‘’Deforestation is a main driver of climate change and biodiversity loss, and the EU contributes to it by consuming a significant share of products associated with deforestation. The EU, therefore, has the responsibility to contribute to ending it.’’ – European Commission
To fight climate change and biodiversity loss, the regulation on deforestation requires companies to ensure that cattle, cocoa, coffee, palm oil, rubber, soy and wood products sold in the EU and exported from the EU (covered products) have not contributed to deforestation and forest degradation. This regulation entered into force on 29 June 2023.
For the purposes of this Regulation, ‘deforestation’ means the conversion of forests to agricultural use, whether or not caused by human activities. As the ESG landscape tends to change rapidly, we wanted to see if some pieces of the Green Deal puzzle are starting to fit together, using deforestation as an example. How does this deforestation regulation interact with the SFDR, Taxonomy Regulation and CSRD? Can you as a financial market participant (re)use data received on deforestation? Let’s have a look.
In another article, we informed you on ESA’s final report on the review of PAI and financial product disclosures in light of the Sustainable Finance Disclosure Regulation (SFDR).
This report responds to a mandate sent by the European Commission (EC) to the European Supervisory Authorities (ESAs) in April 2022 to review several aspects of Delegated Regulation 2022/1288, also known as the SFDR Delegated Regulation or, in short, SFDR level 2.
After a consultation round in April 2023 and considering the feedback to the consultation, the ESA’s propose to adjust the SFDR level 2 in several areas, including PAI disclosures. The ESAs propose the introduction of a few new PAIs and changes to existing PAIs. One of the changes relate to a change of the PAI indicator on deforestation.
For those who are not yet familiar with PAI indicators. It is ana cronym of Principal Adverse Impacts of investment decisions on sustainability factors. The metrics of PAI Indicators are a way of measuring the (negative) impacts that companies (investments) have on the environment and wider society. PAI indicators are presented in Annex I of SFDR level 2 and consist of mandatory Environmental and Social indicators in table 1, and additional opt-in Environmental PAI in table 2 and Social in table 3.
The SFDR requires (among other things) disclosure, for example on an asset manager’s website, of the material adverse impacts of its investment decisions on sustainability factors, including a statement of its due diligence policy with respect to those impacts, whether mandatory or voluntary.In the current SFDR level 2 deforestation is defined as: the temporary or permanent human induced conversion of forested land to non-forested land and it is included as an additional opt-in environmental indicator: 15. Deforestation: Share of investments in companies without a policy to address deforestation.
In this final report the several changes on deforestation are being proposed to the EC.
The ESAs propose to change the definition of ‘deforestation’ aligning it with the recent Regulation on deforestation free products.
The indicator in the PAI statement itself remains unchanged: 16. Deforestation: Share of investments in companies without a policy to address deforestation.
Although it might occur to you that the number has changed into 16. We will circle back on that number later. Finally, a new formula to calculate this indicator has been introduced but remains out of scope for this article.
So yes, for the SFDR this final report shows alignment with the Regulation on deforestation should this proposed change become final. What about the Taxonomy Regulation?
As mentioned in our news item on Taxonomy and deep see mining, the Technical Screening criteria (amongst others) for Objective 6, Protection and Restoration of Biodiversity and Ecosystems, have been adopted (on June 27, 2023).
These Technical criteria do not refer to deforestation at all, let alone account for a list of criteria systematically safeguarding against deforestation or a reference to forest-risk products in scope of the Regulation for Deforestation-free products.
To our surprise, there is no link between the Taxonomy Regulation and the Regulation on deforestation or any reference to deforestation. Lastly the CSRD.
The CSRD requires companies to report on the impact of corporate activities on the environment and society, and requires the audit (assurance) of reported information. The detailed reporting standards are set out in European Sustainability Reporting Standards (ESRS) and were adopted in October 2023. In the ESRS, deforestation is defined as Temporary or permanent human-induced conversion of forested land to non-forested land. As you can see, the definition of deforestation does not refer to the definition in the Regulation on deforestation.
Furthermore, the ESRS on biodiversity and ecosystems requires companies to specifically disclose whether it has adopted a policy to address deforestation and explains that this information supports the information needs of those undertakings subject to SFDR, because it is derived from an additional indicator related to PAI as set out by indicator #15 in Table 2 of Annex I of SFDR level 2 regarding deforestation.
If the proposed changes under the SFDR become final, the current ESRS refers to an outdated PAI number and to a different definition of deforestation then included in the ESRS. As a result, the ESRS refers to deforestation with a different scope.
Our example shows that both the Taxonomy Regulation and CSRD are not – or not fully – aligned to the Regulation on Deforestation, although both could have adopted the newest definition of deforestation included in that Regulation, given timelines above. The proposed changes in the SFDR do seem to interact with the latest developments in the sustainability landscape. Changing only one piece of the puzzle only complicates the jigsaw for financial market participants further. And yes, ESG legislation within in the EU is moving fast, it seems the EU itself is struggling to keep up.
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