The European Green Deal. Directive 2014/95/EU: opportunities and obligations for European businesses. The €750 billion plan, not coincidentally named Next Generation EU by Brussels and approved by European leaders last July, sets among its main objectives that of steering the Union towards a sustainable economy—not only environmentally, but also economically and socially.
Sustainability will be the central challenge of the unprecedented financial plan implemented by the Union to shape the European socio-economic model of the near future. In order to obtain European resources, national plans must ensure that at least 37% of the measures are allocated to the objective of environmental transition, in line with the European Green Deal, which aims to achieve climate neutrality by 2050.
The more than €200 billion allocated to the environment (Next Generation EU and Multiannual Financial Framework 2021–2027) clearly represent Brussels’ intention to leverage environmental policy to overcome the economic crisis and to allow the Union to rise to a position of global technological leadership.
It is therefore necessary to identify the production and consumption standards that will be used in the near future. In this regard, many countries, research centres and companies are investing in various technological paths such as synthetic fuels, batteries (research investments to overcome the inefficiencies of current electric batteries and disposal), electricity, resource recovery from waste, methane, hydrogen nuclear, biofuels, CO₂ capture, energy efficiency, and the circular economy (Enel X, for example, is a cutting-edge business model that positions itself as a true booster of energy circularity within the corporate supply chain).
Always keeping in mind the objective set by the Green Deal on climate neutrality by 2050, our country will have to carry out a wide-ranging investment programme aimed at decarbonising the energy sector, redefining the transport sector, drastically reducing polluting emissions, strengthening renewable energy, increasing the energy efficiency of public and private buildings and production facilities, implementing integrated management of water and waste, promoting the circular economy, and a series of measures to increase resilience to climate change.
It is evident that the Green Deal is the most avant-garde experiment in the field of energy transition on a global scale, because it entails an economic and industrial transformation of the countries involved, which also ensures the social inclusion of the entire process. The European Union has realised that climate and energy policies alone are no longer sufficient to overcome the global climate challenge: the programme launched by the Commission is much more than an energy transformation—it is a true industrial revolution that will impact every aspect of national economic and social systems.
It is precisely in this context that Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 is framed. Although it predates by a few years the communication from the European Commission to the Parliament and the Council on the proposal for the Green Deal, it already reflects the need to bring transparency to the social and environmental information of companies operating across all sectors of the economy, within a renewed Union strategy on corporate “social responsibility” and in a perspective of transparent, responsible business conduct aimed at sustainable and inclusive growth. The European directive sets out the minimum legal obligations for large undertakings to provide, among other things, detailed information regarding environmental aspects, including the current and foreseeable impact of the undertaking’s activities on the environment, health and safety, as well as on the use of renewable and non-renewable energy resources, greenhouse gas (GHG) emissions, water use, and air pollution. The non-financial statement (NFS).
The European legislator requires large undertakings to prepare an NFS, which must contain a brief description of the business model, a description of the policies applied by the undertaking and their outcomes, including due diligence procedures, the principal risks related to the undertaking’s activities—including in connection with its business relationships, products, and services (including the entire supply chain)—that may cause adverse impacts on the environment, and the key non-financial performance indicators relevant to the specific business activity.
The directive further specifies that undertakings required to disclose non-financial information may rely on national, Union-level (such as the EMAS Eco-Management and Audit Scheme), or international frameworks (Global Compact and the United Nations Guiding Principles on Business and Human Rights, the OECD Guidelines for Multinational Enterprises, the Global Reporting Initiative, ISO 26000 of the International Organization for Standardization, etc.).
Several critical issues immediately emerge from the analysis of the directive. Firstly, it does not clarify what the key performance indicators should consist of, to the point that Recital (17) expresses the hope that the Commission will develop non-binding guidelines, including general and sectoral non-financial key performance indicators, in order to facilitate the communication of non-financial information by undertakings. Secondly, the directive refers to national, Union, and international standards for the preparation of the NFS, without providing further details.
