EU regulation drives the sustainability transition

Our analysis focuses on the following five broad themes:

1. Decarbonisation: EU policymakers are prioritising regulatory measures that target decarbonisation across transportation, raw materials and energy. The recent approval of changes to the EU Emissions Trading Scheme (ETS) and Carbon Border Adjustment Mechanism (CBAM) will affect the costs and incentives for companies in these areas–both upstream and downstream in their value chains. The scope and extent of carbon markets are also changing, which will have implications for carbon offset strategies. In 2023 companies should therefore focus on gathering a range of important data across their value chain, including data on their baseline emissions, energy use and extent of their CBAM-covered products.
2. Greenwashing: As companies make a broader range of increasingly ambitious claims about the sustainability of their business strategies, products and services, the risk of statements that mislead consumers or investors – whether deliberately or inadvertently – has also risen. Greenwashing has therefore become a key concern for policymakers and regulatory developments are rapidly expanding across industries, especially with the recent release of the proposed EU Green Claims Directive. In 2023 companies need to begin to roll out steps that will ensure their green claims are accurate, complete and defensible. This involves adopting a green claims management framework, reviewing their governance structure and upskilling their workforce.
3. Transition planning: Transition planning is a key component of the climate strategy of every company. EU policymakers are finalising new rules and standards that will require companies to design and disclose credible transition plans aligned with limiting global warming to 1.5 degrees Celsius. By designing, implementing and disclosing credible transition plans, companies can also reduce the risk of greenwashing and improve their access to sources of green finance. In 2023 companies should first fully understand what they must do to meet their new obligations and then take several initial steps focusing on their governance and culture to ensure senior management is aligned on the direction of their transition plan.
4. Supply chains and circularity: EU policy and changing consumer sentiment towards sustainability will oblige companies to take action to transition from linear to circular economy models. This transition is an immense undertaking and clear direction and support from business leaders is essential. If executed well it has the potential to unlock new revenue streams and reduce companies’ long-term costs. In 2023 companies should pay attention in particular to new measures targeting the design and performance of their products. They should also make timely investments to increase the traceability of different nodes in their supply chains.
5. Sustainable finance: The changing regulatory landscape for financial services (FS) firms will have a significant impact on the cost and availability of financing for companies, whether they rely on banks or capital markets for financing. It will be critical for companies to be able to provide clarity on their transition strategies and evidence of progress made, which will take time to achieve. The market for green bonds is growing steadily, offering additional sources of funding. FS firms already face regulatory requirements to collect this information from corporates, and the breadth and detail of information needed will increase over coming years. In 2023 companies should develop a green finance strategy and define pathways to access public and private finance.

Addressing these priorities will be complex and require long-term planning and significant investment. We highlight a number of ‘first-step’ actions that we believe are priorities for business leaders to consider in 2023. The key considerations for these are summarised in Figure 2.

The regulatory developments analysed in this report may create compliance obligations. But, by considering the implications for companies’ business strategies and operating and finance models they also provide clear opportunities for companies, from enhanced stakeholder reputation and new revenue streams to better risk management and business continuity. By exploring their work within this report’s five thematic areas and taking ambitious action early, companies can build both short-term resilience in a turbulent economy and long-term viability in a world set for significant change.

1. Decarbonisation

Regulation is driving the targeting, sequencing and pace of decarbonisation. Companies need to prioritise decarbonisation of transportation, raw materials and energy in their financial and operational strategies.

The reduction or elimination of carbon dioxide emissions from the economy is an area of focus for EU policymakers, as well as for businesses and society, and decarbonisation of transportation, raw materials and energy is a top priority. Carrying this out will have major financial and operational implications for companies in both their upstream and downstream value chains. Changes to the scope and extent of carbon markets will also have implications for carbon offset strategies.

