This is the second of a series of three blogs on the sustainable finance disclosure regulation (SFDR) for private equity, venture capitalists and any other company-investing firm. Note that the information in this blog is adopted from the Regulatory Technical Standard (RTS) from February 2022. The final version of the RTS is expected to be released in July 2022.
In our previous blog we explained the value of asset-level ESG data with regards to the PAI (principal adverse impact) disclosures under SFDR and the extra value it creates for sustainable portfolio management. In this blog we’ll zoom in on compliance with the ‘do not significantly harm principle’ (DNSH). More specifically the DNSH on the environmental principal adverse impact (PAI) indicators and the alignment with the OECD Guidelines for Multinational Enterprises.
First we’ll introduce the position of the DNSH principle in the SFDR. Second, we’ll take a quick dive into the OECD guidelines on the environment. Finally we’ll answer the question: what does compliance with the DNSH principle mean for my investment firm?
The DNSH principle accounts specifically for the Article 9 financial products from the 2019/2088 SFDR proposal. Article 9 products are those financial products having sustainable investments as objective. For products to be able to be termed as sustainable investments these must comply to a level of DNSH reporting, as stated in the february 2022 version of the RTS:
“In addition to disclosing how the financial market participant has taken into account the indicators for adverse impact in Annex I, the DNSH reporting must also show whether the investments are aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights. The objective of this provision is to bring the DNSH disclosures under SFDR in line with the minimum safeguards in Article 18 of Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (hereinafter “the Taxonomy Regulation”).
Chapter 5 of the OECD guidelines for multinational enterprises states that companies should take due account of the need to protect the environment, public health and safety. They must conduct their activities in such ways that these contribute to the wider goal of sustainable development. More specifically the OECD lists and elaborates on seven guidelines that companies should follow to achieve these objectives on the environment, public health and safety. These guidelines generally entail the plan-do-check-act cycle by mentioning data collection, planning and implementing in regard of sustainability.
For the sake of this article relating DNSH compliance to our PAI indicator we want to mention specifically guidelines 1 and 3.
The first principle mentions the establishment and maintenance of a system of environmental management appropriate to the company. This guideline specifically mentions
a) collection and evaluation of timely and adequate information
b) establishment of measurable objectives
c) regular monitoring and verification
The OECD guidelines mention in this regard specifically the adoption of (parts of) the ISO 14000 series of environmental management systems.
To support the DNSH principle of your portfolio, this typically entails asset-level data measured on company-level (read: investee-level). As we discussed in our previous SFDR blog, adequate information regarding the environmental, health and safety impacts cannot be supplied with ESG data disclosures based on country-sector proxies. Also the establishment of objectives and measurable targets for the improvement of environmental performance must come from the company itself. After all, you cannot monitor the improvement of environmental performance of my organisation with average data.
This principle is to assess, and address in decision-making, the foreseeable environmental, health, and safety- related impacts associated with the processes, goods and services of the enterprise over their full life-cycle. Typically this type of data is created at company-level. Moreover, the quality of this type of assessment is improved when more company-specific data is collected from the supply chain.
Performing LCA studies over your complete portfolio does take some time. However, thinking back to our first principle, it is about the implementation of an EMS (environmental management system). LCAs in combination with the EMS means our data collection and assessment is a dynamic process over time.
As stated in the RTS, a financial market participant must disclose according to the PAI indicators. Subsequently, to term an investment as a ‘sustainable investment’, prove it does not significantly harm any of these indicators. This proof of doing no significant harm is achieved by examining and improving the alignment with, amongst others, the OECD Guidelines for Multinational Enterprises.
Also, this way of data collection requires investor firms to demand collaboration from their investee companies in their portfolio. This does require some effort, and costs are also mentioned in the OECD chapter 5 document. However, typically for our investors (PE, VC, etc) the goal is to retain (partial) ownerships of a company for about 5-10 years, managing improvements in the meantime. Take into account that it is the year 2030 in just eight years: the year of 40% greenhouse gas emission reduction. The year of 32% share of renewable energy. The year of sector-specific circular economy targets with a general objective of 30% improvement of resource efficiency. All of which is facilitated with our environmental management system on company and portfolio level.
Hence, by investing in the environmental performance of your investee companies now, you will receive your financial reward when selling future-proof and environmentally compliant companies in 2030.
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