The vague nature of the provisions contained in Directive 2014/95/EU led the Commission to first issue the communication entitled “Guidelines on non-financial reporting” in June 2017 and, in July 2019, the communication entitled “Guidelines on non-financial reporting: Supplement on reporting climate-related information”.
For the sake of conciseness, we will highlight only the passages contained in the two aforementioned communications that seem most relevant for the purposes of this analysis. Both communications are not technical standards and provide non-binding guidelines without introducing new legal obligations; therefore, those preparing the NFS for undertakings cannot claim that the statements are compliant with the guidelines provided in the communications. With regard to key performance indicators, the 2017 communication highlights the characteristics that such indicators should have to make the performance, results, position, and impact of the undertaking’s activities more understandable, as well as the internal processes for risk management and evaluation. In the section dedicated to environmental issues, the communication provides two examples of key performance indicators.
In the first example, the document refers to the annexes to Commission Recommendation 2013/179/EU, which include methodologies for measuring the environmental footprint of products and organisations; more specifically, these are life cycle assessment methodologies that allow companies to identify, for each product or for an entire organisation, the most significant impacts, their contributing processes, and their emissions throughout the entire value chain of the company.
In the second example, the document highlights how a company may consider, as key performance indicators, energy performance and improvements thereof, energy consumption from non-renewable sources and energy intensity, GHG emissions in metric tonnes of CO₂ equivalent and GHG intensity, emissions of other pollutants (measured in absolute value and intensity), extraction of natural resources, impacts and dependencies in relation to natural capital and biodiversity, and waste management.
Despite this, the document does not concretely clarify—either for environmental issues or for any of the other topics addressed by the directive—how such quantitative indicators should be used in drafting the NFS.
The Commission’s communication of June 2019 aims to fill the numerous gaps in corporate reporting of climate-related information, as well as to further improve the quantity, quality, and comparability of disclosures to meet the needs of investors and stakeholders. The document explores a first important point—that of “double materiality” introduced by Directive 2014/95/EU. On the one hand, the “performance of the company, its results […] and its position” refers to financial materiality, in its broader sense, concerning the impact on the value of the company; in this case, of greater interest to investors, climate-related information must be disclosed as it is necessary to understand the company’s performance, results, and position. On the other hand, the reference to the “impact of the [company’s] activities” refers instead to environmental and social materiality; in this second case, of greater interest to consumers, employees, business partners, the community and civil society organisations, climate information must be disclosed if necessary to understand the company’s external impact on the environment. It is worth noting that in the near future these two perspectives of risk will increasingly tend to overlap.
The document highlights the adaptation of markets and public policies to climate change and examines the positive and/or negative repercussions that businesses may have on the climate, which could translate into commercial opportunities and/or financially significant risks. The assessment of the relevance of climate-related information impacts the entire value chain of the company and implies a broader time horizon compared to that traditionally expected for financial information (the fact that some climate-related risks are perceived as long-term risks should not lead companies to believe that climate is not a relevant topic). Another interesting topic addressed in the document is the analysis of climate-related risks/opportunities. From a risk perspective, the analysis considers, on the one hand, the performance, results, and position of the company deriving from climate change; on the other, the main risks of negative repercussions on the climate resulting from the company’s activities.
The risks of negative repercussions on the company arising from climate change are identified as “physical risks” (linked to future climate events) and “transition risks” (arising from the transition for those sectors and economies that will have greater difficulty adapting to the new paradigm based on the phasing out of fossil fuels).
The negative repercussions of climate on companies (increasingly intense adverse climate events), which can affect different geographical areas and numerous economic sectors, reduce the ability of companies to diversify their risks and can severely destabilize the entire financial system. At the same time, a disorderly transition could generate widespread losses among economic actors due to their exposure to carbon-intensive sectors, with potential systemic effects. Specifically with regard to transition risks, the conversion of the economic system towards sustainability is not an immediate process and is conditioned by numerous variables. It is important to study the effects of climate change on the economy and to quantify the risks that could materialize even in the case of a disorderly transition to a low-carbon economy.
