Expert Opinion (#1-2 January-February 2022)

Sustainability-Related Disclosures in Ukraine: What Businesses Should Expect Soon

by Stepanyda Badovska

On 25 November 2021, the National Bank of Ukraine (NBU) presented the Sustainable Finance Development Policy 2025, which unveiled regulatory targets to be implemented in the Ukrainian financial services market in line with best international practices and standards regarding environmental, social and governance (ESG) regulatory frameworks. As expected, the introduction of ESG-related disclosure standards for both banks and non-bank financial institutions is among the targets. While such disclosures are considered an unalienable pillar of any sustainable finance framework, the introduction of ESG reporting requirements may become one of the most challenging reforms for both state authorities and businesses. The reform will eventually expand outside of the financial sector.

Are there any current requirements for ESG-related disclosures?

There are currently no elaborated legislative requirements for mandatory climate or ESG-related disclosures by Ukrainian businesses. The Ministry of Finance recommends large and middle-size businesses to include information on ecological and social aspects of their activity into the management reports that are submitted together with financial statement, while the NBU requires banks to report on the same aspects but does not elaborate on the content of such reporting. The Policy, which is a framework document, does not elaborate on the content of soon-to-be-implemented regulatory reforms, but outlines a roadmap for reform-related activities. The regulatory requirements for ESG-related disclosures will be introduced via the following steps:

The NBU will present and approve general ESG disclosure standards for banks by the end of 2022.

It will then recommend that banks disclose technical criteria for evaluating and selecting investment projects and develop recommendations on disclosing sustainability-related matters regarding such evaluation and selection (by Q4 2023).

It will eventually adopt legislative requirements regarding disclosing information on the sustainability of the activity of financial institutions (by Q4 2024).

The same steps will be implemented in relation to non-bank financial institutions by Q4 2024.

The NBU was, however, not the first state body to adhere to the worldwide sustainability-related disclosure trend. In March 2020, the National Securities and Stock Market Commission (NSSMC) issued the third edition of the Core Code of Corporate Governance which, for the first time, addressed sustainable development issues in corporate governance. The Code identified the long-term sustainable value of a company as one of its main objectives, along with maximization of returns. It recommended seeking to implement sustainable practices by, in particular, developing its own sustainable development policy and adhering to up-to-date best standards in sustainable development. The Code says a little about the ESG-related disclosures by subjected companies, but strongly advises that the companys impact on society and the environment is made clear to stakeholders in a comprehensible manner. The Code also refers to the companys binding obligation to disclose all material information that could reasonably be expected to have an effect on the companys share price or stewardship decision. However, it does not clarify which ESG-related information may be treated material and relevant in this regard.

So as to address the lack of clarifications on sustainable practices in corporate governance, in December 2021 the NSSMC approved a so-called ESG Annex to the Code. The ESG Annex draws out an organizational framework for introducing and maintaining ESG disclosure processes and refers to various international standards and practices. More concrete and extensive guidelines on ESG corporate disclosures are, however, still to be shared by the
NSSMC.

Separately, there is a legislative requirement to disclose project-related information on sustainable aspects if it is one thats applicable to issuers of green bonds in Ukraine. Hence, given that the by-laws framework for the issuance of green bonds is still pending, this requirement may remain practically ineffective for some time.

From voluntary practices to mandatory rules

The recommendations on disclosures and reporting will not remain voluntary for long, as demonstrated by foreign practice. Neither will the disclosure requirements be limited to the financial industry.

Although more general sustainability-related reporting frameworks were launched even earlier, the buildup of high regard around the disclosure trend was triggered by the problem of climate change and initiated by representatives of the financial sector, who began interpreting climate change as an undiversifiable risk threatening the financial stability of markets. For example, academics believe that climate change and carbon transition implications for monetary policies of the European System of Central Banks fall within their primary objective to maintain price stability.1 One of the best efforts to address the climate-related disclosure initiative was the launch of the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations designed to help companies provide better information to support informed capital allocation.2 There are a number of initiatives, including the Global Reporting Initiative, guiding business disclosures from a broader, sustainability-related perspective beyond net zero and including social impact and governance issues. This broader perspective was inserted into the recent IFRS Foundation initiative on the establishment of the International Sustainability Standards Board to deliver a comprehensive global baseline of sustainability-related disclosure standards for financial reporting.3

Many sustainability-related disclosure recommendations were initially aimed at financial market participants. However, the current trend is to bring a wider range of reporting entities to the table. For example, the TCFD recommendations encourage disclosure by all companies issuing public debt or equity along with financial sector institutions. In April 2021, the European Commission suggested that the disclosure and reporting obligations should be expanded beyond large listed companies at legislative level (more information below).

Building up on the legislative aspect, voluntary disclosures proved not to be sufficiently effective. Given that the relevant information that may be required by investors for decision-making is incomplete without private corporate information, which may not always be disclosed by target companies voluntarily, a regulatory response is required. Countries are not only introducing disclosure requirements, but are also increasingly incorporating necessary guidelines at legislative level. For example, from April 2022, the UK will become the first G20 country to make the disclosure of climate-related risks and opportunities in line with the TCFD recommendations mandatory for the largest British businesses.4

The transformation of sustainability-related disclosure recommendations into legislative requirements may be also conducted by changing the interpretation of more general legal concepts and obligations (such as materiality of issues to be disclosed, fiduciary duties of the companys management, etc.) to require a companys sustainable development or at least net zero targeting to be considered.

