The EU Sustainable Finance Regime

The key regulations comprising the sustainable finance regime are as follows:

• NFRD (Non-financial Reporting Directive): large, listed companies are required to make non-financial statements relating to environmental, social employee, human right, and antibribery and corruption matters including business model description, policies and due diligence. Applicable from 2018.
• CSRD (Corporate Sustainability Reporting Directive): this extends the scope of the NFRD to all large companies and all listed companies (except micro-enterprises) and requires disclosures to be made in accordance with sustainability reporting standards, as well as additional disclosures of so-called Principal Adverse Impacts (i.e., negative effects of investment decisions on sustainability factors) (PAIs) and company strategy and targets.  Phased-in rules apply from 1 January 2024 –1 January 2028.
• SFRD (Sustainable Finance Disclosure Regulation): firms that provide financial products such as insurers, AIFMs, UCITs managers, MIFID portfolio managers, investment advisors and pension providers must publish under mandatory templates, pre-contractual and website disclosures on sustainability risks, PAIs and the ESG features of financial products. They must also disclose the share of environmentally sustainable economic activities within the total assets they finance or invest in. Applicable from 10 March 21- 1 January 2022. Further measures proposed under a potential review of the SFDR include a future product categorisation system and sustainability indicators.
• Taxonomy Regulation: this sets out criteria that an activity must satisfy in order to be environmentally sustainable by reference to specified environmental objectives and as long as it does not significantly harm any of the environmental objectives. These objectives include climate change mitigation, climate change adaptation, use and protection of water and marine resources, biodiversity and ecosystems, pollution prevention and control. Phased-in rules apply from 1 January 2022-1 January 2026.
• CSDDD (Corporate Sustainability Due Diligence Directive): this imposes far reaching due diligence obligations on EU companies (with net worldwide turnover of more than E450m) and non-EU companies (with net EU turnover of more than E450m), covering adverse human rights and environmental impacts of their own operations, those of their subsidiaries, and their upstream and downstream value chain. AIFs and UCITS are excluded. Regulated financial firm do not need to consider their downstream chain of activities. It will be applicable from mid-2027.

As sustainability factors are integrated into firms’ decision-making processes and investment decisions, the regulatory requirements of the various pieces of legislation are likely to impact the securities lending and borrowing market and drive a shift to sustainable practices. Sustainability reporting will require firms to conduct additional due diligence on counterparties by taking into consideration their ESG profiles and practices. The valuation and risk management processes within the securities lending and borrowing industry will also undergo changes. ESG factors will play a more prominent role in determining acceptable collateral, and firms will need to incorporate these factors into their risk assessment models. To comply with the CSRD, firms will also need to collect and manage more ESG-related data, potentially requiring significant technology investments. There is likely to be increased demand for ESG-focused products and a competitive advantage for firms with strong sustainability credentials. Overall, the industry will need to adapt to the new regulatory landscape and invest in resources to meet the challenges and opportunities presented by the sustainable finance regime.

ISLA working in partnership with other securities lending associations and sister associations across the globe (PASLA, CASLA and the RMA), together forming the Global Alliance of Securities Lending Associations (GASLA), have developed a Global Framework for ESG and Securities Lending known as the GFSEL. It has been created to provide lenders and market participants with understanding and practical guidance of ESG related aspects of securities lending and borrowing (SLB), and to help formulate and standardise considerations for ESG management of SLB. Its widespread use, as a practical tool, can facilitate and promote the compatibility of ESG with SLB.

GASLA identified five key considerations covered in the GFSEL for ESG compatibility with SLB. They are voting rights, collateral management, short selling and transparency in the lending chain.

ISLA has further published a document on the Applicability of ESG to Collateral in the context of Securities Lending, as well a whitepaper in conjunction with Allen & Overy: Framing Securities Lending for the Sustainability Era.

ISLA continues to monitor development in ESG and the sustainable finance regime and engage with market participants and regulators so as to ensure that securities lending can operate harmoniously within the ESG frameworks.