Revue Européenne du Droit
A Critique of EU Policymaking on Sustainable Corporate Governance and Finance
Issue #4
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Issue

Issue #4

Authors

Wolf-Georg Ringe , Alperen A. Gözlügöl

Revue européenne du droit, Summer 2022, n°4

  1. Introduction

Global consensus has it that corporations and financial markets are to contribute to the goal of sustainability – a view that has been especially driven by the Covid-19 pandemic and the increasingly visible sustainability challenges of our world such as climate change.

Lawmakers are exploring ways of how to foster this trend, and the EU has arguably been a global leader in this arena. The European Green Deal initiated in 2019 is a prominent example 1 . Over the past several years, an increasing number of measures on corporations, financial markets and sustainability have been either adopted or initiated. For example, the Non-Financial Reporting Directive (NFRD) requires large public-interest entities to disclose non-financial information on certain issues, including environmental, social and employee matters, respect for human rights, anti-corruption, and bribery matters 2 . The recently proposed Corporate Sustainability Reporting Directive (CSRD) aims to reform the NFRD with more detailed reporting requirements for a larger group of addressees 3 . Another important development that concerns corporations is the recent Sustainable Corporate Governance Initiative by the European Commission, which started with a controversial Impact Assessment 4 and culminated in the recent Proposal for a Directive on Corporate Sustainability Due Diligence (‘CSDD’) 5 .

In the context of sustainable finance, the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation (TR) are landmark developments. The former provides various disclosure obligations for financial market participants and financial advisers against ultimate beneficiaries on sustainability-related issues 6 . The latter, perhaps the most ambitious, classifies economic activities as ‘environmentally sustainable’ based on certain criteria as well as providing further disclosure obligations for financial players and companies 7

Not only capital markets but also banks have been subject to continuing sustainability scrutiny in their financing activities. Disclosure of the ‘green asset ratio’, namely to what extent banks’ loan book is associated with ‘green’ activities, is a new requirement brought by the TR 8 . Furthermore, risks posed by climate change for banks’ resilience and thus financial stability have increasingly been on the European regulators and supervisors’ agenda. Accordingly, prudential policy tools such as stress tests and capital requirements have come to include the climate risk as a major threat 9 .

In this piece, we provide a critique of all these efforts in the EU to promote sustainability in corporations and financial markets, especially focusing on climate change as perhaps the greatest sustainability challenge of our time and thus on efforts to achieve a net-zero transition by 2050 in line with the Paris Agreement goals 10 . As the name ‘critique’ implies, our aim is mainly to draw attention to some negative and undesirable aspects of the EU policymaking on sustainable corporate governance and finance while also highlighting what we think as positive and useful features.

  1. A Critique

Our approach is twofold. First, we highlight why some measures or provisions in the relevant EU initiatives are ill-conceived or inconsistent. Second, we draw attention to some unintended consequences of these rules which would arise unless they are supported by policies that make socially undesirable activities more costly for the relevant firm.

  1.  Ill-conceived and inconsistent measures

A primary example of an ill-conceived measure is, in our opinion, the recent Sustainable Corporate Governance Initiative that originally aimed at, among other things, rewriting the law on directors’ duties 11 . More specifically, initial documents show that the intention was to empower ‘company directors to take into account all stakeholders’ interests which are relevant for the long-term sustainability of the firm or which belong to those affected by it (employees, environment, other stakeholders affected by the business, etc.), as part of their duty of care to promote the interests of the company and pursue its objectives’ 12

As is well known, this aspect of the initiative drew a significant backlash from many academics, although there were supporters as well. A main of point of contention was the underlying EY study that appeared partly erroneous and misleading, which we do not need to recount here 13

The proposed CSDD Directive has now opted for a weak provision in this regard, stating that when fulfilling their duty to act in the best interest of the company, directors of companies within the scope of the Directive should ‘take into account’ the consequences of their decisions for sustainability matters, including, where applicable, human rights, climate change and environment, including in the short, medium and long term 14 . Obviously, this provision does not go as far as the options enumerated in the Impact Assessment. In fact, it amounts to only a ‘clarification’ and does not require changing existing national corporate structures 15 .

From a broader perspective, the issue relates to the well-known discussion on what corporate purpose should be and accordingly how directors’ duties should be shaped: shareholder value vs. stakeholder value. 

Given the sustainability challenges of our world, recently, stakeholderism has been touted as a comprehensive solution to put companies on a more sustainable path 16 . There are in fact several Member States in the EU that have long followed a stakeholder approach, partly as a result of path dependency (such as Germany) 17 . We however think that stakeholderist-orientation of directors’ duties is no panacea for achieving more sustainable companies, especially for reducing their environmental externalities. It is also not without undesirable consequences. 

It is important to consider the general (legal and non-legal) framework in which such a scheme would operate in the EU. Directors’ duties are notoriously vague and are rarely enforced in Europe, given the low levels of litigation due to the absence of class actions and the prohibition on contingency fees in most Member States 18 . Furthermore, concentrated share ownership is the norm in Europe, whether in private or public companies 19 . The existence of controlling shareholders particularly affects how directors of a company would perform 20 . Controlling shareholders have the power to nominate, elect and remove company directors which are in turn beholden to his or her interests. In addition, controlling shareholders, their relatives and associates are often represented on the board. Combined with little enforcement and liability risk, company directors will generally follow controlling shareholders’ interests which may not align with environmental interests. This is especially acute in private companies where opaque board structures without any independent directors dominate 21 . This is important because private companies form a significant segment of the economy in Europe and can impose large externalities 22 – a theme we recurrently pick up throughout this piece.

