What does it mean to “Do No Significant Harm”?

This article was written by Nadia Humphreys, Business Manager, Sustainable Finance Solutions at Bloomberg, Co-rapporteur on the Platform for Sustainable Finance of the European Commission.

Demonstrating that investments “do no significant harm” is a cornerstone of the EU’s new sustainable finance framework. In practice however, determining how to apply this principle can be complex for investors. Regulations such as SFDR, the Taxonomy for sustainable activities and the Benchmark Regulation all refer to it with different nuances. How can investors demonstrate that their investments are doing no harm, notably for non-EU companies? What do they need to measure, and with what type of data?

Why investments should “do no harm”

EU regulators introduced the principle of Do No Significant Harm (DNSH) to prevent myopic investment processes, which would focus on a particular environmental or social objective without sufficient consideration for other such objectives. This is particularly important as the new north star of “net zero” is attracting capital to help decarbonise the economy. As a result, targets and metrics used to assess investments tend to focus on the carbon emitted by a company, at the expense of other important environmental data sets such as good water, waste and biodiversity management. DNSH will help ensure that companies doing well on one environmental aspect meet a minimum baseline standard across others.

It will be increasingly important, as the European Commission looks to adopt a complementary delegated act, which would see nuclear recognised under the Taxonomy. Nuclear clearly delivers energy within the 100gCO2e/kWh threshold for substantial contribution, but many NGOs, academics and civil society members have pointed out that poorly run plants can have the potentially to significantly harm local biodiversity through poor water or waste management practices.

How EU regulations refer to “do no harm”

1) Sustainable Finance Disclosure Regulation

According to article 2(17), investors claiming they have made a ‘sustainable investment’ need to demonstrate that:

• it is an investment in an economic activity that contributes to an environmental or social objective,
• the investment does not significantly harm any social or environmental objectives and
• the investee companies follow good governance practices.

Investors need to consider DNSH in the context of the overall objectives of their investment product. Key data sets to evidence a sustainable investment’s compliance with Article 2(17) include:

• Contribution to an environmental or social objective: Investors need metrics or targets that demonstrate the performance of the investment product with regards this objective. For example, if a product intends to reduce waste, the metric may be a combination of total waste produced by the investee companies, a waste intensity metric or efforts taken through enabling technology or recycling practices to reduce waste. There is no singular metric that investors should use across all products. The data should correspond to the objective of the fund and can therefore vary from product to product.
• DNSH to any social or environmental objective: To demonstrate this investors need to disclose Principle Adverse Impacts (PAI) and set acceptable tolerances against specific indicators for PAI set out in Annex I of the February 2021 RTS. Indicators for PAI are a set of pre-defined mandatory and optional data points such as carbon foot-printing, water and waste metrics and human rights policies. An investor could also use this data set to explain how an investment aims to improve over time, or choose a particular threshold or tolerance level from which divestment would occur against certain indicators.
• Good governance: Investors need to prove investee companies follow good governance practices, especially with regards to management structures, employee relations, remuneration and tax compliance. As the definition of “good” is not defined in the regulation investors need to use available data sets and make subjective assessments.

2) EU Taxonomy for sustainable activities

For an investee company to demonstrate it has either turnover, capex or opex aligned to the Taxonomy, it needs to demonstrate that it substantially contributes to at least one of six environmental objectives and does no harm to any other. The Taxonomy regulation provides clear, sometimes threshold-based, metrics to demonstrate that DNSH is met.

Environmental controversies data tends to be used as a proxy to the Taxonomy regulation’s harm indicator. However, it is a blunt tool and fails in a few critical areas.

• Controversies are rarely activity-based but typically indicate “Yes/No” compliance of a whole company and do not identify which portions of a company’s revenue are impacted.
• Controversies rarely consider remedial efforts to correct issues, whereas the Taxonomy encourages a go-forward investment approach.
• Controversies may not apply the very specific test requirements from the Delegated Acts. For example, a company that invests in renewable energies may be substantially contributing, even if it has a subsidiary that harms the mitigation objective by producing energy above the 270gCO2e/kWh threshold for harm. Whilst one subsidiary is considered harmful, and its revenue cannot be counted, the other is considered substantially contributing and its revenue can be counted.

Help is coming for investors however, as large listed European companies will need to self-certify compliance with the DNSH tests from January 2023. Investors in such companies will thus be able to use this information for their own reporting. However, for those who wish to proxy alignment for non-listed European or International investee companies using estimates, they can do so under “equivalent information”, according to article 16b of the RTS for product-level reporting.

Guidance on “equivalent information” is still forthcoming, but in the meantime, a good principle would be to start by ensuring the non-EU investee company does not have a lower reporting burden than its EU equivalent. A data proxy that just measures compliance with local laws may not be sufficient. Ideally, the non-EU company would need to have the same approach to climate risk assessment, water and waste management practices as equivalent EU companies, evidenced in corporate sustainability reporting. Where considering a proxy to DNSH, it is important that investors can see alignment with the tests in the regulation, or the principles on which the EU regulations are based.

3) Paris-Aligned Benchmarks

Under the newly amended Benchmark Regulation, Article 19b states that companies included in climate transition indices cannot significantly harm other ESG objectives. This is further clarified in the Delegated Regulation under Article 12(2), which states that “administrators of EU Paris-aligned Benchmarks shall exclude from those benchmarks any companies that are found or estimated by them or by external data providers to significantly harm one or more of the environmental objectives”, with direct reference to the Taxonomy regulation. The same requirements will apply to EU Climate Transition Benchmarks from 31 December 2022 under Article 10(2) of the Delegated Regulation. There is also guidance on the use of estimates in Article 13(2) of this regulation, which asks that such methodologies are clearly explained and compliant with precautionary principles.

Therefore, the DNSH data used to evaluate Taxonomy-alignment should be used for Paris-aligned Benchmarks. However, benchmark administrators understandably often turn to environmental controversies data for this assessment, as the Taxonomy measures harm at the activity- and not the company-level. The Taxonomy regulation is clear though, and companies that do not meet DNSH requirements must be excluded. One approach could be to exclude companies on the basis of environmental controversies, but to ensure that investee companies are at least compliant with the baseline expectations of the Taxonomy.

In conclusion, investors should no longer invest without being mindful of the holistic sustainability approach of their investment product. It is therefore critical that they understand the nuance of these EU regulations, and ensure they have the right data and proxies to explain their investments through these new regulatory lenses. As more investors are cautious on ‘greenwashing’ claims, taking a robust approach to due diligence on data is essential.

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