Hungary Among Front Runners in Regulation to Enforce ESG

The European Union has proven that it doesn’t lack ambition when it comes to putting together legislative frameworks on contemporary matters with a global impact. Whether on data protection or artificial intelligence, European standards aim for legal supremacy with reason, considering the pioneer nature of well-crafted sets of rules.

The enforcement of environment, social, and governance principles may well earn a similar trendsetting reputation thanks to the Sustainable Finance Agenda, which aims to support the European Green Deal. As part of the package, the EU is creating an EU-wide classification system for sustainable activities, the so-called taxonomy, to reorient capital flows toward a more sustainable economy, integrate sustainability into risk management and foster transparency and long-termism.

One of the cornerstones of this process is a new reporting regime that obliges European companies, except for micro-enterprises and non-listed SMEs, to disclose sustainability-related information of their operations.

As a result, 49,000 EU companies will be required to report in the future, compared with 11,600 today, and for some of these newly obligated firms, compliance is due as early as January 2024. There won’t be too much time to adapt, not least because the first set of reporting standards are expected to be adopted by the commission by June 30 this year.

While the EU is rushing ahead to provide a reliable legal framework, governments can also do their part to make the transition to Net Zero as smooth as possible. PwC’s Global Investor Survey 2022 found that more than three-quarters of investors say that managing regulatory risks is an important factor in including sustainability in their investing decisions. In fact, 54% of them even view targeted government actions, typically in the form of taxes, as a way to encourage corporate action on sustainability.

Practice what you Preach

However, administrations worldwide have shown widely different degrees of willingness to practice what they preach about transforming their economies along green lines. As KMPG’s Net Zero Readiness Index (NZRI) 2021 found, only nine of the 32 countries assessed have so far made binding Net Zero commitments under their national laws. More pertinently, those who have done so, represent just 8% of global emissions; their less active peers represent two-thirds of global emissions.

The NZRI considers 103 indicators assessing what legal action is taken, how the financial sector handles the issue and to what extent businesses are ready to cut carbon-dioxide emissions fully.

A key finding is that, while investors and banks are increasingly factoring climate risk and the Net Zero transition into their investment and lending decisions, governments still tend to fail to implement crucial measures such as sustainability financing strategies, policy or regulatory frameworks, and related tax incentives.

Hungary is doing surprisingly well in this comparison. It was ranked 13th overall in the NZRI, and was among just five countries that received the maximum score in terms of legislative action.

Indeed, the pace of adopting relevant measures has been accelerating. For one, the climate protection law amended as of June 2020 set the target to reach Net Zero by 2050. As the KMPG NZRI report points out, the government is trying to decarbonize transport through tax benefits and cash support for electric vehicles, and encouraging intermodal freight junctions for cities, so containers can be transported mostly by rail with road used for the last few kilometers.

Regarding industry, a number of multinational manufacturers have large Hungarian factories which are run to high environmental standards, and the country’s EU membership means all have to meet its standards. Furthermore, domestically focused companies can potentially benefit from available EU funds and green lending products to make a smooth transition in the following years, it adds.

Fine-tuning Support

Even the framework of investment promotion is being altered to reflect environmental aspects. As István Joó, CEO of the Hungarian Investment Promotion Agency told the Budapest Business Journal in an earlier interview, HIPA has reviewed the state subsidy scheme under which companies are currently able to apply for funding when building a new factory. Currently, up to 25% of the renewably energy-related costs are eligible, but that number is set to increase to 50%. (See “Record Investments Booked for 2022, With Chance to Beat it in 2023” in the January 27 issue of the print BBJ.)

The government’s Factory Rescue program, which was launched in late 2022, also follows an approach of embracing ESG awareness by subsidizing energy efficiency and renewable energy generation-related investments of large firms.

However, it is truly finance, and more specifically in Hungary the national bank, that is the main driver of change. The MNB is eager to reshape the mindset of the sector not only through regulations, but also with positive solutions. Take its measures to promote green mortgage lending or the introduction of a discounted interest rate program for buying or building energy efficient residential properties. It was among the first regulators in the EU to issue green guidelines for banks.

In fact, it updated these in 2022, specifying a timeline and a set of expected measures to be taken by stakeholders. According to the document, expectations need to be met in three waves, the latest as of January 2025, while stakeholders must identify, handle, measure and disclose risks related to climate change and the environment.

Among other steps, a detailed methodology must be crafted that enables lending institutions to control and check whether customers truly use loans for sustainably purposes. They must further analyze and quantify how climate risks affect their “traditional” risks related to lending, operation or liquidity. Compliance is facilitated by a public compilation of green legislation.

This proactive approach by MNB is of key importance for the speed of large-scale implementation of ESG goals because, as the Net Zero Readiness Index points out, if finance supports the green transition, the real economy must follow suit.

This article was first published in the Budapest Business Journal print issue of February 10, 2023.