At depth, a wave may look flat. As it approaches the beach it gathers itself up, curls into a break, and then comes the crash and spray across the shoreline. EU Regulation 2019/2088, part of the sustainable finance process, is likely to play out in a similar way. Its title may appear innocuous: “Sustainability-related disclosure requirements in the financial services sector.” Yet, this sustainability wave will likely end up touching everyone who operates a major solar installation and, later, those who build them as well. On March 10, the wave reached the point where it started to curl. Since that date, merely boasting about sustainability goals no longer cuts it; now the boasts have to be backed up with action.
Environmental, social and corporate governance (ESG) criteria are by no means driven solely by the EU’s mandatory disclosure requirements. Encavis operates more than 160 PV plants in its own portfolio with a total capacity of 1.3 GW. It is a publicly traded company and finances its PV and wind power plants through the stock market. BlackRock holds 10% of its shares, for instance. As an independent producer of electricity, Encavis is not affected by the new disclosure requirements for players in financial markets. Nevertheless, the ESG issue has already reached the company. Some of its investors have, as is customary, commissioned ESG rating agencies to scrutinize it with regard to these criteria.
“It’s not just a matter of using the ESG rating to get better financing terms,” says CFO Christoph Husmann. “ESG rating is going to be a must, otherwise you won’t be able to get financing at all.” We are not there yet, he says, but Husmann expects the relevance of the rating to increase over the next three to five years. “I’d predict that the ESG rating will become at least as relevant as the previous rating.”
Three years ago, the topic began to gain relevance, Husmann continues, but today every investor is asking where investments stand in terms of sustainability. Companies then have to produce evidence, and there is increasing demand for investments in the fossil fuel industry not to exceed a certain share of a portfolio’s total.
The Norwegian state fund Norges, for instance, is withdrawing from all companies that continue to extract, distribute, or burn fossil fuels. Larry Fink, chairman of BlackRock, again explained the ESG orientation of his investment policy in detail this year. Allianz also wants to gradually restructure €800 billion of investments from its own insurance business in such a way as to reduce greenhouse gas emissions 25% by 2025.
Italian utility Enel builds solar power plants around the world, and employs about 20 ESG rating agencies each year. The ratings are primarily useful to institutional investors and asset managers, giving them sound insights into how certain ESG criteria can affect financial performance, a company spokesperson told pv magazine. In addition, Enel said, potential partners look at ESG criteria as part of the due diligence process they conduct on the company. Among them are investors with whom they develop joint ventures to build and operate power plants. Some industrial customers are also starting to pay attention to the criteria, the spokesperson said.
Ratings are an early indicator and an investment precondition for more and more investors, says Husmann. In the rating scheme of the ISS ESG rating agency, Encavis now achieves the Prime label and is rated with a “B”. “Among the companies rated by ISS ESG that also operate PV and wind power plants, only two are better,” Husmann says.
Highest marks
But why doesn’t a PV asset manager have the top score? “That’s a good question,” says the CFO. It’s not just a question of having a positive carbon footprint. “If you drive a Maserati to the construction site, that’s simply not good, even if you generate low-carbon electricity.” ESG rating agencies use extensive catalogs of criteria for evaluating companies. These topics are broadly divided into the three dimensions of sustainability: environmental, social, and governance. A good ESG rating means that a company has done well in all three dimensions of sustainability. “You look at sustainability across the entire value chain,” says Husmann. It shows up in cleaning supplies, travel costs, the gender breakdown of the workforce, and even the question of what the company’s vehicle fleet looks like, he says.
The topic has not yet really reached the level of project developers. “But that will come, too,” says Husmann. Encavis has always attached importance to a strict set of requirements that projects must meet, such as module quality and performance. Increasingly, the carbon footprint of the entire supply chain will come into play, because ultimately how the components are manufactured and how the plant is built will have the greatest impact. The rating agencies give high marks for a positive carbon footprint.
Project developers
Thilo Tern agrees that the ESG wave will also reach project developers. Tern is managing partner of the Silvester Group and advises Husmann on the ESG process. “It’s eating its way through the chain,” he says. His company specializes in sustainability consulting and management and also has its origins in financial communications. Nowadays, ESG communication sometimes takes longer than annual financial reporting, he says.
The challenge, says Tern, is that the EU’s new sustainable finance guidelines have not yet defined specific ESG criteria for the renewable energy industry. In the case of solar power plants, for instance, it stands to reason that environmentally sustainable management of green spaces would have a positive impact on the ESG rating. The specific indicators and standards, such as the carbon footprint or protection of species and human health, which will be evaluated on a graduated scale, have yet to be clarified. In this respect, it is unfortunately not yet clear exactly what will be in store for the installers and operators of solar power plants. “We are trying to work with the various players in the photovoltaics, supplier and financial markets to develop uniform, real-world standards and procedures,” Tern says.