Another potential weakness is the difficulty in balancing different interests when directors need to pursue a stakeholderist approach 23 . Especially, in the context of the net-zero transition, it should be noted that environmental concerns and labour interests may not always be reconcilable 24 . The Volkswagen diesel scandal is a case in point, demonstrating that worker-oriented governance may not always produce best results for the environment 25 .

Lastly, wide discretion under the stakeholder value approach for company directors can be used to increase insulation and reduce accountability to institutional investors as shareholders 26 . This may also adversely affect the net-zero transition as institutional investors are increasingly concerned with green transition as part of their risk calculus or green preferences 27 .

Therefore, although it is ironic that after all the fundamental discussion and efforts, the Proposal arrives at rather an anticlimactic point and aims to provide only a legislative ‘clarification’, which can even be deemed as a waste of legislative resources, it is to be welcomed that Member States have the ultimate choice in how to shape directors’ duties, which will be surely affected by the idiosyncratic legal and non-legal elements in the relevant Member State 28 . Still, the language of the relevant provision on directors’ duty of care (article 25) needs to streamlined. Otherwise, it can even be interpreted in a way that defeats the purpose of the whole endeavour: directors of companies not within the scope of the provision (those outside of Article 2(1)) can be deemed to be given a blank cheque to disregard human rights and environmental matters.

Another problematic example is the Non-Financial Reporting Directive (NFRD), which brought non-financial information disclosure requirements for large, listed companies. Overall, we are in favour of mandatory disclosure of sustainability information. Such disclosure satisfies the growing information needs of investors in this regard as well as sheds light on the environmental (or generally social) impact of the relevant companies for various stakeholders. Although a conclusive cost-benefit analysis has remained elusive, extant literature shows the beneficial effects of mandatory disclosure in terms of filling information gaps in public markets and improving sustainability performance 29 . Therefore, the NFRD is a positive step in theory.

In practice, however, various shortcomings of the NFRD have been exposed. Although supported by the European Commission’s several guidelines, the Directive has largely failed to provide a standardized and comprehensive disclosure regime and prevent greenwashing – the main benefits that were expected from a mandatory disclosure framework 30 . Furthermore, the lack of assurance or audit requirements reduces the reliability of the disclosed information considerably, at least in comparison to traditional financial disclosures 31

It is worth noting another important but largely overlooked defect of the NFRD: it does not require private companies to disclose sustainability information. Only public-interest entities (that are large and have more than 500 employees) are subject to disclosure requirements, which means that private companies are out of scope (unless they issued bonds traded on a regulated market in the EU) 32 . As stated, private companies form a significant segment of the economy across many Member States. Furthermore, these private companies can be quite large in size and impose important (environmental) externalities.

For example, in Germany, which is the highest emitting country in Europe 33 , according to a recent report, a private company (LEAG) owns four of the highest emitting power plants 34 . Similarly, under the EU emissions trading scheme, a private company (EPH) has been among the top three emitters in the EU since 2016 35 .

It is worth pointing out that the goal of the NFRD is not solely investor-facing disclosure. In other words, it follows a so-called ‘double materiality’ approach 36 . It avowedly declares that by requiring disclosures on company impact on climate, it aims to inform consumers, civil society, employees, and investors 37 . Therein lies the primary inconsistency of the NFRD. If the sole aim was to disclose ‘financially material’ climate-related information, it would make sense to require such disclosures only from companies in public markets where information asymmetries are acute and prohibitively costly to overcome for investors. But since the aim is to generate an understanding of the external impacts of the company for a broader audience, then disclosure should also be required from private companies that are relevant from the societal impact perspective. To be sure, the universe of private companies is huge and it would not be prudent to cast the net too wide as that can be too costly; but ‘large’ private companies can be justifiably included in terms of their societal impact 38 .

Importantly, putting spotlight and related scrutiny only on public companies while allowing private companies to operate in the shadows and without market/stakeholder discipline can contribute to the phenomenon of brown-spinning. The latter denotes the passing of highly polluting assets from public to private companies. While it helps public carbon majors to appease environmentally conscious investors and comply with their climate targets, there is no net benefit in terms of climate action when private companies continue highly polluting activities. Climate-related disclosure for private companies can alleviate this form of reputational and regulatory arbitrage to a certain extent 39 – an issue we will come back to below. 

The NFRD’s sole focus on public companies can be rather explained as a result of path dependency, as regular public-facing disclosure has long been a requirement largely for these companies. The newly proposed CSRD seeks to correct some of the deficiencies we recounted above. It intends to bring more detailed and granular disclosure standards with a requirement of independent assurance to ensure verifiability 40 . Importantly, it extends the disclosure requirements to large private companies as well. However, we should also note that whether this expansion of scope would survive is highly uncertain. Member States where a significant number of private companies would be affected by this expansion are likely to water down the proposed rules. The industry is also likely to lobby for a light- or no-touch approach for private companies. For example, an influential industry organization from Germany, Bundesverband der Deutschen Industrie (BDI), objects, in its statement, to this expansion of scope, noting that 15,000 companies in Germany that were previously not subject to reporting will fall under the new reporting requirements 41 .

  1.  Unintended consequences

In this part, we identify how some EU sustainability initiatives can cause unintended but adverse consequences while endeavouring to put companies and financial players on a more sustainable path. First, we argue that EU actions that stir institutional investors’ engagement with companies on sustainability and address related market failures are commendable. But the increasing pressure in public markets can cause assets to shift to private players unless supported by other initiatives that alleviate or remove arbitrage opportunities. Second, we point to the danger of a ‘green asset bubble’ as a result of the efforts to reorient capital flows to green assets. Third, we indicate that going beyond climate-related risks perspective in banks’ capital requirements to directly affect financing of brown or green activities can threaten financial stability. A fundamental question that business law scholars have long grappled with is what role corporate law and finance has in addressing the externalities companies impose? A Friedmanesque answer is well-known and simple: corporations are (justifiably) run for profit and it is the role of external regulation to set boundaries for company conduct 42 . More than 50 years after Friedman’s famous article first appeared in the New York Times, the echo of his statement is still live and powerful 43 .