The pressure to act is now coming, however, not just from policymakers but from multiple stakeholders, including employees, banks and investors, as recent Deloitte research reveals (see figure 3). Companies report that the regulators, consumers and management are the strongest sources of pressure.¹

The complexity of the task, the scale of change and the large investments required means that it will take most companies many years to plan and fully execute their decarbonisation strategies. Companies therefore need to take policymakers’ current and probable future actions into account when setting out their plans. Recent regulatory developments mean that in the next 12 months companies should, in particular, consider focusing their decarbonisation strategies on the areas of transportation, raw materials and production processes, and carbon trading within their value chain.

Regulatory changes and priorities for companies

Carbon will become more expensive across several key industries, increasing the use of green transportation and of green raw materials.

Proposed new EU legislation or changes to existing legislation including the EU Emissions Trading System (ETS), the Carbon Border Adjustment Mechanism (CBAM), the Energy Taxation Directive, Greening Corporate Fleets, the Green Freight Package, the REPowerEU Amendments and the Green Deal Industrial Plan will make carbon more expensive or disincentivise its use.

These initiatives include measures ranging from tighter maximum emissions limits to taxes and incentives. Companies can reduce their carbon use and emissions or pay more for them. They face a range of choices from which they must determine their optimal approach.

Once corporate fleets are covered by EU initiatives, the cost-benefit analysis of transitioning to green transportation changes. At the same time, the availability of affordable, low-emission transportation technologies is increasing rapidly. This means that switching to electric vehicles is now a realistic strategy for companies that own or lease their fleets. However, when a company relies on third parties to provide transportation, whether upstream or downstream, it will have to closely engage with them to ensure that they make increasing use of environmentally-friendly modes of transportation.

Companies in the EU will also be affected by CBAM, as the EU will seek to reduce free allowances to all EU industries covered by CBAM. Companies need to acquire a better understanding of their supply chain and the data related to it in order to be able to assess the carbon footprint of their raw materials (especially those covered by CBAM). This will allow them not only to manage their exposure to carbon taxes but also to reduce the total carbon footprint of products sold. Raw materials wholly produced with fossil fuels using energy-intensive processes will be taxed based on their carbon footprint. Moreover, manufacturers that are already reporting their Scope 3 emissions would need to disclose the higher carbon content of the products they manufacture, which could reduce their appeal to certain consumers.

Fourth parties within the value chain (entities providing goods or services to an organisation’s third party) will also require further consideration. It will be necessary to know whether or not those fourth parties are supporting their suppliers’ decarbonisation transition plans. This could affect a company’s decarbonisation timeline if it becomes necessary to reassess and potentially terminate certain business relationships. There is an element of extraterritoriality, as non-EU based companies serving EU-based companies may be required by clients to comply with EU standards as a condition of conducting business with them.

Increasing the use of clean energy will be increasingly cost effective. Measures such as the Energy Taxation Directive, the REPowerEU Amendments and Green Deal Industrial Plan promote clean energy and disincentivise the use of fossil fuels by making them more expensive.⁴ Fuels will be taxed based on their energy content and environmental performance, with those most harmful to the environment being taxed the most. The use of renewables will be promoted by making power purchase agreements (PPAs) more attractive, accelerating the deployment of renewables and integrating renewables in electricity systems.

Companies should therefore analyse their energy supply to ensure that they use mostly renewable sources and avoid fossil fuels. In addition to identifying clean energy suppliers, companies should also invest in renewables by installing renewable energy solutions (e.g. solar or wind) in their facilities. Similarly, energy suppliers should be prepared for a continuous increase in demand for renewable energy, which will require significant investment.

First-step actions for companies

The initial actions companies should consider taking are:

• In order to respond to the abundant new EU regulation and pressure from stakeholders, we recommend companies prioritise the following: Identify and measure baseline emissions across the entire value chain. This is a prerequisite for setting reliable carbon reduction goals where companies have already set a baseline, but if the company structure or business conditions have changed, the baseline must be recalculated and updated.
• Create climate neutrality plans and conduct energy audits. Companies covered by the Emissions Trading Scheme (ETS) will need to create climate neutrality plans and conduct energy audits to be eligible to receive free allocations of carbon allowances.
• Collect data and prepare reports of CBAM-covered products. Reports of products covered by CBAM will need to be prepared by non-EU exporters, and a process to collect data on embedded emissions should be set up by companies buying raw materials covered by CBAM. It will also be necessary to identify which key contacts within the supply chain of companies using CBAM-covered raw materials can provide this information. Once companies understand the carbon emissions associated with their key raw materials they can look for alternatives and source greener raw materials.
• Negotiate agreements for renewable energy supply. Companies should start negotiating long-term agreements with providers of renewable energy to ensure they secure access to such resources on better commercial terms. Demand for renewable energy is likely to increase significantly, which will probably lead to price increases and supply shortages in the near term.⁵