The situation is confusing for outsiders, as there are two intertwined regulations, the Disclosure Regulation (2019/2088) and the Taxonomy Regulation (2020/852). Technical details of each are still under development. With regard to technical details of the Disclosure Regulation, known by the acronym RTS, the European supervisory authorities recommend using the draft published on Feb. 4 in the financial sector. The technical details of the EU taxonomy, which govern the criteria and how they are to be taken into account in order to be considered a sustainable financial product in the EU, should have been adopted by the end of last year, according to the European Commission. “But there are delays,” says Carsten Auel, a senior manager at Deloitte in Frankfurt, responsible for disclosure and taxonomy issues.
“The discussion over how deep into the supply and value chains to look, especially with regard to components, has begun,” says Tern. He thinks it unlikely that project developers will be able to escape the process, considering how powerfully the wave has swept through the financial market. According to their own figures, the asset managers of Allianz Global Investors alone have invested €158 billion using sustainability-oriented strategies. “Ultimately, the assets have to be evaluated against ESG criteria,” Tern says.
To a certain extent, such assets are already evaluated today. When asked about the issue, the Enel spokesperson told pv magazine that “all of the roughly 20 ESG rating agencies we engage with every year include specific criteria to asses our performance on the construction process of our solar plants.” They also evaluate the company’s environmental and social policies, programs and practices across its value chain, but without conducting a asset-level analysis.
Sustainability risks
The disclosure obligation, applied in the EU from March 10, will reinforce this trend. Since that date it is official policy that, in principle, all financial market participants and advisors now have to disclose how they are addressing sustainability, albeit scaled to the size of the company. Sustainability risks, negative impacts of the activity on sustainability factors, and – if using sustainability aspects for the marketing – a detailed evaluation of the ESG criteria all have to be disclosed. It is possible to argue one’s way out of the latter requirement by explaining that it is an “other financial product” with which one is not pursuing any sustainability goals. “But what investor wants that,” says Thomas Seibel, CEO of Recap Global Investors.
Recap Global Investors is an asset manager in the renewable energy sector that operates, among other assets, PV plants with a combined capacity of around 500 MW in Germany, Denmark, and the Netherlands. The projects were acquired through closed-end funds with terms of 15 to 20 years and are managed by Luxembourg-based BKN Capital, from which pension funds, insurance companies, and others buy shares. Recap is the fund’s official investment adviser.
In addition to operating the power plants, Seibel and his team scout projects and advise BKN Capital on purchases. Since March 10, BKN Capital now has to comply with the additional disclosure requirement in “pre-contractual information on sustainable investments,” according to the regulation. The information will be published in the sales prospectus and online, Seibel is currently working with the capital management company to implement the requirements.
In addition to the other financial products that do not advertise sustainability goals, the EU regulation provides for two categories. They are sometimes referred to as “light green” and “dark green.” A financial product that advertises environmental or social features is considered light green. According to Article 8 of the regulation, the product issuer now has to demonstrate how these characteristics are fulfilled. Dark green means that the product not only has “features” but strives to achieve sustainable goals.
According to Article 9 of the regulation, the fund not only has to describe how the intended sustainability goal will be achieved, but also how sustainability risks will be factored into the final investment decision. This will then also cover other environmental impacts. In the future, compliance with the regulatory requirements will be monitored by the financial supervisory authorities of the respective countries.
“The primary goal of the funds we manage is to reduce carbon emissions,” Seibel says. “But in the process of pursuing this ESG goal, we cannot contradict the other ESG goals.” This is why they increasingly use sheep in their solar power plants, for instance, and avoid the use of mechanical mowers as much as possible. And during construction, there are mitigation measures, such as the creation of ponds to promote biodiversity.
Even Seibel cannot forecast precisely what is in store for the solar industry. But he thinks it is possible, for example, that the supply chains for the components used in PV systems will also become more important. And he assumes that the requirements will become stricter from year to year.
Above all, it is becoming more and more complicated. Even if the issue is not really on the radar for project developers at the moment, it makes sense for them to start looking into it now, says Yvonne Fehrenbach, a director at Deloitte and a member of the Deloitte Sustainable Finance Initiative. “Every year, new regulations are added, and if you don’t deal with it on a continuous basis, you can easily run the risk of being left behind.”
Although it may mean more effort, the trend also brings opportunities. Companies are now required to report the proportion of total revenue that is considered sustainable under the EU taxonomy. And the ESG rating agencies, according to Enel, are also evaluating how quickly the company is decarbonizing its energy mix. Thus, the developments should ultimately lead to more money being invested in PV plants.
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