EU green finance czar: ‘Obvious’ that companies should report on climate risk

For experts sitting on the EU's green finance group, "it was obvious that greenhouse gas emissions should be mandatory disclosures," says Michèle Lacroix. [Amaury Henderick / Flickr]

Reporting on greenhouse gas emissions should become mandatory “as soon as possible” for companies with more than 250 employees, argues Michèle Lacroix, an EU expert who helped design the EU’s landmark green finance taxonomy.

Michèle Lacroix chairs the Project Task Force on Climate-related Reporting at the European Corporate Reporting Lab @EFRAG. She is the lead author of the EFRAG report: ‘How to improve climate-related reporting – A summary of good practices from Europe and beyond​’, published on 6 February 2020.

Lacroix spoke to Frédéric Simon, the energy and environment editor of EURACTIV.

INTERVIEW HIGHLIGHTS:

  • Climate-related reporting is currently not standardised enough, according to a special EU advisory group chaired by Lacroix.
  • Corporate reporting on greenhouse gas emissions should become mandatory as soon as possible, the group argues, and cover scope 1, 2 and 3 emissions.
  • The upcoming revision of the Non-Financial Reporting Directive (NFRD) provides an opportunity to make reporting obligatory.
  • But standardisation beyond greenhouse gas emissions is unlikely to happen, Lacroix says, as key metrics differ too widely across various sectors of the economy.

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You are a member of the EU Technical Expert Group on sustainable finance, which drafted the so-called green finance taxonomy. How can the taxonomy be used in the recovery phase from the COVID-19 crisis?

The taxonomy provides a framework to determine what are green economic activities. It also helps understand how we can reach our climate goals and offers a unique opportunity to build a more resilient and sustainable recovery.

The taxonomy should therefore be seen as a master plan to achieve the European Green Deal by encouraging private capital flows into activities aligned with its goals.

You’re the lead author of a report that looked into climate-related reporting by European companies and multinationals. Many of them produce “sustainability reports” touting their green credentials. But how standardised are those reports? Are we actually comparing apples with apples?

Not at all. Basically, a lot of the reports have adopted the structure of the Task Force on Climate-Related Financial Disclosures, with its four sections on: governance, strategy, risk management and metrics & targets.

But when analysing disclosures from companies, our Project Task Force noticed that all companies present this quite differently. In the governance section for instance, you may have a really nice section about the policies – how they are decided, how they are implemented, what is the role of the various governance bodies, etc. But it’s not the case in all the reports. In some cases, you have a clear view on the policies but not how they’re implemented or assessed within the company.

The strategy, by contrast, is really something more driven, which relates to the company’s mission and unique positioning on the market. So there is no one-size-fits-all way of presenting this.

The section in which you may find more alignment is the metrics and targets section, because most relate to greenhouse gas emissions. But even there it’s not completely aligned. Sometimes you have clear decarbonisation targets with metrics compared to the target and an explanation of why the company may be lagging behind. And in other cases, it’s only one or two figures put together with no link with the rest of the document. So, there is no real alignment here either.

At the same time, I doubt it’s possible to find a standardised way or reporting that speaks for all companies. Because when you’re an oil and gas company, climate is likely to have a completely different impact than if you are a consumer company.

Could regulators maybe apply different reporting standards to different sectors of the economy?

That’s a possibility, yes. Because unfortunately, I don’t think we can go beyond sectors in terms of standardisation.

And when we talk about standardisation, let’s be clear: it cannot be simply a table with a few figures and your report is done. The narrative is really important, because you need to understand what the company is trying to achieve. It’s not only about metrics.

So, I doubt that we will have complete standardisation. I would argue for a minimum of standardisation on very specific types of information. But outside of those key metrics, we absolutely need to leave companies some room for manoeuvre to decide about what they want to report, in terms of their mission and business strategy.

What are the areas where you would expect minimum standardisation? Are there any obvious metrics that, in your view, should be standardised?

I worked on the disclosure sub-group of the European Commission’s Technical Expert Group on Sustainable Finance. For us, it was obvious that greenhouse gas emissions should be mandatory disclosures. And not only for Scope 1 emissions, but also for Scope 2 and 3.

Even if today, it’s not possible to report on Scope 3, it’s only by making it mandatory that one day it will be possible to do it. It’s also a way of pushing things to emerge.

Beyond greenhouse gas emission, let’s be clear: we are far from any consensus for other standardised metrics and it may take time before we get there. The revision of the Non-Financial Reporting Directive (NFRD), together with the Sustainable Finance Disclosure Regulation are likely to improve transparency and potentially foster alignment of disclosures.

When do you believe greenhouse gas reporting should be made mandatory?