2. Greenwashing

Greenwashing has become a key concern for policymakers as misleading practices and unsubstantiated green claims become more frequent. As regulatory developments in this area expand rapidly, companies need to be aware of the risk of being accused of greenwashing and guard against it by ensuring their claims are accurate, complete and fully defensible.

FS firms are already subject to a number of regulatory initiatives that address greenwashing in financial products and services and in reporting. There is no official definition of greenwashing in the EU but the term has been defined in EU financial regulation of some products and instruments.⁷

In this report we define greenwashing as an attempt by a company to make its policies, products or services appear to be ‘greener’ than they actually are, thereby misleading its clients, customers or investors.¹⁰ It is important to note that companies can be judged to be engaging in greenwashing regardless of whether a misleading claim is deliberate or inadvertent.

When the European Commission and national consumer authorities in the EU screened corporate websites in 2020 they found that out of 150 claims about products’ environmental characteristics over 50 percent provided ‘vague, misleading or unfounded information.’ The sectors analysed in the survey included garments, cosmetics and household equipment.¹¹

In a recent survey conducted by Deloitte of 700 business leaders, greenwashing emerged as one of their most serious concerns. Asked what governments should do to encourage businesses to address climate change, business leaders listed ‘a crackdown on greenwashing’ as the highest priority. In fact, greenwashing was considered more important than key strategies such as mandatory climate change reporting or carbon taxes.¹²

Regulatory changes and priorities for companies

There is likely to be increased scrutiny from regulators and stakeholders in coming years as they use existing regulations more actively. In the recent past corporate obligations such as fiduciary responsibility, fair advertising and trading standards have been highlighted to make clear that the issue of greenwashing is already covered by existing regulations. For example, Directive 2019/2161¹³–which entered into force in early 2020 and began to be applied by Member States in May last year, provided remedies to consumers harmed by unfair commercial practices and allowed Member States to adopt rules relating to misleading commercial practices.

The EU Green Claims Directive

New stringent standards requiring companies to substantiate green claims have been proposed. In March 2023 the European Commission proposed a new EU regulation related to greenwashing. The EU Green Claims Directive sets requirements for environmental footprint methods for both products and companies: life cycle environmental performance must be measured and communicated in order to make valid green claims, which must be substantiated and verified ex-ante.¹⁷ Claims would need to be checked by an independent verifier against the requirements of the Directive and the verifier would need to issue a certificate of compliance. Environmental labels or ecolabels are also included in the proposed initiative, requiring testing, third-party verification and regular monitoring for companies to be able to use them. The Directive has extraterritorial reach as it would apply to companies outside the EU making claims for goods and services intended for EU consumers.

Life cycle assessment (LCA)

While the proposed Directive is likely to be modified as part of the legislative process due to the regulatory burden it creates, especially for small and medium-sized enterprises (SMEs), one implication is that sustainability data need to extend beyond aggregate company-level information and focus on products or services. A programme of life cycle assessment¹⁸ (LCA) of core products and services would be an effective way for companies to approach this, and to meet regulatory and stakeholder expectations.

Ecolabels

LCA can also be complemented by the adoption of ecolabels. Though ecolabels do not consider the carbon footprint of a product, they can be helpful in determining the ingredients or raw materials of a product (for example, whether it is ‘organic’) or by disclosing that a product is free of toxic and persistent chemicals and considers the energy used. An example of this is ‘good environmental choice,’ a Swedish labelling scheme. Ecolabels are likely to become more common once the EU Green Claims Directive has been implemented. Companies need to consider that not all products affect their GHG emissions.

