While the U.S. walks back its sustainability commitments, Europe is more resolute in its ESG ambitions, albeit with calls for tweaks to what some stakeholders see as prescriptive and burdensome rules.
On Feb. 26, the European Commission released an omnibus package, which looks to amend sustainable finance regulations in Europe and ease the reporting burden for corporations. Under the auspices of boosting the bloc's commercial competitiveness, the commission proposes streamlining rules on sustainability reporting, due diligence, taxonomy and more.
The commission estimates these changes could save an estimated €6.3 billion ($6.5 billion) in annual administrative costs and mobilize an additional €50 billion in public and private investments, according to a Feb. 26 news release.
Hyewon Kong, sustainable investment director at U.K. alternatives firm Gresham House, warned against drawing similarities between Europeans' calls for eased sustainability reporting and the backlash against ESG in the U.S.
“We have to be quite careful about putting every geography in one bucket, and defining deregulation as a global trend. What's happening in the U.S. is quite different from what is happening in the EU and the U.K. Both in the U.K. and EU, I think the focus is purely on streamlining,” Kong said.
Other investors may be more wary. A February survey from U.K. pension consultancy XPS Group found that over half of fund managers respondents believed that pushback on ESG and climate change initiatives in the U.S. would spill over to European markets.
According to Morningstar data, in 2024, European sustainable funds registered lower inflows compared with 2023, with investments of $53 billion, down from $78 billion in 2023 and a record high of $527 billion in 2021.
But while the world's largest asset managers are parting ways with climate investor groups, for instance, Kong said she sees this as an opportunity for ESG-friendly funds to fly their flag for asset owners still pushing to decarbonize their portfolios.
“Many (European) asset owners are doubling down and asking asset managers to put more effort into climate stewardship. They are looking under the hood, inspecting what managers are saying vs. what they are doing,” Kong said.
Gresham House managed approximately £8.8 billion ($11.4 billion) in assets as of June 30.
Push to streamline
One of the regulations the commission wants to amend is the Corporate Sustainability Reporting Directive.
Initially rolled out in January 2023, CSRD currently requires large, listed companies to publish regular reports on the social and environmental risks they face, and on how their activities impact people and the environment; small and midsize enterprises are due to report for 2026 and onward.
In December, there were calls from the German government to reform CSRD, including delaying elements of its implementation and restricting the reporting burden to only the largest companies.
That was followed by a similar proposal from the French government in January, which also argued for the creation of a “mid-cap” category that would contain further reporting exemptions and simplifications. Its proposal came after an October report, overseen by the former president of the European Central Bank, Mario Draghi, put the initial cost of CSRD compliance for a French mid-cap at €800,000 over two years, or 12.5% of investment volume.
Furthermore, a February survey of French and U.K. businesses with European operations, conducted by data firm Semarchy, showed that currently fewer than one in five (17%) businesses said their data is currently audit-ready for CSRD compliance.
"Although all the changes already visible on the horizon, such as the omnibus bill, may seem daunting at first glance, they also present an opportunity to simplify reporting obligations and provide better guidance,'' said Robert Bluhm, head of sustainability at Universal Investment Group, a fund service platform provider that administers assets of €1.2 trillion.
"That is what we all ultimately want, a simplification and consolidation of the reporting requirements at the corporate level, and greater specificity at the fund level,” he said.
In its proposal for amending CSRD, the German government insisted that this could be done without comprising the European Green Deal, a 2020 initiative carrying the ultimate goal of a net zero European Union by 2050, of which it remained supportive.
Ursula von der Leyen, president of the European Commission, echoed these sentiments in the commission's news release announcing the omnibus proposals: "Simplification promised, simplification delivered! ... "This (omnibus package) will make life easier for our businesses while ensuring we stay firmly on course toward our decarbonization goals."
In its omnibus package, the commission proposes removing "around 80% of companies from the scope of CSRD, focusing the sustainability reporting obligations on the largest companies which are more likely to have the biggest impacts on people and the environment."
The commission also proposes postponing reporting requirements for these companies until 2028.
The omnibus package also calls for changes to the Corporate Sustainability Due Diligence Directive, which seeks to improve companies' oversight and accountability in areas such as human rights.
