ESG trend: Green Business Entities

13 October 2022


There has been a long-standing debate in academic circles about the real purpose of companies. The classical approach, which has also been adopted by Slovenian legislator, emphasises that the purpose of companies is to carry out exclusively profit-making activities in order to realize a profit (Article 4(1) and (2) of the Slovenian Companies Act; ZGD-1). Hence, in Slovenia we have enacted a theoretical approach that emphasises the benefits of shareholders (shareholder theory). A new theory, however, emphasises that companies shall not solely pursue benefits of their shareholders but must also consider benefits of all stakeholders, including employees, suppliers, NGOs and the wider community (stakeholder theory).

In investment circles, a stakeholder theory approach to investing has evolved in a mindset that looks beyond pure profit maximisation and includes broader environmental, social and governance impacts of investing: Environmental, Social, and Governance criteria - ESG.

In light of climate change crisis has this debate also been reflected in the practical response of relevant regulatory bodies in global markets. Legislative steps have also been taken at the level of the European Union.

European level

In the European Union (EU) there is a far-reaching and ambitious political consensus on ESG issues, which has resulted in adoption of the legally binding European Climate Law (ECL).

ECL contains the legally binding target to reduce the EU's greenhouse gas emissions to zero by 2050, thereby achieving climate neutrality. ECL also set an interim target of reducing net greenhouse gas emissions by at least 55% by 2030 compared to 1990 emission levels.

The EU sees sustainable investment as a key component of the Union's ability to meet its climate targets. The EU wants to make the public aware of the opportunities for investing in the green economy and, accordingly, investors and other stakeholders need relevant information with ESG content. The EU therefore wants to encourage companies (in the EU context we use the term "undertaking") in the EU internal market to disclose ESG information in a practical way, this means by publishing it in annual reports.

The stimulating sustainable investment framework thus covers a range of initiatives aimed at driving investment in the green economy, including:
- The Taxonomy Regulation - Regulation (EU) 2020/852;
- Regulation on Disclosure of Sustainable Finance - Regulation (EU) 2019/2088;
- The establishment of the voluntary European Green Bond Standard;
- Proposal for the Directive on Corporate Sustainability Reporting.

The latter directive proposal from the European Commission in April this year introduces new standards on sustainability reporting and expands the range of ESG reporting entities. Under this proposal the Member States will have to adopt a new comprehensive package of reporting requirements into their legal system.

In addition, undertakings will have to report on, among others, (i) the resilience of their business model and corporate strategy to sustainability risks; (ii) the sustainability opportunities and sustainability plans for the undertaking; (iii) the way in which the undertaking's business model and strategy reflect the interests of the undertaking's stakeholders; (iv) the way in which the undertaking's ESG strategy has been implemented; and so forth.

Reporting entities will be:
- all large undertakings (i.e. those that meet at least two of the three criteria: 250 employees, net revenue of €40 million or more and balance sheet total of €20 million or more), whether or not they are listed on EU regulated markets; and
- all listed undertakings (i.e. those offering securities on EU regulated markets), including small and medium-sized enterprises (SMEs), but excluding micro-enterprises, as all are defined in the EU Accounting Directive 2013/34/EU.

The directive proposal also provides for a collective responsibility of members of the administrative, management and supervisory bodies to ensure that their company has ESG reporting standards in compliance with EU requirements.

It is estimated that around 49,000 companies in the EU internal market will be subject to ESG reporting under the directive proposal, compared to around 12,000 companies with reporting obligations under the current regime.

However, once the directive is adopted at the EU level, Member States will need to transpose these new rules into their legal systems. Thus, the first mandatory reporting under the new ESG rules is not expected before 2025.

Impact on business in Slovenia

In the light of the above, ESG topics have already taken its first regulatory steps at the supranational EU level and we expect the regulatory process to continue and intensify in the coming years. However, for the time being Slovenia does not have a legally binding ESG definition or a legislated catalogue of information on ESG requirements applicable to Slovenian companies.

On the other hand, effects of the new trend are already seen in the market: borrowers with humble ESG credentials are less attractive for debt financing, and in M&A, potential ESG risks raise eyebrows among investors and therefore such potential risks need to be covered by legal due diligence.

Times change and the zeitgeist imposes new requirements on business entities. At Kirm Perpar we keep a close look on these new developments.