To promote greater comparability of non-financial information, in the 2019 communication the Commission urges companies subject to Directive 2014/95/EU to consider the possibility of disclosing the key performance indicators analytically listed in the document, together with the unit of measurement to be used, the rationale behind the application of the indicator, the alignment with other standards on information disclosure, and the reference to Union policies. The explanatory tables indicated in the 2019 communication refer to GHG emissions (direct GHG emissions; indirect GHG emissions from the production of electricity, steam, heating or cooling acquired and consumed; all other indirect GHG emissions generated in the reporting company’s value chain), to energy consumption (total consumption and/or production of energy from renewable and non-renewable sources; energy efficiency objective; objective of consumption and/or production of renewable energy), to physical risks (assets located in regions likely to become more exposed to acute or chronic climate-related physical risks), to products and services (percentage of revenue, in the reporting year, derived from products and services associated with activities that meet sustainability criteria, contributing to the mitigation of climate change or adaptation to it, as set out in the regulation establishing a framework to facilitate sustainable investment; percentage of investments (CapEx) and/or expenditures (OpEx), in the reporting year, for assets or processes associated with activities that meet the criteria to contribute to the mitigation of climate change or adaptation to it, as set out in the regulation establishing a framework to facilitate sustainable investment), to green finance (green bond ratio related to climate and/or green debt ratio), and to banks and insurance companies (amount or percentage of carbon-associated assets in each portfolio in millions of euros or as a percentage of the current portfolio value; weighted average carbon intensity of each portfolio, where data is available or can be reasonably estimated; volume of exposures by counterparty sector; lending and investment activities; insurance underwriting activities; asset management activities). The quantification of the economic risks linked to climate change. Green finance. In recent years, the international community has made increasing efforts to tackle climate change, which has led to a major push in the analysis of related economic risks, sparking significant interest in the financial world. Over the years, specialised data providers have developed scores relating to social, environmental, and governance (ESG) sustainability aspects for listed market activities, which are now carefully considered by investors alongside the economic and financial characteristics of companies.
Green finance, although it has stimulated the conversion of business activities towards a green economy, has nonetheless imposed a series of necessary reflections on the market. First of all, it is necessary to quantify climate risks for individual economic entities and for the financial system as a whole in order to develop policies for mitigation and adaptation to climate change. The quantification of risks, both physical and transitional, is far from easy—not only because the information, in the form of estimates derived from natural and climate sciences, is inherently difficult to measure, but also due to the lack of detailed databases useful for quantifying the exposure and vulnerability of individual economic entities or specific business activities.
The economic risk for a company resulting from a climate shock (physical or transitional) is generally defined as the product of three components: the expected probability of the event in question (hazard), which may manifest as the occurrence of an extreme natural event (heatwave, flood, etc.) or the introduction of a specific alternative energy technology or unexpected regulation aimed at limiting the use of a fossil fuel; the economic value of the activities exposed to such events (exposure); the expected loss per exposed unit, or vulnerability. Recent studies have shown that companies generally show limited attention to the management of climate risks (both physical and transitional), which could stem from a cultural issue (in terms of low sensitivity to the topic) but also from the difficulty of measuring such risks due to a lack of data. Regarding physical risk, the difficulties related to measuring hazard arise from the fact that the potentially usable information assets across the national territory appear partial (lack of historical data for each individual economic entity, detailed data on the impact of natural disasters over past decades, and public data on the location of households and their properties or on the existence of insurance policies for real estate or businesses against extreme events), highly fragmented (some data, for example, is available only at the provincial level), and not always usable for financial analysis. In practice, for financial risk analysis, even assuming that hazard is known with sufficient territorial detail, it is not always straightforward to quantify exposure (consider companies with operating units such as plants, offices, warehouses, etc., located in areas exposed to varying levels of risk or even in different countries), as it would be necessary to know the monetary value of each business unit in order to determine overall risk exposure. If hazard and exposure are known, even assuming a certain margin of error, vulnerability—that is, the expected loss for the capital exposed to the risk—would still need to be estimated. Regarding the financial materiality of transition risk for companies (which results from the rapid repricing or devaluation of high-carbon assets induced by policy changes), to assess the exposure of already-financed business activities, it would be advisable to gather information on the sources of financing and the related greenhouse gas emissions.
