Providing catalytical capital: for Multilateral Development Banks and governments to mobilise private investments for biodiversity goals by serving as cornerstone investors.
Committed to becoming a global leader in sustainable finance, the European Commission (Commission)’s Action Plan on Sustainable Finance was adopted in March 2018, informed by the recommendations of the High-Level Expert Group on Sustainable Finance (HLEG). The Action Plan on Sustainable Finance has three main objectives:
* to reorient capital flows towards sustainable investment, to achieve sustainable and inclusive growth.
* to manage financial risks stemming from climate change, environmental degradation and social issues.
* to foster transparency and long-termism in financial and economic activity.
The Action Plan on Sustainable Finance included the following key policy actions:
* Establishing a clear and detailed EU taxonomy, a classification system for sustainable activities.
* Creating an EU Green Bond Standard and labels for green financial products.
* Fostering investment in sustainable projects.
* Incorporating sustainability in financial advice.
* Developing sustainability benchmarks.
* Better integrating sustainability in ratings and market research.
* Clarifying asset managers’ and institutional investors’ duties regarding sustainability.
* Introducing a ‘green supporting factor’ in the EU prudential rules for banks and insurance companies.
* Strengthening sustainability disclosure and accounting rule-making.
* Fostering sustainable corporate governance and attenuating short-termism in capital markets.
Not all areas have been implemented in full. A Renewed Sustainable Finance Strategy is due to be published in the beginning of 2021 which is expected to make proposals to build on the 2018 Action Plan and identify further areas for reform. This includes the proposed adoption of an EU Green Bond Standard and the establishment of an ecolabel for retail investment products.
We consider below the action and progress towards implementation of EU sustainable finance policy to date.
Targets
A cornerstone of the EU Green Deal is the target of achieving climate neutrality for EU member states as a whole by 2050. This objective is proposed to be implemented via a proposed European Climate Law. EU leaders have also agreed an interim emissions reduction target of 55 percent by 2030 as a checkpoint to the 2050 target. The targets are not only intended to mitigate the effects of climate change, but to achieve economic growth, transitioning all aspects of the EU economy toward sustainable methods.
In tandem, the European Commission launched the European Green Deal Investment Plan (also known as the Sustainable Europe Investment Plan) to mobilise EU funding and create an enabling framework to facilitate and stimulate the public and private investments toward an climate-neutral, green, competitive and inclusive — in short, a sustainably financed — economy.
The European Investment Bank will play an important role in delivering the Sustainable Europe Investment Plan. In November 2019, it approved a new climate strategy and energy lending policy which has at its heart the aim of mobilising €1 trillion into climate action and environmental sustainable investment up to 2030 so that by 2025, 50 percent of its operations will be dedicated to supporting sustainable financing. The bank has also committed to aligning all of its financing principles to reflect the goals of the Paris Agreement from the end of 2020.
Taxonomy
A central aspect of the Action Plan on Sustainable Finance was to develop a taxonomy for climate change and environmentally and socially sustainable activities which would provide a legal basis for using this classification system across different areas (e.g. standards, labels, green-supporting factor for prudential requirements, sustainability benchmarks).
The Taxonomy Regulation (EU) 2020/852 was published in the Official Journal on 18 June 2020. This was supported by the Technical Expert Group’s (TEG) report on the EU Taxonomy, published in March 2020, prepared to support the Commission in the development of future delegated acts.
The Taxonomy Regulation establishes a unified and consistent system of indicators to classify and compare which economic activities and investments are deemed “environmentally sustainable”. These must contribute substantially to one or more of the following objectives whilst (i) not significantly harming any other objectives, (ii) meeting minimum social safeguards, and complying with the technical screening criteria:
The technical screening criteria against which these are judged are established through delegated acts. The European Commission published the draft delegated act setting out technical screening criteria on climate change mitigation and adaptation on 20 November 2020 for a four-week consultation period. The deadline for the Commission to adopt the delegated acts is 31 December 2020. The remaining delegated acts are expected to be finalised by the end of 2021. By June 2021, the European Commission will also adopt a delegated act specifying the extent to which companies must disclose their adherence to environmentally sustainable taxonomies.
The Taxonomy Regulation is, with its delegated acts, a work in progress. Notably, it does not provide a comprehensive list of “green” activities, much less a separation of ‘good’ and ‘bad’ economic activities and investments. Rather, it provides a common set of principles to be observed by investors, financial institutions, companies and issuers in line with their own ESG commitments and the mobilisation of capital toward more sustainable financing. To do so, the technical screening criteria makes reference to where greener alternative practices exist in order to meet the outlined criteria and objectives. For this reason, some industries such as aviation and maritime shipping are not yet included for lack of technological and economically-feasible alternatives — but this will be reviewed as credible thresholds become apparent.
Labelling
One application of the taxonomy is in a Green Bond Standard being considered by the Commission to label financial products. Whilst the precise legal format is yet to be determined, the TEG, in publications in June 2019 and March 2020 recommended a voluntary scheme built upon ‘best practices’ and verifiable “use of proceeds” to financing green projects. A legislative proposal laying down a framework for an EU green bond standards is expected in Spring 2021. In addition, the Commission is considering the establishment of an Ecolabel for retail investment products. In this context, the European Commission Joint Research Centre (JRC) published the third version of its technical report on the requirements for an ecolabel on retail investment products in October 2020. The Annex to the report provides the draft conditions and thresholds for investment funds to be labelled with an Ecolabel.