As soon as possible. And I hope that the European Commission will take the opportunity of the NFRD revision to move in that direction. That is also in line with the recommendations made in the Technical Expert Group report on disclosures that we presented one year ago.

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Coming back to current practices: How much of the existing climate reporting taking place at the moment do you consider to be “greenwashing” or grossly exaggerated claims?

We have identified three categories of reports:

  • Firstly, some of them are done only to ‘tick the box’. In those cases, the report is an accumulation of information with no real articulation. This means it is very difficult to understand how the company defines its climate strategy based on the different elements of the report.
  • Secondly, some reports are quite well documented with a story that makes sense. But there are only very few of such reports.
  • And in the middle, you have many reports with very different levels of maturity, even between sections.

Unfortunately, our task force wasn’t able to find one report that was good at addressing all the information and all the elements of the format. Even within the most advanced reports, there was always something missing.

Commissioner Dombrovskis said he will review corporate disclosure rules as part of the review of the non-financial reporting directive. Do you believe now is the time for the European Commission to impose a standardised format for climate related reporting and make it a legally binding obligation on companies? 

Yes. Transparency is key to foster sustainable finance. And we all know how regulation can speed up best practices.

There will probably be opposition against this, so how soon do you think it can realistically be done? Or do you expect it to pass without much opposition?

When France passed the now famous Article 173 of the law for the energy transition, we did not smile, but we did it. Article 173 makes it compulsory for banks, investors and financial actors to report on how they embed environmental, social and governance (ESG) criteria in their investment decisions.

As soon as you have more than €500 million under management, be it for your own use or on behalf of external clients, you have to report on climate, on the actions you take, and so on and so forth.

And honestly, when it came into force at the end of 2015, it was a revolution, because nobody really knew how to do it.

The first reporting cycle under the French law came out in 2017, based on the 2016 exercise, so there is a bit of hindsight. What’s your assessment: did it work?

Broadly speaking, it went very well. Of course, like with anything, there are leaders and laggards, depending on companies’ ambition and sustainability strategy but also depending on the resources they have, according to their size.

But because it is mandatory, companies don’t ask whether it’s a good or a bad thing, they just report. And the French experience was also very helpful last year for the European Commission’s Technical Expert Group on sustainable finance.

Now, we expect a Commission proposal to revise the Non-Financial Reporting Directive (NFRD) by the end of 2020. And yes, I hope there will be at least mandatory greenhouse gas reporting included in there.

Do you think the French regulation is a template that could be adopted at European level?  

I would not recommend that. The revised NFRD should set the minimum mandatory type of information that should be provided by companies.

And then it should mention other additional information that is “nice to have”, depending on the sector. Because you cannot ask the same type of information from an oil and gas company, from an insurance company and from a consumer company, it’s really business specific. It has to be meaningful for the company who reports.

First of all, non-financial reporting has to tell the story of a company vis-à-vis the environmental and social aspects of the business. It cannot be that they report something just because they have been requested to do so. It’s really a strategic exercise where companies ask themselves: What are we doing in this category? How are we doing it? Is it correctly set up? Is it correctly organised? Is there strong governance framing in the way we are doing it? It has to be meaningful.

And the most standardised you are, the less meaningful you are at a company level.

But how would that work in practice at EU level? What are the other things that companies should report, beyond greenhouse gas emissions?

The type of information companies provide on environmental objectives should be in line with the EU taxonomy on sustainable finance. For example, a company could mention the percentage of revenues coming from green activities, or the percentage of investments that have been invested in green activities.

Maybe it would also be interesting to ask companies to define what they consider “brown” activities. Because this hasn’t been defined yet by the taxonomy sub-group, while companies will have to disclose about it.

But, I wouldn’t reinvent the wheel. Let’s take the tables that we drew in the report for the revision of the non-binding reporting guidelines, which differentiated between universally mandatory information and sector-specific tables of Key Performance Indicators (KPIs) that would be “nice to have”. Potentially one or two of those KPI’s could be mandatory by sector, but not all. And let’s leverage the screening criteria set in the taxonomy report to align all requirements.

I think the regulation should go beyond what is mandatory and define such ‘nice-to-have’ KPIs as well.

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In the French law, reporting is mandatory above a turnover threshold of €100 million. What should be the threshold on a European level?

The existing Non-Financial Reporting Directive already mentions this. Reporting is mandatory from 500 employees upwards.

Do you think that is the right threshold?

No, I think it should be at least lowered to 250 employees, which seems like an acceptable threshold to me. In fact, a lot of member states have lowered this threshold to 250 employees when transposing the existing NFRD.