But the corporate landscape has shifted considerably since then. Massive assets have accumulated in the hands of institutional investors, and the rise of modern portfolio theory ensured that these assets have been invested across a substantial segment of the economy 44 . Consequently, shareholder engagement (or activism) has become mainstream. Shareholder apathy has been replaced with institutional investors being more willing to use their voice and team-up with activists 45 or taking up the role of systematic stewards 46 . Activist hedge funds have also changed and refined their strategy. The aim was no more (only) the pursuit of short-term gains through financial gimmickry but long-term strategies that needed the support of fellow shareholders, namely institutional investors 47 .

The role of institutional investors in sustainability and climate action is also now a prominent point of discussion 48 . Two influential papers have shown that shareholder welfare is not the same as shareholder value 49 . Shareholders may have other preferences that they may be willing to trade against financial returns. Overall, this suggests that institutional investors may have green preferences, and as shareholders, they may be willing to give up financial returns for the green transition 50 . The rise of ESG investing and environmentally conscious groups of beneficial owners confirm this assertion 51

Furthermore, many large institutional investors are subject to climate change as systematic (financial) risk. Although the theory is still in contention, this means that as universal (or common) owners (ie as investors that have stake in a wide range of asset classes broadly diversified across the economy, meaning that they effectively own a slice of the broad economy) 52 , they would be willing to reduce climate externalities imposed by individual investee companies at the expense of immediate profits if this helps the overall portfolio in the long run 53 . Empirical evidence also associated institutional investors (especially the ‘Big Three’, ie BlackRock, Vanguard and State Street) with better environmental performance and specifically less greenhouse gas emissions in the investee companies 54 .

In this regard, we welcome the EU efforts that facilitate institutional investors’ engagement and overall address market failures. Crucial issues include the agency problems between asset owners and asset managers, and rampant greenwashing. Although we acknowledge that they are not magic bullets and are fraught with some problems 55 , the TR and SFDR aim to address these problems with wide-ranging disclosure obligations while the former also provides a general framework in determining what is in fact ‘green’. If successful, sustainable finance initiatives can unleash the potential of financial markets to allocate capital to socially desirable activities 56 . Furthermore, in an attempt to facilitate and encourage shareholder engagement, the Shareholder Rights Directive II requires (on a comply or explain basis) institutional investors and asset managers to develop and publicly disclose an engagement policy, describing how they monitor investee companies on relevant matters including environmental and social issues 57 . This would help beneficial owners to understand how their assets are managed and take action, if necessary, in accordance with their preferences. Moreover, the European Securities and Markets Authority (ESMA) has recently proposed to revise its White List with activities that do not count as ‘acting in concert’ under disclosure and takeover rules, and add an explicit reference to coordination activities among institutional investors in the area of ESG, to stimulate engagement in this field 58 . This move holds the promise of significantly facilitating and encouraging coordinated action for sustainability engagement and is to be welcomed 59 .

ESG ratings and indices play also an increasingly important role in this investor-led sustainability 60 in companies: while the former help companies and investment firms measure and demonstrate the ESG performance of their activities and investments, the latter indicate an investable portfolio of companies that are compliant with certain ESG criteria. Growing mistrust in such tools due to dubious and untransparent methodologies can hamper market-led sustainability. Therefore, it is vital to address certain issues associated with ESG ratings and indices. With regard to the latter, the EU has already made some amendments to the Benchmark Regulation to enhance the ESG transparency of benchmark methodologies and to put forward standards for the methodology of low-carbon benchmarks 61 . The landscape for ESG ratings is also likely to change as the European Commission, in its Strategy for Financing the Transition to a Sustainable Economy, stated that it would take action to improve the reliability, comparability and transparency of ESG ratings 62 .

However, institutional investors and activist hedge funds are largely present and powerful in public companies. They increasingly put pressure on public carbon majors to take climate action via individual engagements, say-on-climate initiatives and even proxy fights for board election. This leads to an arbitrage opportunity for private companies that have been immune to that pressure. As we noted above, private companies have increasingly been buying carbon-intensive assets (that remain highly profitable) from public companies: the phenomenon of brown-spinning. Notable examples from Europe include public-private deals between TotalEnergies and Neo Energy 63 , Ørsted A/S and Ineos 64 , OMV and Siccar Point Energy 65 , and Engie and Riverstone Holdings 66 . On the supply side, we can expect more disposals from public carbon majors under the pressure to accelerate their green transition and fulfil their climate pledges. A recent report from an industry insider writes that the oil and gas assets up for sale across the industry amount to more than $140bn 67 . On the demand side, this phenomenon of brown spinning is largely driven by private equity. In a recent issue, The Economist noted that “[i]n the past two years alone these bought $60bn-worth of oil, gas, and coal assets, through 500 transactions – a third more than they invested in renewables.” 68

Discounts imposed on carbon-intensive assets in financial markets linked to sustainability factors rather than underlying financials cause mispricing which private players can exploit 69 . Overall, these private buyers are apparently betting on two conditions: (i) the demand for these assets will contract less slowly than supply and (ii) the green transition will take longer than intended. 