EU legal framework for sustainability-related disclosures

The EU was among the first jurisdictions to introduce mandatory ESG-related disclosures. Given that Ukraine is on the road to harmonizing its legislation with EU standards and practices, we can assume that the EUs approach will be taken into consideration when designing the Ukrainian legal framework for sustainability-related disclosures. EU legislation imposes different disclosure and reporting requirements, the scope of which depend on the status (financial/non-financial institution, credit rating agency, benchmark administrator, listed/non-listed company) and size (large, SME, micro) of the company.
The disclosure requirements cover those on sustainability-related products and services, the sustainability-related practices of a business and their impact on both society and the environment. The main legislative acts addressing mandatory ESG-related disclosures are referred to below.

Directive2014/95/EU of 22 October 2014, amending Directive2013/34/EU with regard to disclosure of non-financial and diversity information by certain large undertakings and groups (NFRD), imposes a reporting obligation on large public-interest entities withmore than 500 employees. It requires these companies to include a non-financial statement in the management report with information on a companys performance and the impact of its activity relating to environmental, social and employee matters, respect for human rights, and anti-corruption and bribery matters. The disclosure should encompass a description of the undertakings business model and its ESG policies, a description of due diligence processes, the main risks related to ESG matters and linked to the undertakings operations, how those risks are managed, etc. The NFRD covers disclosures from so-called double materiality, requiring the effect of sustainability issues on business (the outside-in effect) and a companys impact on society and the environment (the inside-out effect) to be reported.

The SFDR, or Regulation (EU) 2019/2088 of 27 November 2019 on sustainability-related disclosures in the financial services sector, relates to financial market participants and financial advisers. It establishes transparency rules regarding integrating sustainability risks and considering adverse sustainability impacts in their activity, as well as delivering sustainability-related information on their financial products. This includes the obligation to publish information on a website about policies on the integration of sustainability risks in investment decision-making processes, the consistency of remuneration policies with the integration of sustainability risks, etc. The SFDR obliges financial institutions to disclose particular information on each subjected financial product, including how a product treats principal adverse impacts on sustainability factors and how the declared environmental or social characteristics of a product are met.

The CSRD (proposal for a Corporate Sustainability Reporting Directive revising the NFRD) was adopted on 21 April 2021 and is yet to become law. The CSRD is aimed at introducing more detailed reporting requirements and expanding them to include a wider range of companies (all large companies, including private ones, and all listed companies (expect for micro-size companies)).

Regulation (EU) 2020/852 of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), introduces two more sets of disclosures. The first one applies to companies subject to the NFRD and requires that they unveil how, and to what extent, their activities qualify as environmentally sustainable. This includes information on the proportion of environmentally sustainable products and services in a companys turnover and the proportion of the linked capital and operating expenditure. The second type obliges financial product issuers to disclose how financial products contribute to an environmental objective, promote environmental characteristics, etc. The obligation is effective from January 2022 in relation to activities addressing climate adaptation and mitigation objectives.

Credit rating agencies and benchmark administrators are also subject to additional reporting obligations under separate pieces of EU legislation.

The challenges faced by lawmakers and businesses

One of the problems with regard to making sustainability-related disclosures work and efficient was addressed by shaping them as law. There are other issues that ensure that this piece of legislation is constantly evolving, which should be taken into consideration by Ukrainian authorities when designing the relevant regulation. These challenges include defining what is material for disclosures, the scope of disclosures (this especially concerns climate-related disclosures), the treatment of confidential information, and the unification of standards and techniques for collecting information for disclosure.

One of the most fundamental problems, however, is how to collect relevant information. In the EU, this issue is being partially resolved by introducing mandatory rules on company due diligence and corporate accountability. The European Parliament resolution of 10 March 2021 provides recommendations to the European Commission on the text of the relevant directive and underlines that voluntary due diligence standards have not achieved significant progress in preventing human rights and environmental harm and in enabling access to justice. The directive will apply to large undertakings, publicly-listed small and medium-sized undertakings, as well as high-risk small and medium-sized undertakings, with the aim of ensuring that they do not cause or contribute to a potential or actual adverse impact on human rights, the environment and good governance. These undertakings will be obliged to develop their due diligence strategies, publish statements if no risks or harm is identified, and check their subsidiaries, suppliers, contractors and other stakeholders.

Actions to be undertaken

Although no comprehensive legal framework on ESG-related disclosures exist in Ukraine yet, businesses should start planning their activity with regard to upcoming reforms and international disclosure practices. In particular, they should develop sections of reporting documents devoted to ESG issues, define materiality criteria for their business, analyze their activity against their impact on the environment and society, and choose standards for disclosure. To comply with the requirements of their counterparties for which corporate disclosures are mandatory by virtue of law or their policies or pledges, businesses should also implement strategies on conducting due diligence and pre-contractual/contractual disclosures. Prospective issuers of green and sustainable financial instruments should also plan their disclosures as per the frameworks of instruments.

Stepanyda Badovska is an associate at Baker McKenzie-Kyiv

1https://www.law.ox.ac.uk/business-law-blog/blog/2021/12/climate-change-and-monetary-policy-euro-area

2https://www.fsb-tcfd.org/about/

3https://www.ifrs.org/groups/international-sustainability-standards-board/

4https://www.gov.uk/government/news/uk-to-enshrine-mandatory-climate-disclosures-for-largest-companies-in-law

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