The proposed changes, which have drawn critics on both side of the Atlantic for varying reasons, include delaying CSDDD's roll-out for large companies to mid-2028, reducing the frequency of periodic monitoring exercises, and no longer requiring companies to assess adverse impacts from indirect business partners.
"The postponement of the CSDDD weakens essential supply-chain accountability, delaying necessary progress in environmental and social governance," said Gresham House's Kong.
"While reducing administrative burdens is an important goal, it should not come at the expense of corporate accountability and sustainability progress," she said.
On the other side of the debate, U.S. Congressmen including French Hill, R-Ark., and Tim Scott, R-S.C., are calling for the EU to indefinitely pause the roll-out of CSDDD due to its impact on U.S. companies with global operations.
"CSDDD represents a serious and unwarranted regulatory overreach, imposing significant economic and legal burdens on U.S. companies. We strongly urge immediate diplomatic engagement to challenge and halt its implementation," the Congressmen said in a Feb. 26 letter to Scott Bessent, U.S. Treasury secretary, and Kevin Hassett, director of the National Economic Council.
According to the CSDDD data hub, at least 300 U.S. companies listed in the S&P 1500 will be directly affected by the directive.
Reforming the taxonomy
The German government's proposal on CSRD also urged the commission to reform the EU Taxonomy, a classification system to help investors determine which economic activities are environmentally sustainable.
“When we look at financial market data, so far the taxonomy has not really established itself as a reference framework for corporate funding plans, especially green bond issuance, and also not as the standard for sustainable investment in the EU,” said Silvia Merler, head of ESG and policy research at Algebris Investments, which managed around €28 billion ($29.6 billion) of assets as of Nov. 30.
Merler urged the commission to further investigate why the taxonomy has yet to become the go-to standard for sustainability in Europe. So far the taxonomy has faced setbacks such as the fierce debate between France and Germany over the classification of nuclear power as sustainable.
Also holding back a fuller embrace of the taxonomy is the complex and stringent nature of its "do no significant harm" criteria which assesses if an overtly sustainable investment may also be failing environmental or ESG metrics in other areas.
Research by S&P Global showed that only a small percentage of company activities that substantially contribute to climate change mitigation can be shown to meet the DNSH criteria for all other environmental objectives.
In the omnibus package, the commission proposes simplifying the DNSH criteria as well as reducing "the burden of the EU Taxonomy reporting obligations and limit(ing) it to the largest companies."
Confusing fund labels
Confusing sustainability fund labels also add to the complexity for European investors.
While not part of the omnibus review, reforms to the Sustainable Finance Disclosure Regulation are due out later this year.
Originally created as a disclosure and reporting framework, the SFDR has become a de facto labeling system. SFDR currently categorizes funds as Article 6 — which do not require integration of any kind of sustainability into the investment process; Article 8 — promoting ESG compliance; and Article 9, which are strategies with investments that specifically target sustainable outcomes.
Under the reforms, funds would be labeled as "sustainable," transition," or "ESG collection," giving clearer names than the more opaque Articles classifications, and "putting retail investors and their needs at its core," according to the EU Platform on Sustainable Finance.
These reforms are separate from the European Security and Markets Authority's updates on ESG-labeled funds, published in May.
“SFDR gives a definition of sustainable investment where it must meet certain requirements. Those requirements are very broad and they're not really prescriptive," Merler said.
Learning from peers
Appearing to have learned the lessons of its EU predecessor SFDR, the U.K.'s Sustainability Disclosure Requirements were launched last year as a dedicated labeling system, categorizing funds under four labels: “sustainability focus,” “sustainability improvers,” “sustainability impact” and “sustainability mixed-goals.”
However, since SDR's July launch date, only 64 sustainability-labeled funds were registered as of Feb. 3, giving the impression that the labeling approach is too restrictive, according to Hortense Bioy, head of sustainable investing research at Morningstar.
“The issue here is a lack of choice. Almost three-quarters of the funds have adopted the 'sustainability focus' level, and more than three-quarters of the funds are equity funds with very few fixed-income options," Bioy said.
"The European Commission can learn from these developments if they decide to remove Article 8 and 9 (of SFDR) and replace them with product categories. There is always the risk with labels that if they're too prescriptive, they end up reducing opportunities for investors," she said.