These conditions are most likely to continue to exist unless relevant rules or taxes are in place or stringent/sufficient enough to prohibit socially undesirable activities or make responsible groups internalise their externalities. If this is not the case, well-intended measures to increase sustainability pressure in public markets can unintendedly shift polluting assets to private players. As we argued above, levelling the playing field between public and private players in terms of disclosure will help us understand to what extent this is happening and harmful as well as providing a certain disciplining mechanism for private players. This would also complement certain disclosure obligations for private equity funds in terms of ‘adverse sustainability impacts’ under the SFDR 70 .

Asset shifting might not only happen in companies. As stated above, the TR requires banks to disclose their green asset ratio, providing transparency on to what extent credit institutions finance activities aligned or not-aligned with the TR. A single metric on the green credentials of banks’ balance sheet would improve comparability and mitigate the risk of greenwashing. Yet, a side effect is that to polish their green credentials, banks may only transfer their ‘brown’ loans to private-debt funds. While this improves the green asset ratio, similar to the effects of brown-spinning in companies, there is no adverse impact on the financing conditions of the underlying activities. A recent example is the sale of the entire portfolio of North American oil and gas loans by ABN AMRO, a Dutch Bank to Brookfield, an alternative asset management company based in Canada 71 .

To be sure, the EU has also put in place a carbon pricing system that attaches financial consequences to carbon emissions. Rather than being based on a public/private divide, this system is activity-based, thus encompasses every player active in sectors covered by the emissions trading system (ETS) 72 . As economists indicate, taxation is the primary way to internalize an externality, and a carbon tax scheme is therefore the most lauded method in climate change mitigation 73 . The EU is one of the few global players that operates a carbon tax scheme, and the ETS is being gradually expanded to cover more greenhouse gasses and sectors 74 . Yet, the success of this system has been questionable, especially in terms of to what extent carbon prices reflect the true social cost of carbon 75 . Establishing an effective carbon pricing system is highly challenging as distributional consequences loom large, and the lack of international coordination paves the way for legal arbitrage and carbon leakage 76 . In comparison, sustainable finance can be powerful with its cross-border effect of closing the money tap for brown assets or activities: even states that have undiversified economies and are consequently unwilling to join global climate action would be hesitant to forego foreign direct investment that comes with sustainable finance. Yet, ultimately, it remains crucial that there is really no trade-off between maximizing profits and green activities/investing, which is unlikely as long as the externalities created by polluting firms are legal and untaxed 77 . Otherwise, there will always be some parties undertaking those polluting activities and investors attracted to high returns on those assets.

Another unintended consequence that relates to the detachment between fundamentals and sustainability imperatives is what is called a ‘green bubble’. A bubble, in economic terms, indicates that certain asset prices are much higher than what the underlying fundamentals can reasonably justify 78 . A recent asset bubble burst was experienced during the mortgage crisis and following the global financial crisis during 2007-08 79 . Some are also arguing that climate risks are not sufficiently priced in markets, which can create a ‘climate bubble’ and lead to a ‘Minsky moment’ 80 . Greenwashing can also create a situation where asset values can change too suddenly. When over-exaggerated green credentials are exposed, asset values can plunge. Therefore, sustainable finance initiatives that aim to prevent mispricing of climate risk and greenwashing contribute to financial stability. EU initiatives such as NFRD, CSRD and SFDR all involve provisions to this effect 81

However, from another perspective, where, as a result of the efforts to reorient capital flows to green assets, investments accumulate in these assets without any risk assessment or justifying fundamentals, we can find ourselves in a ‘green assets bubble’, as the Bank for International Settlements (BIS) recently warned and likened it to parts of the mortgage-backed security market in the run up to the global financial crisis 82 . Price-to-earnings ratios are very high for ‘green’ companies (the prominent example being Tesla) that increasingly attract the interest of short-sellers 83 . A study by The Economist finds that a portfolio of companies that stand to benefit from the energy transition, with a total market capitalisation of $3.7trn, has risen by 59% since the start of 2020, twice the increase in the S&P 500 84 . We experience a huge surge of interest in green investing; however, depending on the pace and shape of net-zero transition (as well as macroeconomic and sector-based trends), ‘green’ assets can go through a significant price correction like 19th-century railroad stocks and the dot.com bubble 85 . Fortunately, the BIS concludes that there is currently not too much a danger for financial stability yet 86 . But it still provides a cautionary tale in terms of the limits of what sustainable finance can and should do. Rules and transparency on investment in ESG assets will provide a clearer picture of to what extent assets cumulate in certain segments. Further nudges for green investment without a risk perspective or with a detachment from fundamentals can do more harm than benefit. A conceivable option in this direction could be, for instance, as the Commission consulted on as part of the Renewed Sustainable Finance Strategy, to offer retail investors sustainable investment products as a default option if they are available at a comparable cost and meet the suitability test 87 . In its Strategy for Financing the Transition to a Sustainable Economy that followed the consultation 88 , the Commission seems to have dropped the option, which is to be welcomed due to certain dangers associated with it 89 .