Water footprinting is becoming increasingly relevant, and companies need to be aware that stakeholders are now scrutinising all product aspects, including water use (especially in water-depleted areas) and ecosystem depletion.

Incremental effect of greenwashing rules

The objectives of the proposed Green Claims Directive are aligned with other pieces of legislation such as the Ecodesign for Sustainable Products Regulation (ESPR), the Corporate Sustainability Reporting Directive (CSRD) and industry guidance. The potential incremental effect is that many companies, especially small and medium sized ones, could be subject to adverse competitive consequences because they decide not to make environmental claims due to the high costs of compliance and sustainability disclosures. Making unsubstantiated claims could expose companies to fines, legal action, a consumer and investor backlash or a decrease in brand value. With regard to industry guidance, the adoption of the ISEAL Code of Good Practice, which is currently under post-consultation review, is likely to be aligned with the Green Claims Directive.

First-step actions for companies

The initial actions companies should consider taking are:

• Adopt a ‘green claims management’ control framework whereby internal and external claims are assessed and verified. This can provide a strong foundation for a company’s efforts. The assessment and verification process will ensure that clear language is used and that the claims made are accurate, complete and substantiated by high-quality data and, where necessary, third-party verification.
• Commission LCAs and water footprinting analyses of core products or services. Companies should consider commissioning initial LCAs of core products or services using emissions data from the entire value chain. The control framework should also consider how the company will deal with potential greenwashing complaints. Water footprinting analyses of core products or services could be commissioned at the same time as the initial LCA to increase efficiency. It should be noted that the cost to conduct LCAs and water footprinting analyses could be high, especially for companies with multiple production facilities, product lines or complex value chains. Companies should consider these costs carefully and use a prioritisation approach to focus on products and services where the disclosure of green features is essential.
• Review governance structure to establish oversight, control and validation processes for green claims. Business leaders need to determine how greenwashing is being tackled. They need to set the tone from the top and ensure it is embedded in company culture and set up a control framework and validation processes. To assist with this, business leaders can be provided with data on metrics regarding how green claims are assessed and verified, and how complaints are dealt with.
• Train staff to make them aware of greenwashing and its risks. Companies can also provide training to their staff to ensure they are familiar with the concept of greenwashing and the risks it creates–and that there is a common understanding of environmental risk across the company. Training can be complemented with the creation of internal guidance to familiarise staff with a company’s green claims management framework and to help staff respond to greenwashing complaints.

3. Transition planning

New regulations–and rising expectations from stakeholders–are obliging companies to gain a deeper understanding of how to design, implement and disclose a credible transition plan aligned with the 1.5 degrees Celsius target. By prioritising this now, companies will be able to turn their climate ambition into action, reduce the risk of greenwashing and improve their access to sources of green finance.

Despite the rise in the number of companies setting and publicly declaring climate commitments, few have translated their climate ambitions into action. For those which have, only a small number have fully considered and implemented all the steps they must take to pivot their entire strategy and business model to become aligned with limiting global warming to at most 1.5 degrees Celsius above pre-industrial levels. However, stakeholders are increasingly expecting companies to develop and show evidence of actionable and credible transition plans so that they can make an immediate start on the next chapter of their climate journeys. These include policymakers, who are now introducing new standards and disclosure requirements.

Regulatory changes and priorities for companies

New regulations will likely eventually require every large company to design and disclose a transition plan. The EU’s Corporate Sustainability Reporting Directive (CSRD)²⁰ and its accompanying standards (set to be finalised by June 2024)²¹ state that all listed companies (including SMEs) in the EU and all large companies operating in the EU will need to disclose a transition plan aligned to 1.5 degrees Celsius warming in their annual reports or explain why they have not (and if not, whether they plan to adopt a plan in future). With the CSRD now in force, we will begin to see companies disclose their transition plans in 2025 (figure 8).

