exceed levels that adversely affect populations of marine animals.

Screening for sustainability in practice

In terms of the Taxonomy Regulations, screening for sustainability is actually tantamount to assessing compliance (with reams and reams of very granular and technical standards). These are the kinds of data that can only be captured and maintained by the likes of EHS managers at an operation specific level and only by using sophisticated regulatory technology that makes this kind of non-financial bookkeeping tractable and possible. Without non-financial bookkeeping, there can be no non-financial or sustainability reports or disclosures to head office, let alone in terms of NFDR or SFDR. 

Financial reporting relies on accurate financial bookkeeping and auditing according to GAAP. An appropriate equivalent for non-financial bookkeeping and reporting has been a long time coming and a lot of useful consolidation has been happening in this space and it will inevitably culminate into legally binding standards for non-financial accounting and disclosure (a topic for another day).

While this “consolidation of standardisation” runs its course, the Taxonomy Regulations provide for a level of non-financial accounting that brings certainty as to what’s required. The next phase of the journey will be the building out of teams of non-financial “bookkeepers” probably from the ranks of EHS managers that will use technology like Libryo Assess to assess compliance with and screen against the requirements in the Taxonomy Regulations and with emerging sustainability standards. This, in turn, will enable the required reporting and disclosures to be made and will ultimately open up the black box of ESG ratings that can be trusted so that allocators of capital can invest in ways that actually do make the world a sustainable place.

If you want to learn more about Libryo and see our features in action:




Annexure - some of the regulations incorporated by reference in the technical screening criteria, compliance with which needs to be assessed in order to determine whether an economic activity is environmentally sustainable or not. Confidential compliance information is now required for sustainability disclosures and ESG ratings.

  • Regulation (EU) 2020/852 (Taxonomy) on the establishment of a framework to facilitate sustainable investment
  • Regulation (EU) 2018/842 of the European Parliament and of the Council of 30 May 2018 on binding annual greenhouse gas emission reductions by Member States from 2021 to 2030 contributing to climate action to meet commitments under the Paris Agreement and amending Regulation (EU) No 525/2013
  • Commission Implementing Decision (EU) 2018/1147 of 10 August 2018 establishing best available techniques (BAT) conclusions for waste treatment, under Directive 2010/75/EU of the European Parliament and of the Council 
  • Commission Regulation (EU) 2016/2281 of 30 November 2016 implementing Directive 2009/125/EC of the European Parliament and of the Council establishing a framework for the setting of ecodesign requirements for energy-related products, with regard to ecodesign requirements for air heating products, cooling products, high temperature process chillers and fan coil units
  • Commission Regulation (EU) No 206/2012 of 6 March 2012 implementing Directive 2009/125/EC of the European Parliament and of the Council with regard to ecodesign requirements for air conditioners and comfort fans
  • commission Regulation (EU) No 813/2013 of 2 August 2013 implementing Directive 2009/125/EC of the European Parliament and of the Council with regard to ecodesign requirements for space heaters and combination heaters
  • Decision (EU) 2017/1442.
  • Decision (EU) 2017/848 in relation to the relevant criteria and methodological standards for that descriptor.
  • Directive (EU) 2015/2193 
  • Directive 2000/60/EC
  • Directive 2008/50/EC
  • Directive 2008/56/EC, requiring that the appropriate measures are taken to prevent or mitigate impacts in relation to that Directive’s Descriptor 11 (Noise/Energy)
  • Directive 2009/125/EC 
  • Directive 2010/75/EU of the European Parliament and of the Council(174), emissions are within or lower than the emission levels associated with the best available techniques (BAT-AEL) ranges set out in the latest relevant best available techniques (BAT) conclusions, including the best available techniques (BAT) conclusions for large combustion plants
  • Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a system for greenhouse gas emission allowance trading within the Union and amending Council Directive 96/61/EC (Text with EEA relevance)Text with EEA relevance
  • directive (EU) 2015/2193
  • Regulation (EU) 2018/841 of the European Parliament and of the Council of 30 May 2018 on the inclusion of greenhouse gas emissions and removals from land use, land use change and forestry in the 2030 climate and energy framework, and amending Regulation (EU) No 525/2013 and Decision No 529/2013/EU
  • Regulation (EU) 2017/1369 on energy labels
  • Regulation (EU) 2019/1009 or national rules on fertilisers or soil improvers for agricultural use
  • Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (Text with EEA relevance)
  • Regulation (EU) No 528/2012 of the European Parliament and of the Council of 22 May 2012 concerning the making available on the market and use of biocidal products
  • Directive (EU) 2018/2002 of the European Parliament and of the Council of 11 December 2018 amending Directive 2012/27/EU on energy efficiency
  • Council Directive 2003/96/EC of 27 October 2003 restructuring the Community framework for the taxation of energy products and electricity
  • Renewable Energy Directive
  • Commission Delegated Regulation (EU) 2021/2139 supplements regulation 2020/852 by establishing the technical screening criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change mitigation or climate change adaptation and for determining whether that economic activity causes no significant harm to any of the other environmental objectives.
  • Commission Delegated Regulation (EU) 2021/2178 supplements regulation 2020/852 by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU concerning environmentally sustainable economic activities, and specifying the methodology to comply with that disclosure obligation.