Exploring Sustainable Finance in the EU: Upcoming Regulations and Disclosure Requirements for Financial Institutions in 2024

Coauthored by Madalena Martins and Angélica Afanador

As climate change impacts are increasingly felt, governments and regulatory bodies are responding by introducing new environmental, social, and governance (ESG) regulations. According to an analysis by ESG Book, ESG regulations have increased globally by 155% in the past decade. For example, the European Union’s sustainable finance framework introduced six different elements, including the EU Taxonomy, the Corporate Sustainability Reporting Directive (CSRD), the Sustainable Finance Disclosure Regulation (SFDR), and the European Green Bond Standard. While all of these new regulations are key for incentivizing sustainability, it can be challenging for organizations to identify what they must report and ensure compliance. This blog post focuses on the most prominent changes for financial institutions happening in 2024 within the EU.

Sustainable Finance Disclosure Regulation

Under the SFDR, financial institutions must report on new ESG disclosure requirements, including their financed emissions, by June 2024.

The SFDR is a mandatory disclosure requirement for financial market participants active in the EU. It sets the rules on how financial institutions need to disclose ESG indicators at an entity and product level. Those indicators are clustered into what the regulation defines as principal adverse impacts, or PAIs, which refers to unfavorable effects driven by investment decisions. One of the key indicators is the climate impact of financial activities or financed emissions. Financial institutions will need to disclose these emissions from mid-2024 at the latest and are encouraged to use the standards developed by the Partnership for Carbon Accounting Financials (PCAF). PCAF has grown into the leading initiative for measuring emissions associated with financial activities and is compatible with globally recognized standards and initiatives.

Previously, firms could use the “comply or explain” principle to explain why they were not complying yet. Under phase 2 of the SFDR, which started on January 1, 2023, firms covered by the SFDR no longer have that option and are required to report annually under the SFDR disclosure requirements. The report for each reference period is due by June 30 of the subsequent year. This means that the reporting for the 2023 period must be done by June 30, 2024. From this reporting period onward, it will also be mandatory to include a year-on-year comparison between the reference periods. This comparison must cover at least five reference periods once the fifth reference period has been reached.

Corporate Sustainability Reporting Directive

Financial institutions covered by the CSRD will need to apply the European Sustainability Reporting Standards (ESRS) disclosure requirements to their reports in 2024, and those not yet covered need to prepare for the following years.

The CSRD is a mandatory requirement for “in scope” companies and financial institutions to report on their ESG impacts, risks, and opportunities. Replacing and enhancing the Non-Financial Reporting Directive (NFRD), the CSRD, through its supporting ESRS, will introduce more detailed disclosure requirements. For example, it requires companies to measure the carbon (and environmental) footprint of their value chains. This can help financial institutions access better information on the emissions of their portfolio companies. CSRD-related disclosures will also enable financial market participants to assess the ESG risks and opportunities of their investments and include the associated information in their SFDR reporting.

The CSRD has been in effect since January 2023, with a phased implementation through 2028. Starting in 2024, all large companies and financial institutions already covered by the NFRD will have to report in line with the CSRD. In 2025, this requirement will extend to all large companies and financial institutions meeting two of the following criteria: 250 or more employees, a net turnover of €50 million, or assets totaling €25 million (see here for guidance on the recently amended criteria for defining company and group sizes in the EU). Preparation for CSRD reporting should start in 2024 for entities falling under this extended group.

European Green Bond Standard

From 2024 onward, issuers must comply with the Green Bond Standard if they want to label their bonds as such.

The recently approved Green Bond Standard establishes a set of rules that determines what is required for labeling a bond as green in line with the EU Taxonomy. This standard will ensure consistency and comparability in the market, benefiting both bond issuers and investors. It also ensures transparency, as issuers will have a tool to demonstrate they are funding legitimate green projects aligned with the EU Taxonomy. While the standard is voluntary, once it enters into force at the end of 2024, compliance becomes mandatory for issuers wanting to call their bonds EU Green Bonds.

Green Asset and Banking Book Taxonomy Alignment Ratios

Starting in 2024, the Green Asset Ratio (GAR) and Banking Book Taxonomy Alignment Ratio (BTAR) will require banks to report how much of their portfolio is invested in sustainable activities.

The GAR, a new key performance indicator for European banks, measures the percentage of a bank’s assets invested in EU Taxonomy-eligible economic activities. As part of the European Banking Authority’s wider regulatory framework on sustainability, about 150 large EU lenders will be required to disclose their GAR starting next year.

This new metric will become mandatory to disclose starting in January 2024 for the 2023 financial year, requiring a higher level of granularity from banks for taxonomy reporting. However, the GAR does not include assets not aligned with the taxonomy or assets whose sustainability cannot be assessed because they are, for example, not covered by the NFDR/CSRD. From June 2024 onward, banks must also report the BTAR, which expands the range of the GAR and includes exposure to assets not covered by the NFRD/CSRD, including small and midsize enterprises and non-EU clients.

What’s Next?

The list of sustainable finance regulations is complex and demanding. Nonetheless, these regulations offer an opportunity for financial industry players to find their niche in the transition to a climate-neutral, climate-resilient, resource-efficient, and fair economy. And they will ultimately create transparency in the market for sustainable investments.

To learn more about Guidehouse’s holistic approach to sustainable finance, contact Angélica Afanador and Dylan Hauser.