A similar situation can arise when banks’ financing turns away from brown to green assets or activities. Stress tests are a useful way to understand how and to what extent banks are exposed to climate risk (both transition and physical risk) 90 . Climate risk can also be taken into account in capital adequacy when calculating risk-weighted credit exposures and corresponding asset holding requirements 91 . However, a further step where banks’ capital requirements change depending only on to what extent the loan book is ‘green’ or ‘brown’ can be harmful. To be sure, brown assets can involve financial risk in relation to climate change mitigation and this can be reflected in default risk and thus in capital requirements. But, further than that, treating these assets less favourably and allowing banks to apply a lower risk weight to green assets just because they are ‘green’ can be disastrous 92 . It can strip banks’ balance sheets of a true risk assessment. As the ECB conducts a climate risk stress test in 2022, there are fears that capital requirements can be affected by the ambitions to allocate financing from brown to green assets 93 . An amendment to the Capital Requirements Regulation mandated the European Banking Authority (EBA) to assess whether a dedicated prudential treatment of exposures related to assets, including securitisations, or activities associated substantially with environmental and/or social objectives would be justified 94 . EBA is to deliver its report by June 2025 95 . We would welcome the efforts to reflect the growing concerns about climate risk in the traditional risk framework but caution against more ambitious attempts.

  1. Conclusion

The EU has become an international pacesetter in pursuing sustainability initiatives, in particular for corporations and financial markets, with a large array of policy actions, directives and regulations on different issues. In this contribution, we took stock of main initiatives and provided a critique. 

Some initiatives such as the ‘sustainable corporate governance’ agenda with its ambition to reform directors’ duties were ill-conceived. Furthermore, while the imperative to disclose non-financial information was commendable, the relevant measures showed inconsistency, leaving out an important segment of the economy in the form of private companies. Encouragingly, the latest developments regarding both initiatives address the relevant concerns.

Financial markets currently go through a significant shift towards sustainability. And the EU, understandably, endeavours to use the power of financial markets to bring about socially desirable changes. Actions to support institutional investors’ engagement as shareholders and addressing emerging troubling issues such as greenwashing are steps in the right direction. However, the EU should be mindful of arbitrage opportunities. Growing pressure in public markets and banks may only bring the unintended consequence of carbon-intensive assets shifting to private players (such as private companies and private-debt funds): the so-called brown-spinning. To address potential detrimental outcomes, we advocated disclosure obligations for private players. Strengthening the EU ETS can also alleviate the mispricing that private players thrive on.

Lastly, we would caution against the danger that sustainability imperatives can create when they are too ambitious, in other words, too detached from the fundamentals. Two examples are the ‘green bubble’ in financial markets and banks’ balance sheets not reflecting true risk assessments as a result of differential capital treatments for green assets. While climate risk should certainly be reflected in prudential and supervisory tools, further actions that the EU signalled in different measures can do more harm than benefit.

