The EU Taxonomy and New European ESG Regulations – Summer Update

The inclusion of aviation as a ‘transitional’ activity within the EU Taxonomy is set to change how aircraft finance and leasing will be transacted in Europe. Meanwhile, ESG ratings are to become a regulated activity and new corporate sustainability reporting directives will determine how aircraft portfolio emissions will need to be reported from 2024.

EU Taxonomy

As part of the package of the “Fit for 55” reforms, the EU Commission has proposed the inclusion of aviation within the EU Taxonomy. The final proposals have been slightly amended – strengthening noise level requirements and increasing the use of SAF from 2030 to 15% (up from previously proposed 10%). The aviation taxonomy restricts financing and leasing to ‘Best in Class’ aircraft, and it requires the decommissioning of one older aircraft for each new aircraft financed or leased, within both the airline’s fleet and the bank’s/lessor’s portfolio.

From January 2024, European financial institutions such as banks and aircraft lessors will also need to report their EU Taxonomy Green Asset Ratio (GAR) on a ‘report or explain’ basis, thereby providing a publicly available league table of taxonomy compliant portfolios.

Regulation of ESG rating Providers

The ESG ratings market currently suffers from a lack of transparency and so the EU Commission is proposing a Regulation to improve the reliability and transparency of ESG rating activities. The proposal will require that ESG rating providers offering services to financiers and investors in the EU be authorised and supervised by the European Securities and Marketing Authority (ESMA).

ESG rating providers will be required to use methodologies that are “rigorous, systematic, objective and subject to validation.” These new rules will enable investors to make better informed decisions regarding sustainable investments. Moreover, this will also ensure the quality and reliability of their services to protect investors and ensure market integrity.

Corporate Sustainability Reporting Directive (CSRD)

The European Commission has released a series of proposed changes to the European Sustainability Reporting Standards (ESRS), the rules and requirements for companies to report on sustainability-related impacts, opportunities and risks under the EU’s upcoming CSRD.

The Commission’s proposals were released as a draft Delegated Act, along with a consultation requesting feedback on the new rules, which will be open until 7 July. The most significant amendments are proposals to ease the burden on smaller companies and first-time reporters by extending the phase-in times for some key sustainability factors. An example is Scope 3 value chain emissions, extended by one year. It also includes rules enabling all companies to focus specifically on material sustainability factors. Regardless of any extension however, financiers and investors will require Scope 3 emissions data from airlines and aircraft lessors as they are not subject to any extension or opt outs.

The CSRD, on track to apply from the beginning of 2024, is aimed as a major update to the 2014 Non-Financial Reporting Directive (NFRD), the current EU sustainability reporting framework. The new rules will significantly expand the number of companies required to provide sustainability disclosures to over 50,000 from around 12,000 currently.

Corporate Due Diligence Directive (CS3D)

The European Parliament has also adopted amendments to the EU Council’s CS3D that will require in scope companies to implement climate transition plans in line with the Paris Climate Change Agreement’s objective to limit global warming to 1.5°C, including Scope 1, 2 and 3 emissions. In addition, companies will also be required to perform due diligence on climate impacts, also in line with the Paris goals.

Challenges facing Organisations in Reporting

As these sustainability regulations continue to proliferate, they are presenting significant challenges for in-house reporting within organisations. Those responsible for reporting must navigate expanding regulatory frameworks while ensuring the robustness and accuracy of their data.  In Ireland, a recent survey conducted by the Irish Compliance Institute indicated that over 40 percent of companies will struggle to provide the required data, while nearly 60 percent expect the new rules to significantly or greatly impact their business.

This will undoubtedly add to their workloads, for instance, a 2022 EY report revealed that in-house lawyers face competing objectives and increasing workloads. About 95 percent of law departments acknowledged the challenge of reconciling trade-offs between financial and sustainability goals. Furthermore, 99 percent anticipated a workload surge over the next three years due to environmental and social concerns.

Legal teams must also address emerging ESG risks, such as suppliers’ labour practices breaching ethical standards or public statements on emissions reduction that do not align with the company’s actual performance, also known as “greenwashing.”

As regulatory frameworks are reinforced with legal sanctions, how will organisations within the aviation sector adapt and scale to grow to meet the challenges, resources and data requirements needed to comply?

In summary

The reporting landscape increases in its fluidity, and changes between draft proposals and implementation dates are placing a burden on all stakeholders in aviation, especially those with more limited ESG resources and experience. Over the coming months we will expand on some key examples from the industry, but in the meantime should you need help or advice please get in touch.

Barry Moss is President of PACE with 35 years’ of aviation experience, and a leading authority on how carbon emissions are driving ESG strategy in the Aviation financial sector.