The reporting scope is key to ensure that stakeholders get enough information to make sound investment decisions. We should be more ambitious and extend the requirement to smaller companies, beyond listed ones, and potentially using different threshold depending on activities. Impact on environment may be much more material for a small chemical company than for some large blue chips operating in services.

250 employees is a threshold that includes medium-sized companies. Isn’t there a risk that they will find it too burdensome in terms of the administrative requirements?

Maybe. But users of the information typically say regulators don’t go far enough in their reporting requirements on companies. So, yes, it is burdensome, but ultimately the climate crisis may be much more damaging than this effort.

How will the EU green finance taxonomy change the way reporting is done? If banks now use the taxonomy to guide their investment strategies, then that will de facto become some sort of reporting standard, correct? 

Yes, it will. Economic activities in the green finance taxonomy are typically what should be listed among the mandatory information in the NFRD.

You cannot on the one hand put together an EU taxonomy with corresponding metrics and at the same time not ask companies to report on that specific metric.

A political agreement on the taxonomy regulation was reached in December, but there is still a series of implementing legislation, which needs to be adopted. And there are big battles ahead about how to define economic activities depending on their green credentials. How do you see this developing?

I disagree, because in the taxonomy, the big emphasis has been put on energy. So for each type of energy, the thresholds are very clear. You either comply, or you don’t.

There will probably be pressure to change these thresholds…

I’m not sure that there will be pressure on thresholds. I think there will be pressure on including certain activities, but not on the thresholds as such.

For instance, I know that there is pressure on gas from Germany and on nuclear from France, to include these two activities within the taxonomy under so-called ‘transition’ activities. So maybe this could be amended locally.

But I don’t see how we can have an aligned EU taxonomy if member states start playing with the thresholds. Keep in mind that the thresholds are dynamic, they will be revised on a regular basis to make sure that we transition to a low carbon economy. If member states start to play with them, I don’t see how it can work.

They probably will… Maybe a potential compromise there would be to treat both gas and nuclear as transition fuels, and then gradually tighten environmental criteria? Could that be a way forward?

Two sentences have been included in the last version of the taxonomy to potentially allow for nuclear and gas.

However, until now nuclear was unable to demonstrate that it complies with the ‘do no significant harm’ principle, which is linked to other environmental objectives, because of issues related to waste management.

So we leave it to nuclear people to try and demonstrate compliance with the ‘do no significant harm’ principle. I doubt that it will be acceptable.

And when it comes to gas, it’s simply a question of setting an emissions performance standard?

Yes. And on top of that, there is something else which is interesting: investments should not create a lock-in effect into “transition” assets.

And this is the point on which gas investments may fall out of the taxonomy, because the lifecycle of gas investments goes beyond 2050. So, starting a new gas plant today is not compatible with that requirement.

It has been put in a very smart way, but for sure there will be discussion and there will be a lot of push from countries to try and get around certain things. It may be quite complex as it becomes a political battle going far beyond sustainable finance goals.

How can the taxonomy avoid this lock-in into fossil gas? Because you can always claim that the infrastructure can be retrofitted to enable low-carbon gases such as hydrogen. Is there a measurable way of determining what constitutes lock-in? 

Honestly, I don’t know. I am not technical enough. There were more than 100 external experts who were consulted by the Technical Expert Group to set the thresholds and I haven’t attended all these workshops so it would be very tough for me to answer.

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To conclude, the CEO of BP and Shell have both announced that they would aim to make their company carbon neutral, including so-called Scope 3 emissions, which covers the usage of their products by customers. Should that kind of reporting become standard across the economy?

Yes, we cannot avoid Scope 3. The issue is, we don’t know how to measure it. But let’s not limit ourselves to what we know now. We can still say that it is mandatory to report on Scope 3 emissions, even if we recognise that we don’t know how to measure it now because the science is not there.

Think of it like this: would it be acceptable for a company to say: ‘We don’t know how to measure Scope 3 emissions so let’s forget about it and talk about something else’?

So, you say this can be refined over time as the science becomes clearer?

Absolutely, and that’s the beauty of the sustainable finance taxonomy. The European Commission is putting in place a sustainable finance platform to revise the thresholds on a regular basis, because everyone agrees that the science is evolving quickly and new developments and progresses need to be taken onboard.

So, for sure there will be new types of activities that will emerge in the future which are not yet considered as green, because we don’t know them or they are not mature right now.

Take Carbon Capture and Storage for instance: who knows exactly how that will develop? It has to be included in the taxonomy, because obviously, it helps mitigating emissions. But how far should we go regarding technologies which are only just emerging? We have to be very pragmatic and make sure that, if we take the wrong direction, we still have time to come back on it afterwards.

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