Notes

  1. For further information, updates and developments on the European Green Deal, see, https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en#documents
  2. Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups [2014] OJ L330/1 (below: NFRD).
  3. European Commission, Proposal for a Directive of the European Parliament and of the Council amending Directive 2013/34/EU, Directive 2004/109/EC, Directive 2006/43/EC and Regulation (EU) No 537/2014, as regards corporate sustainability reporting (21 April 2021), COM(2021) 189 final.
  4.  Inception impact assessment (30 July 2020), Ares(2020)4034032 (below: Impact Assessment).
  5. European Commission, Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 (23 February 2022), COM(2022) 71 final (below: CSDD Proposal).
  6. Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector [2019] OJ L317/1, as later amended (below: SFDR).
  7. Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 [2020] OJ L198/13 (below: the Taxonomy Regulation or TR).
  8. Taxonomy Regulation Article 8, supplemented by the Commission Delegated Act, C/2021/4987 final.
  9. See notes 91-92 below and text thereto.
  10. Research on ‘planetary boundaries’ show that there are many environmental issues that can affect the stability and resilience of the Earth system. See https://www.stockholmresilience.org/research/planetary-boundaries/the-nine-planetary-boundaries.html.
  11. For background information on the Initiative, see https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12548-Sustainable-corporate-governance_en
  12.  Impact Assessment (n 4) 2. 
  13. See Alexander Bassen, Kerstin Lopatta and Wolf-Georg Ringe, ‘The EU Sustainable Corporate Governance Initiative – room for improvement’, Oxford Business Law Blog (15 October 2020), available at https://www.law.ox.ac.uk/business-law-blog/blog/2020/10/ec-corporate-governance-initiative-series-eu-sustainable-corporate; Alex Edmands, Luca Enriques, Jesse Fried, Mark Roe and Steen Thomsen, ‘Call for Reflection on Sustainable Corporate Governance’ (7 April 2021), available at https://ecgi.global/news/call-reflection-sustainable-corporate-governance; Mark Roe, Holger Spamann, Jesse Fried and Charles Wang, ‘The Sustainable Corporate Governance Initiative in Europe’ (2021) 38 Yale Journal on Regulation Bulletin 133.
  14. CSDD Proposal Article 25. It should be also noted that Article 26 involves a specific provision on directors’ duties: directors of companies within its scope are responsible for putting in place and overseeing the due diligence actions and the due diligence policy referred to in other articles of the Proposal.
  15. CSDD Proposal Recital 63.
  16.  See for example Colin Mayer, Prosperity: Better Business Makes Greater Good (OUP 2018); Leo E. Strine Jr., ‘Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy A Reply to Professor Rock’ (2021) 76 The Business Lawyer 397.
  17. Katharina Pistor, ‘Codetermination: A Sociopolitical Model with Governance Externalities’ in Margaret M. Blair & Mark J. Roe (eds), Employees and Corporate Governance (Brookings Institution Press, 1999) 163.
  18. Bassen et al. (n 13) 3-4.
  19. For a recent study, see Gur Aminadav & Elias Papaioannou, ‘Corporate Control around the World’ (2020) 75 Journal of Finance 1191.
  20. See Alperen Afşin Gözlügöl, ‘Controlling Shareholders: Missing Link in the Sustainability Debate?’, Oxford Business Law Blog (16 July 2021), available at https://www.law.ox.ac.uk/business-law-blog/blog/2021/07/controlling-shareholders-missing-link-sustainability-debate
  21.  On the corporate governance of privately held companies see generally Joseph A. McCahery and Erik P.M. Vermeulen, Corporate Governance of Non-Listed Companies (OUP 2008); Holger Fleischer, ‘Comparative Corporate Governance in Closely Held Corporations’ in Jeffrey N. Gordon and Wolf-Georg Ringe, The Oxford Handbook of Corporate Law and Governance (OUP 2018) 679. 
  22. See Alperen A. Gözlügöl & Wolf-Georg Ringe, ‘Private Companies: The Missing Link on the Path to Net Zero’ (ECGI Law Working Paper No. 635/2022, available at https://ssrn.com/abstract=4065115).
  23. See also Lucian A. Bebchuk and Roberto Tallarita, ‘The Illusory Promise of Stakeholder Governance’ (2020) 106 Cornell Law Review 91, 116-23.
  24. See generally, Alperen A. Gözlügöl, ‘The Clash of ‘E’ and ‘S’ of ESG: Just Transition on the Path to Net Zero and the Implications for Sustainable Corporate Governance and Finance’ (SAFE Working Paper 325) at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3962238
  25. See Martin Gelter, ‘Employee Participation in Corporate Governance and Corporate Social Responsibility’ (ECGI Law Working Paper No. 322/2016) 25-28 at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2798717.
  26. See Bebchuk & Tallarita (n 23) 164-68.
  27. Climate risk may have a substantial adverse impact on the portfolio returns of institutional investors, giving them incentives to engage for climate change mitigation. See notes 54-55 below and text thereto. Green preferences indicate the willingness of investors to give up financial returns for positive sustainability impacts. See notes 50-52 below and text thereto.
  28. For a brief commentary on other aspects of the CSDD Proposal, see Wolf-Georg Ringe & Alperen A. Gözlügöl, ‘The EU Sustainable Corporate Governance Initiative: Where are We and Where are We Headed?, Harvard Law School Forum on Corporate Governance (18 March 2022), available at https://corpgov.law.harvard.edu/2022/03/18/the-eu-sustainable-corporate-governance-initiative-where-are-we-and-where-are-we-headed/
  29. For a review of the literature, see Hans B. Christensen, Luzi Hail and Christian Leuz, ‘Mandatory CSR and Sustainability Reporting: Economic Analysis and Literature Review’ (2021) 26 Review of Accounting Studies 1176.
  30. See The Alliance for Corporate Transparency, ‘Research Report 2019: An analysis of the sustainability reports of 1000 companies pursuant to the EU Non-Financial Reporting Directive’ at https://corporatejusticecoalition.org/resources/alliance-corporate-transparency-2019-research-report/; European Securities and Markets Authority (ESMA), ‘Report: Enforcement and regulatory activities of European enforcers in 2020’ (6 April 2021) at https://www.esma.europa.eu/press-news/esma-news/esma-publishes-2020-report-enforcement-corporate-disclosure