More specifically, the Greenhouse Gas Protocol of the World Resources Institute provides a classification of greenhouse gas emissions into three categories: emissions produced during the creation of goods and services (direct emissions, “scope 1”); emissions resulting from energy inputs used in production processes (indirect emissions, “scope 2”); and all remaining indirect emissions produced along the company’s value chain, different from “scope 2” (emissions “scope 3”). Based on this international classification, the total emissions of a company’s product/service are obtained by summing scope 1, 2, and 3 emissions.
If, on the other hand, one wishes to assess the exposure of activities to be financed, it would be advisable to obtain detailed information on the emissions that would be produced in connection with such activities. In practice, it is clear that acquiring the necessary information is not always easy. The development of the market for environmentally sustainable financial instruments: green finance and ESG scores.
According to a report by the Global Sustainable Investment Alliance, in 2018, at least 30.7 trillion dollars (14 in Europe and 12 in the United States) were allocated to sustainable investments, an increase of 34% compared to 2016. The future of the green financial instruments market will depend on the quality and reliability of the data used for investment decisions. One of the sustainability metrics on which sustainable investments are based is represented by ESG scores.
Based on information acquired from open sources (internet, public databases, questionnaires, press news, and other sources), some data providers have developed scores for companies—independent of their core business—related to three ESG aspects: Environmental, Social, and Governance.
The aggregation of these scores—based on a weighted average of different criteria used to determine the final score—provides investors with a measure of a company’s ability to respond to ESG risks (such as, for example, market risks related to climate regulation, risks arising from lawsuits initiated by consumers or penalties for unlawful behavior, and reputational risks, etc.) and to seize new opportunities (such as the ability to innovate sustainably, streamline internal business processes, and increase the competitiveness of products) through virtuous practices (such as reducing waste production or implementing proper waste management and disposal processes, which represent positive externalities for the community in the long run). ESG scores, to date, present numerous critical issues. First of all, the methods of evaluating and aggregating the individual factors into overall scores still appear unclear, making it difficult to assess—beyond the final score—the specific weight assigned to the individual E, S, and G components related to a specific activity.
The arbitrariness in the selection of data considered in the evaluation process leads to significant discrepancies between the scores assigned by different data providers, highlighting clear limitations in the use of such scores for investment decisions. But let’s go into more detail. Currently, the qualitative level of information on green bonds, GHG emissions, and ESG ratings of individual companies—provided by the various independent data providers operating in the market—is extremely variable, in the sense that, at the level of a single company, the assessments developed by different providers on the same aspect often differ significantly.
For example, with regard to GHG emissions, the reliability and consistency of estimates are greater for direct emissions (scope 1), followed by indirect emissions (scope 2), and increase exponentially if the data is provided by the company under evaluation. However, the limited number of companies that autonomously provide this data leads data providers to make assessments characterized by high margins of error, which become even more evident in the case of scope 3 emissions.
The unreliability of the estimates is also due to the lack of disaggregated and timely information on the energy consumption of companies, which is a fundamental factor for calculating emissions. In Italy, for example, there are no official data on the energy consumption of households and businesses, in the sense that the Integrated Information System (SII) is managed by the GSE Group, which holds information on electricity and gas consumption as recorded by meters, but such data are not available, not even in aggregated form. Similarly, there is a high degree of heterogeneity between the ESG ratings of the same companies produced by different data providers.
Given the limited availability of granular data, in our country it is currently possible to obtain information from Istat, on an annual basis, on greenhouse gas emissions (scope 1 and 2) through the Air Emissions Accounts (AEA, formerly NAMEA accounts), relating to the total national emissions broken down by 2-digit ATECO codes for companies. The unreliability of these indicators increases the risk of greenwashing—i.e., the improper use of a green label falsely attributed to specific company activities—to the detriment of potential clients and investors. In this regard, the absence of a requirement to audit companies’ non-financial declarations (DNF), the use of non-standardized indicators, and the arbitrariness in how qualitative information is acquired (which allows ample room to distort the real sustainability performance of assessed companies solely to attract market capital) have encouraged unscrupulous investors to fund activities with only apparent green characteristics.