For the largest companies operating in the EU (proposed by the Commission as EU companies with more than 500 employees and a net global annual turnover of €150m, and non-EU companies with an EU-wide annual turnover of over €150m), the design of transition plans is expected to become mandatory under the forthcoming Corporate Sustainability Due Diligence Directive (CSDDD).²² The CSDDD is expected to dovetail with the technical requirements set out in the CSRD’s accompanying standards and will set out the obligation for companies to adopt a transition plan; the CSRD will then continue to govern how they disclose it. The CSDDD is currently making its way through the European legislative process. We expect it to be finalised in 2023 and apply from 2026.

The CSRD and CSDDD are extensive in their requirements and go beyond regimes, such as the recommendations made by the Taskforce for Climate-related Financial Disclosures (TCFD), and therefore require a tailored strategic response. Companies’ transition plans must include reduction targets for Scope 1, 2 and 3 emissions²³ that are aligned with 1.5 degrees Celsius consistent scenario, be implemented in the company’s business strategy and financial plan and be assured by a third party. As a result, the new regulations cannot be met through a one-size-fits-all approach. Instead, companies need to ensure their responses to the proposals are comprehensive, strategic and embedded within the context of their business, taking into account its size and complexity. This is paramount for company directors who, under the CSDDD, will be responsible for designing and overseeing execution of the transition plans.

The whole value chain needs to prepare for the regulatory changes. Companies within the scope of the regulations will need to scrutinise climate action across their value chain to measure and reduce their Scope 3 emissions, and to identify new risks and opportunities. We expect companies without a credible transition plan in time to find it harder to access new sources of finance from financial institutions. This effect on the value chain is expected to be especially apparent for the business partners of companies within scope of the CSDDD. Under the proposed requirements, in scope companies are responsible for identifying and addressing environmental impacts across their value chain. Business partners can therefore expect to be asked to contractually agree and verify that they will comply with new climate-related obligations as companies pass on their regulatory demands.

First-step actions for companies

The initial actions companies should consider taking are:

• Develop a thorough understanding of the new regulations and the steps required to comply with them. The required actions can be broken down into five phases: Aim, Plan, Structure, Deliver and Report (see figure 9). We recommend that companies start the first phase of this approach in 2023 by completing scenario analysis and GHG emission baselining to help inform their target-setting process.
• Before companies start the first phase of this five-phased approach, they should implement several steps focused on governance and culture. Business leaders can ensure their transition planning begins in the best way by: (1) assigning an executive leader who understands what transition planning entails and articulates its importance; (2) consulting with stakeholders to secure organisational support; (3) assessing the level of change required; and (4) understanding how transition planning can align with other strategic priorities. Due to the scale of the challenge associated with designing and executing a transition plan, this focus on governance and culture can better equip companies in their regulatory responses by ensuring senior management is aligned on the actions required for the first and subsequent phases of transition planning. They can also pre-empt future regulatory and supervisory expectations (see case study on strengthening governance and culture to execute the transition plan).
• Refer to a number of leading examples of guidance, criteria and recommendations from regulators and industry groups on transition planning. This will enable business leaders to understand how to ensure their transition plans are credible and able to withstand heightened scrutiny. Useful material includes publications by the Glasgow Financial Alliance for Net Zero (GFANZ – targeted at financial services firms), the UK Transition Planning Taskforce (TPT), the UN High-Level Expert Group on the Net Zero Emissions Commitments of Non-State Entities, and the Corporate Net-Zero Standard from the Science Based Targets Initiative (SBTi).

4. Supply chains and circularity

Changing consumer sentiment towards sustainability and a busy EU policy agenda on supply chains and circularity will force companies to rethink fundamental aspects of their business strategies and take action to transition from linear to circular economy models.²⁵

Companies will need to focus on increasing the traceability of different nodes in their supply chains and, depending on the strategy they choose, ultimately implement reverse supply chain management systems to ensure products return to vendors or suppliers to be repaired, reused, recycled or remanufactured. This is an immense undertaking for which direction and support from business leaders is critical. However, if executed well it opens up the potential for companies to unlock new revenue streams and reduce costs in the long term. The upcoming regulatory changes relating to supply chains and circularity will act as a catalyst for this transition and provide clarity on how companies can navigate these complexities.