  31. The NFRD only requires that the statutory auditor or audit firm checks whether the non-financial information has been provided. It is the Member States’ choice to further require that the non-financial information be verified by an independent assurance services provider. For how Member States have transposed these provisions into national law, see Accountancy Europe, ‘Towards Reliable Non-Financial Information Across Europe: Factsheet’ (February 2020) at https://www.accountancyeurope.eu/wp-content/uploads/Accountancy-Europe-NFI-assurance-practice_facthseet.pdf.
  32. NFRD Article 1. Public-interest entities are defined under the Article 2 of the Accounting Directive (Directive 2013/34/EU) as entities ‘governed by the law of a Member State and whose transferable securities are admitted to trading on a regulated market of any Member State’.
  33. On the EU Member States’ GHG emissions, see EEA greenhouse gases – data viewer (13 April 2021) at https://www.eea.europa.eu/data-and-maps/data/data-viewers/greenhouse-gases-viewer
  34.  See Deutsche Emissionshandelsstelle, ‘Greenhouse Gas Emissions in 2020: Stationary Installations and Aviation Subject to Emissions Trading in Germany (2020 VET report)’ (May 2021), 7 at https://www.dehst.de/SharedDocs/downloads/EN/publications/2020_VET-Report_summary.pdf?__blob=publicationFile&v=3 (Lausitz Energie Kraftwerke AG (LEAG) owns the second, third, sixth and seventh highest emitting power plants, which is in turn owned by EPH, a Czech private utility company, and PPF Investments, a private equity firm; on the ownership, see https://www.leag.de/de/unternehmen/).
  35. See Carbon Market Data Press Releases on the EU ETS Company Rankings at https://carbonmarketdata.com/en/news
  36. See Communication from the Commission — Guidelines on non-financial reporting: Supplement on reporting climate-related information C/2019/4490, 4 (‘the Non-Financial Reporting Directive has a double materiality perspective’).
  37. ibid 4-5.
  38.  Gözlügöl and Ringe (n 22).
  39. ibid.
  40.  (n 3).
  41. See BDI, ‘Stellungnahme zum Richtlinienvorschlag der Europäischen Kommission “Corporate Sustainability Reporting Directive” (CSDR)’ (4 June 2021) at https://www.bmj.de/SharedDocs/Gesetzgebungsverfahren/Stellungnahmen/2021/Downloads/0604_Stellungnahme_BDI_CSRD.pdf?__blob=publicationFile&v=3
  42. Milton Friedman, ‘A Friedman doctrine‐- The Social Responsibility Of Business Is to Increase Its Profits’ The New York Times (13 September 1970) at https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html
  43. See for example Tyler Cowen, ‘Milton Friedman Is More Relevant Than Ever’ Bloomberg (18 November 2021) at https://www.bloomberg.com/opinion/articles/2021-11-18/milton-friedman-is-more-relevant-than-ever
  44.  See generally Alejandra Medina, Adriana De La Cruz & Yung Tang, ‘Owners of the World’s Listed Companies’ (OECD Capital Market Series, 2019) at www.oecd.org/corporate/Owners-of-the-Worlds-Listed-Companies.htm
  45. See Ronald J. Gilson and Jeffrey N. Gordon, ‘The Agency Costs of Agency Capitalism: Activist Investors and the Revaluation of Governance Rights’ (2013) 113 Columbia Law Review 863.
  46. See Jeffrey N. Gordon, ‘Systematic Stewardship’ The Journal of Corporation Law (2022, forthcoming).
  47. Gilson and Gordon (n 46); Wolf-Georg Ringe, ‘Shareholder Activism: A Renaissance’ in Jeffrey Gordon & Wolf-Georg Ringe (eds), The Oxford Handbook of Corporate Law and Governance (OUP 2018), chapter 15.
  48. See generally Wolf-Georg Ringe, ‘Investor-led Sustainability in Corporate Governance’ (ECGI Law Working Paper No. 615/2021, November 2021) at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3958960
  49. See Oliver Hart and Luigi Zingales, ‘Companies Should Maximize Shareholder Welfare not Market Value’ (2017) 2 Journal of Law, Finance, and Accounting 247; Roland Bénabou and Jean Tirole, ‘Individual and Corporate Social Responsibility’ (2010) 77 Economica 1. 
  50. See for example Samuel M. Hartzmark and Abigail B. Sussman, ‘Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows’ (2019) 74 The Journal of Finance 2789 (finding evidence consistent with nonpecuniary motives influencing sustainable investment decisions).
  51. See Ringe (n 49) 10-14. See also Michal Barzuza, Quinn Curtis and David H. Webber, ‘Shareholder Value(s): Index Fund ESG Activism and the New Millennial Corporate Governance’ (2020) 93 Southern California Law Review 1243, 1283 ff. (part III.).
  52. See Robert Monks & Nell Minow, Watching The Watchers: Corporate Governance In The 21st Century 121 (1996)
  53. See Madison Condon, ‘Externalities and the Common Owner’ (2020) 95 Washington Law Review 1; John C. Coffee, Jr., ‘The Future of Disclosure: ESG, Common Ownership, and Systematic Risk’ (2021) Columbia Business Law Review 602; Gordon (n 47). Cf. Roberto Tallarita, ‘The Limits of Portfolio Primacy’ Vanderbilt Law Review (Vol. 76, 2023, forthcoming). 
  54. See for example Jose Azar and others, ‘The Big Three and Corporate Carbon Emissions Around the World’ (2021) 142 Journal of Financial Economics 674; Alexander Dyck and others, ‘Do Institutional Investors Drive Corporate Social Responsibility? International Evidence’ (2019) 131 Journal of Financial Economics 693.
  55. See for example Georg Zachmann, ‘‘Europe’s sustainable taxonomy is a sideshow’, Bruegel Blog, 22 February 2022 at https://www.bruegel.org/2022/02/europes-sustainable-taxonomy-is-a-sideshow/
  56. For a discussion in this regard, see Sebastian Steuer & Tobias H. Tröger, ‘The Role of Disclosure in Green Finance’ Journal of Financial Regulation (2022, forthcoming).
  57. Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement [2017] OJ L132/1.
  58. ESMA, Report: Undue short-term pressure on corporations, ESMA 30-22-762 (December 2019) 69-70.
  59. See Ringe (n 49) 42.
  60. See for example Florian Berg, Julian F Kölbel and Roberto Rigobon, ‘Aggregate Confusion: The Divergence of ESG Ratings’ (Working Paper, 2022) at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533; Florian Berg, Kornelia Fabisik & Zacharias Sautner, ‘Is History Repeating Itself? The (Un)Predictable Past of ESG Ratings’ (ECGI Finance Working Paper 708/2020, August 2021) at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3722087
  61.  Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks [2019] OJ L317/17.