The creation of a harmonized system for classifying sustainable activities—taxonomy—represents a decisive step in redirecting private capital flows toward sustainable economic activities, thereby avoiding the phenomenon of greenwashing. Regulation (EU) 2020/852.
On 12 July 2020, Regulation (EU) 2020/852 of the European Parliament and of the Council entered into force, establishing a framework to facilitate sustainable investment and setting out the criteria for determining whether an economic activity can be considered green, with the aim of identifying the degree of environmental sustainability of an investment and the transparency (disclosure) obligations for large companies and financial market participants operating within the Union.
In particular, large companies subject to the obligations of the Non-Financial Declaration (NFD) will be required to publish, in 2022, the share of revenue and investments related to sustainable activities (with reference to the 2021 financial year), as defined by the taxonomy and with regard to climate change mitigation and adaptation. Likewise, any company wishing to market a financial product labeled as sustainable within the Union must demonstrate its compliance with the taxonomy criteria (by 31 December 2021 for already existing products). The regulation sets out the requirements for a sustainable activity: first, it must contribute substantially to at least one of the six environmental objectives (climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources; transition to a circular economy; pollution prevention and control; protection and restoration of biodiversity and ecosystems); second, it must not cause significant harm to any of the other environmental objectives (“do no significant harm”); third, it must comply with minimum social safeguards; and finally, it must meet the technical screening criteria.
In Italy: obligations relating to the individual non-financial declaration in the environmental field.
Legislative Decree No. 254 of 30 December 2016, which transposed Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014, requires listed companies, banks, and insurance companies with at least 500 employees and either assets over 20 million euros or net revenues exceeding 40 million euros to publish a NFD containing at least information regarding: the use of energy resources, distinguishing between those from renewable and non-renewable sources and the use of water resources; GHG emissions and atmospheric pollutants; the environmental impact, where possible, based on realistic assumptions or medium-term scenarios, on the environment, health, and safety.
Legislative Decree No. 254/16 also allows all other companies that are not obliged—thus considered virtuous—to voluntarily submit a non-financial declaration, with simplified procedures for SMEs. On this topic, in the article “New global sanctioning framework of the European Union on serious violations and abuses of human rights,” published in Il Sole 24 Ore Norme e Tributi plus on 18 March 2021, we not only examined in detail the features and content of the NFD but also highlighted the importance of due diligence in this specific field.
In the table, we recall the heavy sanctioning framework provided by Legislative Decree No. 254/16 for companies that fail to meet the obligations:
The Future Scenario. We are at the beginning of an unprecedented energy transformation, one that will trigger a Copernican revolution of the entire industrial, economic, and social system. How can companies optimise the resources made available by Brussels to improve their management and organisational models, thereby enabling a social and environmental transformation of their structure, in line with the binding national legislation in force and avoiding the associated heavy sanctioning framework? How should their investment plans be structured to ensure compliance with the relevant regulations, and which of those investments can effectively be considered green? Since last July, companies must comply with the criteria imposed by the recent Regulation (EU) 2020/852 so that their investments can be considered environmentally sustainable and, consequently, improve a green indicator — such as the carbon footprint, water footprint, pollutant emissions, the degree of circularity of products (secondary raw materials), or the share of renewable energy — without worsening the others.
Improved communication of climate-related information can bring significant benefits to companies, such as a higher level of awareness, understanding, and better management of risks and opportunities related to climate change; more informed internal decision-making and strategic planning; a more diversified investor base and potentially lower capital costs; a more constructive dialogue with stakeholders (particularly investors and shareholders); an improved corporate reputation in terms of mitigating reputational risk; and the preservation of the company’s “social licence to operate.”
