Cornelia Frentz, Director - Governance and Sustainable Investing, European Circular Bioeconomy Fund.

Andrew Putwain: Can you give us some background on what your organisation does and its purpose?

Cornelia Frentz: The European Circular Bioeconomy Fund is the first venture capital fund dedicated to the (circular-) bioeconomy. It aims to speed up the shift from a fossil-based to a circular bio-based economy. Due to this environmental objective, ECBF is classified as an Article 9 fund according to the EU Sustainable Finance Disclosure Regulation (SFDR).

We invest in four industry verticals. The first is agricultural technology including forestry, and the blue economy, the second is industrial biotechnology, the third is packaging and construction and the fourth is foodtech and nutrition. These areas are bio-based industries that are intrinsically circular.

The fund was established in 2019 before SFDR and before Covid 19. Once the SFDR entered into force in March 2021, the fund was classified as Article 9.

Article 9 funds need to contribute to an environmental or social objective and our investments contribute to climate change mitigation. We need to make sure that every investee somehow saves GHG emissions in the course of our ESG due diligence before investing.

Andrew: Talk to us about the current state of reporting regimes in general – what are you seeing and what’s coming down the pipeline? When we say proliferating regimes what do we mean by this?

Cornelia: Looking back at 2023 and at the first half of 2024, regulatory sustainable finance disclosure and reporting regimes continued to evolve across different geographies worldwide.

The period saw an emphasis on stricter stances on ESG reporting and greenwashing, in particular. The financial marketplace is transitioning from a voluntary disclosure regime towards mandatory disclosure requirements and that's important to us because we are investing in companies in the EU27 and 16 other countries with which the European Union has economic agreements.

Due to ECBF’s article 9 SFDR status, we need to make sure that portfolio companies only commission suppliers with high sustainability standards themselves. This is why globally increasing sustainability standards are helping us.

Examples of developments in sustainable finance regulation include the adoption of the Names Rule by the US Securities and Exchange Commission (SEC) for registered funds which may mislead investors about a fund’s investment targets and risks due to sustainably sounding names.

Furthermore, there have been rule enhancements in the US to foster the disclosure of comparable and reliable information for investors concerning the incorporation of ESG factors in investment decisions.

Likewise in the UK, the British Financial Conduct Authority (FCA) published its Sustainability Disclosure Requirements (SDR) and fund labelling rules in November 2023. It established four sustainable investment labels: Sustainability Focus, Sustainability Improver, Sustainability Impact and Sustainability Mixed Goals, and these rules are being rolled out in 2024.

"When we look at the sustainable finance regulations development at EU level there are a lot of changes happening as well."

There are a number of other examples in Asia too: several countries have published and implemented EU-style green taxonomy frameworks to direct capital towards sustainable activities (e.g. China’s Green Bond Principles, South Korea’s K-Taxonomy). In 2023, the Hong Kong Monetary Authority (HKMA) prepared the Hong Kong Taxonomy for Sustainable Finance that aimed to ensure EU-China interoperability and was published in May 2024.

A further example is the International Sustainability Standards Board’s (ISSB) new global sustainability disclosure standards, which consist of IFRS S1 on general sustainability disclosures and IFRS S2 on climate-related disclosures which received positive feedback from many Asian regulators, suggesting that more Asian countries would be adopting these new standards.

When we look at the sustainable finance regulations development at EU level there are a lot of changes happening as well. In 2019, the EU passed the Green Deal, a reform program for various policy areas with which it aims to achieve climate neutrality in the EU by 2050 and reduce GHG emissions to at least 50% and towards 55% compared with 1990 levels by 2030.

By strengthening disclosure requirements, the EU is improving and standardising sustainability reporting, making it more transparent and verifiable. In this way, the European legislator intends to channel capital into primarily sustainable companies, i.e. into investments that reduce exposure to climate and environmental risk.

To enforce these new and more stringent disclosure requirements, the EU has introduced a sustainable finance framework consisting of the Corporate Sustainability Reporting Directive (CSRD), which is to be applied by defined companies for reporting from 2024 onwards, the SFDR, applied since March 2021, and the EU Taxonomy for sustainable activities, applied since January 2022.

Andrew: What are the opportunities proliferating regimes bring?

Cornelia: When a new regime is launched, usually those developing it are trying to be as pragmatic as possible.

When we read new regimes, we look for parallels to the European regulation - the SFDR was the first regulation that came out on sustainable investment, and it’s typical European legislation with a lot of cross-references to other directives and regulations.

"When the SFDR came out, there were a lot of Q&As in the aftermath, and a lot of the financial market participants didn't understand how to apply it."

Others are trying to produce something that's similar and enables operability with the European standards, but at the same time, is much easier to apply or more pragmatic.

So, these different regimes are trying to harmonise their standards, and make them more applicable.

