EU Taxonomy and the startup ecosystem: NFDR, SFDR, and CSRD explained

Remember the times when startups were all about the move fast, break things mentality? While growth and innovation are still key elements in the startup environment, when it comes to sustainability, the EU has implemented new regulations that will soon require investors and businesses to take more responsibility for how they treat people and the planet.

TL;DR: The main thing to keep in mind is that the new EU regulations will affect:

1. All banks and VC funds and their portfolio companies;

2. Scaleups that will either:

   1. Go public

   2. Meet 2 out of the following criteria:

      1. €40 million in net turnover

      2. €20 million in assets

      3. 250 or more employees

3. Startups that sell to affected market participants. 

These new regulations will require companies to be more transparent about their ESG-related efforts, and the investors will be obliged to report on what their investees are doing to improve the people and planet’s wellbeing. But before we dig deeper, let’s note which terms are important to know.

Key terms

The European Green Deal is a set of policies that aim to turn the EU into a more resource-efficient economy, which means becoming climate-neutral by 2050.
EU taxonomy is a classification system of environmentally sustainable business activities. 

CSRD means Corporate Sustainability Reporting Directive. NFRD (Non-Financial Reporting Directive) was superseded by CSRD. The EU law requires all large/ public businesses to share information on how they manage ESG risks. 

SFDR stands for Sustainable Finance Disclosure Regulation, and it requires financial market participants to provide transparency on their ESG management, as well as impose mandatory ESG disclosure obligations. 

ESG stands for environmental, social, and corporate governance. NB! Not to be mistaken with impact. ESG focuses on internal governance, like financial risk, however, impact focuses on the external results.

CSRD, SFDR, NFRD — what applies to me?

Before dissecting each of the three legislations, it’s important to understand what the sustainability objectives entail. The EU Taxonomy has six environmental objectives:

1. Climate change mitigation

2. Climate change adaptation

3. Sustainable use and protection of water and marine resources

4. Transition to a circular economy

5. Pollution prevention and control

6. Protection and restoration of biodiversity and ecosystems (Source)

If you're a company founder, take these objectives as a guiding light toward where the European economy is going. And continue reading to understand what direct impacts to expect for your business. 

SFDR 

Relevant for:

• Asset managers and investment firms (also VC funds, accelerator programs, etc.)

• Financial advisors

• Banks

• Insurance companies

Simply put, the regulation requires reporting on the sustainability risks of the portfolio, regardless if they offer sustainability-related products or not. This regulation aims to prevent greenwashing and pave the road to more sustainable investment decisions. 

The real challenge of SFDR implementation for many VC funds is to start working on compliance using the draft Regulatory Technical Standarts with incomplete and complex guidelines on implementation. 

If the SFDR Regulatory Technical standards are approved now, the first report will need to include data from 2022 and be published on June 30, 2023. But gathering data from investee companies takes time. 

As for investment funds, per SFDR, they can be classified into 3 articles:

Article 6: Funds with no sustainability scope. 

Example: tobacco companies, coal-fired power generation, mining

Article 8: Funds that promotes, among other characteristics, environmental and/or social onces, provided that the companies in which the investments are made follow good governance practices. These funds are also called light green funds.

Example: software companies increasing operational efficiency, hardware companies building electrical scooters

Article 9: Funds that primarily invest in companies who have sustainability as their main goal, or dark green funds

Example: carbon accounting platforms, software for managing ESG risks, solar panel or wind turbine companies

What this means:

• All FMP (Financial Market Participants) are required to disclose information on their sustainability practices (firm-level) and their financial products (product-level);

• If the fund is smaller than 500 employees and they choose not to disclose this information, they have to provide an explanation why.

• Funds that classify under Article 9 need to report on their Principle Adverse Impacts (PAI) on both firm and product levels. (Source)

NFRD

Relevant for:

• Listed and large public-interest companies with 500+ employees and €40M+ turnover and/or €20M+ in total assets

What has to be reported?

According to the directive, companies must publish their information related to:

• Environmental protection (e.g., CO2 footprint, water consumption, waste management processes, etc.)

• Social responsibility and treatment of employees

• Respect for human rights

• Anti-corruption and bribery

• Diversity on company boards (in terms of age, gender, educational and professional background) (Source)

Since NFRD affects only about 12 000 companies, the European Commission developed an expanded version of this directive — the CSRD.

CSRD

Relevant for:

• All large companies with 250+ employees and €40M+ turnover and/or €20M+ in total assets

• Listed companies

The CSRD introduces detailed ESG metrics and requires external auditing, too. Basically, it requires the same data as NFRD but affects more businesses and is more demanding in reporting. Think of CSRD as an extended and more detailed version of NFRD. 

What about SMEs?

The CSRD proposal would not put any new mandatory reporting requirements on SMEs, except those with securities listed on regulated markets. There are new reporting standards on the way for listed SMEs (a simplified version of CSRD) and non-listed SMEs (voluntary). (Source)

Is there a specific timeline?

The CSRD was adopted in April 2021, however, it will be gradually phased in until 2023. What it means is that businesses affected by this directive will be obliged to report their sustainability efforts pretty soon — in 2024, businesses will have to submit their reports for the 2023 financial year. 

It can take months to calculate the carbon footprint of a company, so it’s important to start early. What’s more, investors will also be on the lookout for CSRD, as this reporting data is essential for drawing up an SFRD. 

The future startup is green

Even though these directives sound like a lot of paperwork and extra hours of research and data gathering — which they will be — this process will get easier with time as companies get more acquainted with it. Plus, the new policies will also:

• Encourage and support sustainable businesses;

• Provide more transparency — both for startups and their investors;

• Pave a way to a more sustainable economy.

And there’s also a competitive advantage to going greener and doing it fast. Investors will be looking for companies that have their sustainability data in check, so sorting it out early will put startups looking for their next investment round ahead of the competition

Are you a tech company owner in the research phase of your business’s sustainability journey, exploring sustainability regulations and figuring out ways to make your business greener? Consult a professional — working with a sustainability advisor will help you save time and money!

Your Impact House is more than ready to help you advance on your sustainability journey and increase your competitive advantage. Let’s talk - book a call here!

P.S. - This article is a compilation of the research I’ve done on the subject, but it’s not legal advice. Consult your lawyer to determine the materiality and relevance of these regulations to your business.