EU regulators warn omnibus proposal could increase financial risk

The EU’s sustainable omnibus package promises to simplify climate reporting requirements for companies, reducing the scope for 80% of firms. But some financial regulators and experts are concerned the proposed changes would increase economic risk and make it more difficult to invest in green projects.

The European Central Bank (ECB) has cautioned the EU from drastically reducing the scope of the corporate sustainability reporting (CSRD) and due diligence directives (CSDDD). In an opinion released earlier this month, the central bank welcomed the European Commission’s goal of simplifying requirements. But it cautioned that its plan could increase risk for the economy, investors and the EU’s wider sustainable goals.

“The right balance” is needed to ensure reporting benefits are met, as “well-calibrated sustainability reporting requirements can support the [EU’s] priorities, including those set out in the competitiveness compass”, the ECB said.

The ECB recommends the EU limit the reduction of the scope of companies covered by CSRD to 500 employees instead of 1,000. It also proposes any credit institution, regardless of size, that is a “significant institution” be subject to CSRD “due to the importance of ensuring sufficient ESG data from the banking sector”.

The reduction in scope also means that a large number of third-country companies with operations in the EU would not be required to report, and the ECB recommend the threshold for other countries not be amended as it  “increases the gap in data availability between Union and third-country undertakings, with negative consequences for financial institutions’ risk management”.

Physical and transition risks from climate change have “profound implications” on price and financial stability and the ECB needs to take these impacts into account when determining its monetary policy stance, it said.

“The availability of sustainability information is a minimum requirement to enable it to do so”.

How would the EU’s sustainability omnibus impact financial regulators?

The ECB isn’t the only regulator to voice concerns about changes through the EU omnibus to the CSRD and CSDDD.

The Dutch Authority for the Financial Markets (AFM) has warned that the reduction in scope “could result in less information being available to investors and other stakeholders”.

The AFM called on listed companies and audit firms to still provide transparent and reliable sustainable data, as the proposal “reflects a political stance and is yet to be finished”. The regulator is still going ahead with a study of the sustainability reports of large listed companies, as well as an investigation into how audit firms are preparing assurances based on CSRD.

Meanwhile, the European Banking Authority issued a report just before the omnibus was proposed that highlights the complexity of ESG risks and the need for standardised and high-quality climate data. The report notes that while there has been some progress on data access, it is still incomplete and data from the CSRD and other sustainable reporting rules are needed to help mitigate climate change risk.

There are also concerns that it could impact insurers’ transparency and limit data needed to assess climate risks, as up to 85% of European insurance firms could be exempt from sustainable reporting.

The European Commission has said the EU’s Green Deal won’t be diminished. Humberto Delgado Rosa, director for biodiversity and environment at the European Commission, said during a panel at the Sustainable Investment Forum Europe conference in Paris that the simplification process doesn’t mean deregulation for the sake of less red tape.

“The simplification agenda is a very legitimate one, one that aims to maintain competitiveness, because without it we would not be able to move towards sustainability,” he said.

The need for ESG data

While some lobby groups have welcomed the EU’s omnibus changes, many investors, asset managers, nonprofits, supervisors, and regulators are concerned about its diminished scope and the potential lack of data.

The CSRD is vital for managing the risks investors and central banks face from climate change and plays a role in keeping the EU competitive, said Vincent Vandeloise, senior researcher at Finance Watch.

“Today, financial lobbies welcome the omnibus package but tomorrow they will be back to complaining about data availability and the quality of the information communicated by their data providers,” he said.

Key changes to the CSRD include changing the legislation that only covers companies with more than 1,000 employees or revenue of more than €50mn net turnover. Instead, smaller companies can opt to voluntarily report their climate data. But experts have long argued that voluntary climate measures don’t always work.

Helena Viñes Fiestas, chair of the EU platform on sustainable finance and commissioner of the Spanish Financial Markets Authority, said that going back to voluntary measures defeats the whole purpose of the legislation which is about comparability.

“In my CV, I’m going to report the best, I’m not going to report certain things. [The voluntary sustainable reporting] is the same. Why would your company report on something that performed really badly? It is not mandatory, right?” she said.

Unintended consequences of the EU omnibus

The reduction in scope would also undermine other rules such as the ESG rating regulation which focused on governance and transparency from rating providers. The regulation assumes that transparency and access to data would encourage rating agencies to develop their offerings, but with fewer companies reporting under CSRD rating providers will instead divert “resources to fill data gaps, rather than enhancing their methodologies”, said Finance Watch’s Vandeloise.

“This is a major setback, as 70% of the banks reported that they rely on ESG ratings to manage their risks. Improving their quality is therefore fundamental,” said Vandeloise.

The ECB says harmonised, standardised and reliable sustainability data will also help investors and facilitate capital, which is needed as the EU transitions to a green economy and puts its Clean Industrial Deal in place. Not only will this help increase competition, but harmonised data will also reduce compliance costs for companies and data users.

“The sustainability reporting framework, in particular the reporting standards on climate change, offers valuable metrics to inform investments in low-carbon industries, renewable energy projects, transition finance and other clean and green initiatives, thereby supporting both competitiveness and the achievement of the Union’s climate targets”, the ECB’s opinion states.