Another action was to create a new category of low-carbon and positive carbon impact benchmarks (the Regulation on low carbon and positive impact benchmarks). In September 2019, the TEG published its final report on climate benchmarks and benchmarks’ ESG disclosures, recommending minimum technical requirements for the methodologies of sustainability benchmarks to address the risk of greenwashing. The Disclosures Regulation (EU) 2019/2088, most provisions of which will apply from March 2021, and amended Benchmark Regulation (EU) 2016/1011 (Low Carbon Benchmarks Regulation), which applied from April 2020, have been introduced. The former imposes new disclosure requirements on all financial market participants regarding sustainability risks in their decision-making processes, and how sustainability objectives are intended to be applied. The latter, meanwhile, defines two new types of climate benchmark: the EU Climate Transition Benchmark, labelling portfolios on a ‘decarbonisation trajectory’ toward the Paris Agreement objectives, and the EU Paris-Aligned Benchmark, labelling those which are already aligned with the objectives of the Paris Agreement insofar as the carbon emissions savings of each underlying asset exceeds its carbon footprint. The delegated acts underpinning the Low Carbon Benchmarks Regulation were published in the Official Journal of the EU on 3 December 2020.
Disclosure
The HLEG recommendations included assessing the fitness for purpose of the current legislative framework, including the Non-Financial Reporting Directive 2014/95/EU, in line the EU’s Taxonomy Regulation. On 18 June 2019, the European Commission published new, non-binding, guidelines for company reporting on climate-related information. The guidance applies to large listed companies, banks and insurance companies with more than 500 employees. It proposes ways by which to assess climate change impacts on the financial performance of companies, and incorporates the recommended disclosures of the TCFD. It is expected to be strengthened and updated by the Renewed Sustainable Finance Strategy, making it easier for investors and companies to identify sustainable investments and ensure that they are credible and enable climate and environmental risks to be managed and integrated into the financial system.
The European Securities and Markets Authority (ESMA) published its own strategy on sustainable finance on 6 February 2020. ESMA will take into account sustainable business models and integrating ESG related factors across its activities, including the implementation of the EU Single Rulebook, supervisory convergence, direct supervision and risk assessments. ESMA’s key priorities include completing the regulatory framework relating to transparency obligations arising under the Disclosure Regulation (EU) 2019/2088, and to work with the European Banking Authority and European Insurance and Occupational Pensions Authority to produce draft technical standards on this subject. ESMA will also include a dedicated chapter on the risks related to sustainable finance in its biannual reports on trends, risks and vulnerabilities (TRV), which it has published twice (February and September 2020) since adopting this policy. It will also analyse the financial risk from climate change, including climate-related stress testing, foster a supervisory convergence of EU law in the ESG area, focus on mitigating the risk of greenwashing, prevent mis-selling and misrepresentations, and improve transparency and reliability in reporting non-financial information. It also has a role on the Sustainable Finance Platform to maintain EU taxonomy and monitor capital flows to sustainable finance.
Changes are also being introduced to affect how company disclosures are interpreted and relied upon. In 2019, ESMA published a Technical Advice paper and Final Report on the Credit Rating Agency Regulation (EU) 462/2013 pertaining to the relevance of sustainable finance in the credit rating market. These documents suggested that a ‘good practices’ document should be published collating the disclosure requirements that are applicable to credit ratings’ press releases and reports — as they pertain to investors. This would aim to also improve the transparency of credit rating actions concerning the extent to which sustainability factors have been key driving factors.
Advice
Measures were also proposed in relation to including ESG considerations into the advice that investment firms and distributors offer clients. The Commission published delegated legislation amending the Markets in Financial Instruments Directive 2014/65/EU and Insurance Distribution Directive (EU) 2016/97. Through these actions, investment firms and insurance distributers are obliged to take into account sustainability issues when providing advice to their clients. This ensures that the information disclosed by companies reach the end-consumers in a format they understand from the advice they receive.
Further integration of ESG considerations
The introductions of and revisions to the EBA Regulation (EU) No 1093/2010, Capital Requirements Regulation (EU) No 575/2013 and Directive 2013/36/EU, Investment Firms Regulation (EU) 2019/2033 and Directive (EU) 2019/2034, and the European Commission’s Action Plan on Sustainable Finance have mandated the European Banking Authority to promote sustainable finance models. It is expected to deliver much of this work between now and 2025, but will see ESG risks integrated into the oversight of institutions’ risk management policies, national regulators evaluation processes, and stress-testing methodologies to identify climate-related risk, exposures, and other vulnerabilities. To this end, in November 2020 the EBA published a discussion paper on the management and supervision of ESG risks for credit institutions and investment firms, setting out how ESG factors and ESG risks are identified and explained, giving particular consideration to risks stemming from environmental factors and especially climate change.
The Commission is also expected to clarify the role of fiduciary duties of institutional investors and asset managers in relation to sustainable finance as part of the Renewed Sustainable Finance Strategy ahead of regulatory reform. In March 2019, EU policy makers achieved political agreement on requiring ESG integration by financial market participants such as institutional investors and asset managers. This is expected to change the language of current requirements, making it that they “must” consider risks and “opportunities” pertaining to sustainably financing, and requiring greater disclosure and reference to sustainability targets and objectives.
A similar approach toward prudential oversight and duties is taking place in the pensions sector. In 2019 the European Insurance and Occupational Pensions Authority submitted advice to the Commission, of which a key recommendation was the integration of sustainability concerns in their investment decisions and underwriting practices. It suggests careful embedment of this advice under Solvency II Directive 138/2009/EC and the Insurance Distribution Directive (EU) 2016/97 to emphasise these risks but the legislative language ends which will be adopted remains to be seen.
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