When the SFDR came out, there were a lot of Q&As in the aftermath, and a lot of the financial market participants didn't understand how to apply it. Learning from that process in other places has become the new emerging trend.

There's a lot of room for improvement, and this is why the European Commission published a consultation in September of 2023 asking users how to make it easier to apply and what the difficulties are.

Proliferating regimes often have their origins in the fact that a geographical region establishes a sustainability regime, and other geographical regions have to follow suit in order to ensure continued economic cooperation in the economy, i.e., interoperability.

Proliferating regimes represent an opportunity to align global standards and harmonise sustainability requirements. They are of particular importance for sustainable funds and influence portfolio companies’ European and non-European operations, value chains, customers, co-investors, cooperation partners, competitors and other stakeholders.

Due to our Article 9 SFDR status, portfolio companies may only commission suppliers with high sustainability standards. Higher sustainability standards in Asia make Asian suppliers accessible to them. At the same time, funds, such as ours, become more attractive to non-European investors which need to raise their sustainable investment approach in response to increasingly stringent regulatory sustainable finance standards.

The implementation of sustainability-related disclosure regimes primarily means environmental and social protection, which is urgently needed.

Andrew: Does there need to be a more explicit call for national harmonisation of reporting regimes? Or are there other challenges?

Cornelia: There is a lack of harmonisation of sustainable reporting regimes. Financial market participants who are active in different regimes in particular are very challenged by the different requirements and have to put a lot of time and effort into the compliance with different reporting regimes.

However, there are signs of a global trend towards harmonisation. In this respect, it can be assumed that the regimes will change again in the short term. Hopefully, however, not to the detriment of environmental or social goals.

There are also various other challenges when dealing especially with Article 8 and 9 SFDR categorisations. For instance, there are a number of ways in which the SFDR may increase the risk of greenwashing – in particular, of product managers over-stating a product’s green credentials. Another aspect is that the SFDR does not provide fully workable standardised definitions of sustainable investments. This could allow firms to label investments as “sustainable” even if they do not meet commonly accepted ESG criteria. For example, it is possible to offer an ‘Article 9’ fund – which should have specific sustainability goals as an objective – without a taxonomy alignment or PAI reporting. This lack of consistency in definitions also makes it difficult for investors to compare sustainability performance side-by-side across different funds.

"Some companies may be inclined to exaggerate or misrepresent their sustainability practices to attract investors or comply with the regulation."

The SFDR creates a disproportionate compliance burden for some firms, particularly smaller firms or those that cannot take advantage of third-party data sources. Compliance with the SFDR requires companies to gather and report a significant amount of data on their sustainability practices, which is time-consuming and expensive. This may create a temptation to simply meet the minimal disclosure requirements.

The SFDR relies on self-assessment and self-reporting by financial firms. This may not always be reliable, either because of data quality or internal resource capacity. Some companies may be inclined to exaggerate or misrepresent their sustainability practices to attract investors or comply with the regulation.

The regulation’s requirements are not always clear or specific, which allows firms to interpret the regulation in a way that suits their interests. For example, the regulation requires firms to disclose how they integrate sustainability risks into their investment decision-making process – but it doesn’t specify how to measure or assess those risks.

There are no strong enforcement mechanisms to ensure compliance included in the SFDR. Firms that do not comply with the regulation may face reputational damage, but they may not face significant legal or financial penalties.

Andrew: Taking a step back from this, talk to me about the processes you’re seeing – are there good things being developed or are we still missing certain aspects from these areas that are essential to future-proofing the industry?

Cornelia: Whatever is being developed, the SFDR, the IRA in the US or the SDR in Great Britain – the development that needs to be done needs to look at harmonisation – and that harmonisation needs to take those ideas on board, and reporting needs to be made to be much easier. It needs to be simplified.

Despite the potential for improvement, I am grateful for the introduction of the SFDR, its and other legally required sustainable reporting frameworks. Because they are enshrined in law, they are more efficient than voluntary frameworks.

"The reporting requirements should be so good that the majority of users are convinced that reporting makes a real difference and adds value to their asset management."

By forcing us to comply with the SFDR requirements, the industry has been given a framework with which it must quantify and measure impact in an evidence-based manner. This creates experience, knowledge and awareness among portfolio companies of their direct environmental and social impact. It also gives us and the world a rough idea of how to define sustainability.

The current regulatory frameworks are a good start, albeit not a perfect one. Unfortunately, regulatory improvements are very slow to materialise, particularly within the EU. There is a lack of speed and pragmatism.

In my opinion, much more awareness of the urgency of action needs to be created. The reporting requirements should be so good that the majority of users are convinced that reporting makes a real difference and adds value to their asset management. Reporting and adhering to standards should cause changes in the operational management of companies towards sustainability. The requirements must not become a compulsory exercise.

Cornelia Frentz will be speaking at Fund Operator Summit | Europe in October in London. You can see details of that, and register for the event, by clicking here.

 

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