Regulatory changes and priorities for companies

Circular Economy Action Plan (CEAP) initiatives are in full swing.²⁶ During 2023 some of the all-important detail will emerge, together with the long-awaited implementation timelines. Navigating the complexities of the EU regulatory landscape, as well as having a good understanding of the interplay of relevant measures at the EU and national levels, will be crucial for companies operating in the EU or placing their products or services in the EU market.

New product design and performance measures will lead the transition to a circular economy. The EU aims to ensure that sustainable, circular, and non-toxic products and materials become the norm. With the Ecodesign for Sustainable Products Regulation (ESPR), which we expect to be adopted in the second half of 2023, the EU is introducing higher standards for companies in the design and performance of their products, and more detailed information requirements in the form of a Digital Product Passport (DPP).²⁷ A significant amount of often new information will need to be transferred through the entire value chain to fulfil these requirements. The ESPR will be supplemented by legislation targeting specific product categories. Companies can expect that the first targeted regulations will become applicable in late 2024 or early 2025. Priority industries selected by the European Commission, such as batteries and vehicles, electronics and ICT, packaging, plastics, textiles and construction and buildings, are likely to play a crucial role in the roll out of the new requirements to other industries. The new Batteries Regulation, which is likely to gradually enter into force from 2024, outlines the most recent product-specific provisions driving the battery industry towards more circular operations.

In this context, companies should also stay abreast of potential rule changes to Extended Producer Responsibility (EPR) which will require producers to take financial and organisational responsibility for management of the waste stage in a product life cycle. Importantly, EPR rules are often designed for specific product groups and may vary across different Member States. The EU does, however, plan to introduce a harmonised regime for textiles.

Due diligence and traceability of supply chains

The CSDDD is expected to introduce new measures requiring businesses to perform mandatory due diligence checks to identify and account for negative human rights and environmental impacts in the company's own operations, subsidiaries, and downstream value chains. Although the CSDDD is not likely to enter into force until 2026, the current draft bears some similarity to the German Supply Chain Due Diligence Law (SCDD) which came into force on 1 January 2023. The SCDD obliges German-based companies above a certain size to fulfil their human rights and environmental responsibilities throughout their operations and in their global supply chain. Large EU and non-EU companies operating in the EU in priority industries such as textile manufacturing or food production, among others, are likely to fall under the scope of the CSDDD and therefore could benefit from monitoring its implementation in Germany.

First-step actions for companies

The initial actions companies should consider taking are:

• Invest in reliable systems and technology. Across industries we observe an insufficient level of transparency between different actors in the value chain, hindering information transfer. Timely investments in reliable systems to improve communication, and solutions to gather, process and analyse data will pay off as they have the potential to identify weak points in companies’ supply chains as well as new business opportunities, partners or suppliers. All of this will also help companies substantiate their green claims and reduce greenwashing risks.
• Perform an overarching waste audit. While staying abreast of changing EPR rules, companies should perform an overarching waste audit to understand what their waste streams look like and how the presence of certain environmentally harmful substances may affect their relationships with key stakeholders, including investors.
• Analyse the packaging portfolio and its carbon footprint. A wide range of companies supplying materials, manufacturing packaging or managing packaging waste and purchasing packaging for their products will also need to look at their packaging portfolio and its carbon footprint. The EU’s proposals for a revision of the EU legislation on packaging and packaging waste foresee ambitious and gradually increasing targets. The overall goal is to make all packaging in the EU reusable or recyclable by 2030 and reduce packaging waste by 15% by 2040 per Member State per capita (as compared to data from 2018).²⁸
• Take stock of consumer preferences. Consumers also place value on circularity, though they may not use or recognise that term. Deloitte’s recent study on the adoption of sustainable lifestyles by consumers in the UK shows that increasing interest in sustainability is evident in consumers’ purchases of everyday items. Consumers are more likely to avoid single-use plastic and to choose brands that have environmentally sustainable and more ethical practices and values.²⁹

5. Sustainable finance

The changing regulatory and supervisory landscape for FS providers will have a significant impact on the cost and availability of financing for companies.