  62. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions Strategy for Financing the Transition to a Sustainable Economy, COM(2021) 390 final (6 July 2021) 16. This followed the Commission’s own study and ESMA’s letter to the Commission on ESG ratings, respectively available at https://op.europa.eu/en/publication-detail/-/publication/897bee11-509d-11eb-b59f-01aa75ed71a1/language-en and https://www.esma.europa.eu/document/esma-letter-ec-esg-ratings. ESMA also recently published a call for evidence to gather information on the market structure for ESG rating providers in the EU. See, https://www.esma.europa.eu/press-news/esma-news/esma-launches-call-evidence-esg-ratings
  63. See TotalEnergies Press Release, ‘Total Closes the Sale of Non-Core UK Assets to NEO Energy’ (6 August 2020) at https://totalenergies.com/media/news
  64. See Ineos Press Release, ‘INEOS to buy the entire Oil & Gas business from DONG Energy A/S for a headline price of $1.05 billion plus $250m contingent’ (24 May 2017) at https://www.ineos.com/news/ineos-group/ineos-buy-entire-oil-and-gas-business-from-dong-energy/
  65. See Blackstone Press Release, ‘Siccar Point Energy announces acquisition of OMV (U.K.) Limited’ (9 November 2016) at https://www.blackstone.com/news/press/siccar-point-energy-announces-acquisition-of-omv-u-k-limited/
  66. See Engie Press Release, ‘ENGIE to sell its German and Dutch coal assets and boosts the implementation of its strategy’ (26 April 2019) at https://www.engie.com/en/journalists/press-releases/sell-german-dutch-coal-assets
  67. See Anjli Raval, ‘A $140bn Asset Sale: The Investors Cashing In On Big Oil’s Push To Net Zero’ Financial Times 6 July 2021 at https://www.ft.com/content/4dee7080-3a1b-479f-a50c-c3641c82c142 (citing energy consultancy Wood Mackenzie).
  68. See ‘Who Buys the Dirty Energy Assets Public Companies No Longer Want?’ The Economist 12 February 2022 at https://www.economist.com/finance-and-economics/who-buys-the-dirty-energy-assets-public-companies-no-longer-want/21807594
  69.  ibid.
  70. SFDR Article 4 (transparency of adverse sustainability impacts at entity level) and Article 7 (transparency of adverse sustainability impacts at financial product level).
  71. Who Buys the Dirty Energy Assets Public Companies No Longer Want?’ (n 69).
  72. On how this system works and the sectors covered, see https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets_en
  73. Ian Parry, ‘Putting a Price on Pollution’ (2019) 56(4) IMF Finance & Development 16, at https://www.imf.org/external/pubs/ft/fandd/2019/12/the-case-for-carbon-taxation-and-putting-a-price-on-pollution-parry.htm
  74. See, https://ec.europa.eu/clima/eu-action/european-green-deal/delivering-european-green-deal/increasing-ambition-eu-emissions-trading_en
  75. See for example Joseph E. Aldy and Robert N. Stavins, ‘The Promise and Problems of Pricing Carbon: Theory and Experience’ (2012) 21(2) Journal of Environment and Development 152; Nicholas Koch et al, ‘Causes of the EU ETS price drop: Recession, CDM, renewable policies or a bit of everything? – new evidence’ (2014) 73 Energy Policy 676.
  76.  See for example Itzhak Ben-David et al, ‘Exporting Pollution: Where Do Multinational Firms Emit CO2?’ (2021) 36 Economic Policy 377; Söhnke M. Bartram, Kewei Hou and Sehoon Kim, ‘Real Effects of Climate Policy: Financial Constraints and Spillovers’ (2022) 143(2) Journal of Financial Economics 668. In response to this problem, the EU wants to adopt the so-called Carbon Border Adjustment Mechanism. On the initiative and how it works, see https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_3661.
  77.  See also ‘Green Investors’ Filthy Secret: The Truth about Dirty Assets’ The Economist 12 February 2022 at https://www.economist.com/leaders/2022/02/12/the-truth-about-dirty-assets
  78. See Burton G. Malkiel, ‘Bubbles in Asset Prices’ in Dennis C. Mueller (eds), The Oxford Handbook of Capitalism (OUP 2012).
  79. ibid.
  80. See Madison Condon, ‘Market Myopia’s Climate Bubble’ (2022) Utah Law Review 63; Mark Carney et al, ‘The Financial Sector Must Be at The Heart of Tackling Climate Change’ The Guardian (17 April 2019) at https://www.theguardian.com/commentisfree/2019/apr/17/the-financial-sector-must-be-at-the-heart-of-tackling-climate-change
  81. While the NFRD and its successor CSRD aim to provide disclosure on climate risk at the company level, the SFDR covers disclosures at the investment fund or manager level. 
  82.  See, Sirio Aramonte and Anna Zabai, ‘Sustainable finance: trends, valuations and exposures’ (BIS Quarterly Review, September 2021) at https://www.bis.org/publ/qtrpdf/r_qt2109v.htm
  83. ibid.
  84. See ‘A green bubble? We dissect the investment boom’ The Economist (20 May 2021) at https://www.economist.com/finance-and-economics/2021/05/17/green-assets-are-on-a-wild-ride.  See also Billy Nauman, ‘‘Green bubble’ warnings grow as money pours into renewable stocks’ Financial Times (19 February 2021) at https://www.ft.com/content/0a3d0af8-7092-44c3-9c98-a513a22629be
  85. Aramonte and Zabai (n 83).
  86.  ibid.
  87. See European Commission, ‘Consultation on The Renewed Sustainable Finance Strategy’ (8 April 2020) 21, at https://ec.europa.eu/info/consultations/finance-2020-sustainable-finance-strategy_en
  88.  (n 63).
  89. See also Veerle Colaert, ‘The Changing Nature of Financial Regulation: Sustainable Finance as a New Policy Goal’ (on file with authors), pp. 18-19.
  90.  See Patrizia Baudino and Jean-Philippe Svoronos, ‘Stress-testing banks for climate change – a comparison of practices’ (BIS FSI Insights on policy implementation No. 34, July 2021) at https://www.bis.org/fsi/publ/insights34.htm
  91. Ivana Baranović et al, ‘The Challenge of Capturing Climate Risks in the Banking Regulatory Framework: Is There a Need for a Macroprudential Response?’ (ECB Macroprudential Bulletin, Issue 15, October 2021) at https://www.ecb.europa.eu/pub/financial-stability/macroprudential-bulletin/html/index.en.html.
  92. Cf. Colaert (n 90) 21-22 (distinguishes between green supporting factor and brown punishing factor and states that the latter does not pose any danger).
  93.  Nicholas Comfort and Frances Schwartzkopff, ‘ECB Has Banks Bracing for Capital Hit as Climate Risk Tested’ Bloomberg (8 February 2022) at https://www.bloomberg.com/news/articles/2022-02-08/ecb-has-banks-bracing-for-capital-hit-as-climate-risk-is-tested
  94. Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 [2013] OJ L176/1 (as amended), Article 501(c).
  95. ibid.
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