With the renewed sustainable finance strategy EU policymakers aim to mobilise sustainable investments in the transition to a low-carbon economy and mitigate sustainability risks.³¹ Companies outside the FS sector need to monitor these developments closely to understand the effect on their access to finance, whether from banks or capital markets.

Regulatory changes and priorities for companies

Financial services sector leads the way Banks play a critical role in providing credit to the real economy, whether directly via lending or through their support for capital markets activity. In November 2022 the European Central Bank (ECB) set out its expectations and gave banks an 18-month deadline to formulate their implementation plans and take steps to integrate climate and environmental risk into their strategy, governance, business processes and risk management frameworks. The combination of their own transition plans and enhanced risk management capabilities has made banks pay closer attention to evaluating their climate-related exposures.

Banks look to improve their green credentials

To gain insight into their portfolios, banks are collecting data on climate and environmental risks and monitoring risk indicators, often using available ESG ratings. Just like businesses in other sectors they are required to report and disclose more detail on their carbon footprints, including how green their balance sheets are, and they will look over time to improve their green credentials. Lenders may therefore seek to reduce their carbon emissions (taking into account Scopes 1, 2 and 3) through a combination of credit repricing and exclusion strategies that involve withdrawing from certain sectors or projects. We already see this trend evolving. Examples include thermal coal, oil sands and Arctic drilling projects.

The same trend is evident in other FS sectors. Many of the largest UK insurers, for instance, have announced plans to phase out gradually insurance coverage for certain carbon-intensive industries and projects. To avoid being excluded, companies need to have credible transition plans and be ready to provide them to banks and other FS providers.

Banks are being pressed by supervisors to engage proactively with companies. This will oblige banks to change the way they assess the risk associated with their counterparties, ultimately influencing available products, including revolving credit facilities (RCFs), their pricing, collateral valuations and the terms on which they engage with companies.

ESG factors play a more prominent role in credit rating assessments

In addition, although ‘green factors’ are not formally part of the capital requirements framework yet, banks already have to factor ESG risk into their capital risk assessments. 2023 may also see changes to the way credit rating agencies incorporate ESG factors into their assessments. These developments should benefit companies that are responding to climate change and adapting their business strategies accordingly and disadvantage those that are lagging behind. For example, investment grade companies which lose access to RCFs may not maintain a rating that enables them to issue bonds and this in turn might compromise their access to capital markets.

ESG-labelled funds face imminent reclassifications

In 2023 EU policymakers intend to provide further clarity on the requirements in the SFDR and the EU Taxonomy Regulation affecting FS providers, such as investment managers, pension funds and insurers. Imminent reclassifications of certain ESG-labelled funds may affect the companies these FS firms invest in and change the terms on which they are able to raise equity and/or debt. In the last quarter of 2022 several large asset managers reclassified around EUR 130 bn of SFDR Article 9 products.³³

Green bonds attract attention

Although the market for green bonds is still relatively small, it is steadily growing. We see high demand for sustainable debt products among certain asset managers, insurers and pension funds.

First-step actions for companies

The initial actions companies should consider taking are:

• Develop a green finance strategy and define pathways to access public and private finance, which will be key for value-adding investment decisions. Companies should also take a closer look at the upcoming EU Green Bond Standard Regulation which may allow them, subject to meeting the relevant criteria, to raise large-scale financing for environmental projects and earn credibility among investors.
• Ensure the quality of transition plans. Those relying on bank lending should expect their lenders to scrutinise their disclosures under the CSRD and Article 8 of the EU Taxonomy Regulation. Companies should evaluate their Paris-aligned transition plans–which are likely to be further regulated in coming years. The quality of companies’ transition plans could have a direct impact on banks’ assessments of companies’ riskiness from a Transition Planning perspective.
• Carefully communicate net-zero commitments to preserve reputational image. Securing sustainability-labelled financing structures is a way to communicate a company’s commitment to ESG. Announcement of a financing event can be used to illustrate to investors, customers and employees that sustainability is at the heart of a company’s strategies.