European developments in sustainable finance

The Paris Agreement of December 2015 signalled an international intention to mitigate climate change and attempt to contain the global temperature rise.  To have any chance of achieving the targets we need to step up investment into clean energy and energy efficiency.  The World Economic Forum stated that the Paris Agreement was a $23 trillion investment opportunity.  Carbon Brief estimated that to achieve a 1.5°C investment into clean energy would need to be 50% higher.  The IEA says that to achieve its Efficient World Scenario would require investment in energy efficiency, currently about $270 billion a year, to double between 2017 and 2025 and then double again between 2025 to 2040.  The European Commission estimate that to achieve its energy and climate goals requires an additional investment of €170 billion per annum.

So how is Europe approaching the need to steer more investment into clean energy and energy efficiency, as well as wider sustainability objectives?  In 2016 the EC convened the High Level Expert Group (HLEG) on Sustainable Finance to provide advice on how to ‘steer the flow of capital towards sustainable investment; identify steps that financial institutions and supervisors should take to protect the financial system from sustainability risks; and deploy those policies on a pan-European scale’.   The HLEG met from December 2016 to December 2017 and its report made the following recommendations:

• Introduce a common sustainable finance taxonomy to ensure market consistency and clarity, starting with climate change.
• Clarify investor duties to extend time horizons and bring greater focus on ESG factors.
• Upgrade Europe’s disclosure rules to make climate change risks and opportunities fully transparent.
• Empower and connect Europe’s citizens with sustainable finance issues.
• Develop official European sustainable finance standards, starting with one on green bonds.
• Establish a ‘Sustainable Infrastructure Europe’ facility to expand the size and quality of the EU pipeline of sustainable assets.
• Reform governance and leadership of companies to build sustainable finance competencies.
• Enlarge the role and capabilities of the European Supervisory Authorities to promote sustainable finance as part of their mandates.

The report was followed quickly by the Commission publishing an Action Plan on Sustainable Finance in March 2018. This included:

• Establishing a common language for sustainable finance, i.e. a unified EU classification system – or taxonomy – to define what is sustainable and identify areas where sustainable investment can make the biggest impact.
• Creating EU labels for green financial products on the basis of this EU classification system.
• Clarifying the duty of asset managers and institutional investors to take sustainability into account in the investment process and enhance disclosure requirements.
• Requiring insurance and investment firms to advise clients on the basis of their preferences on sustainability.
• Incorporating sustainability in prudential requirements.
• Enhancing transparency in corporate reporting.

The Commission also published three legislative proposals covering the taxonomy, disclosure and duties and benchmarks.  Then in July 2018 the Commission convened the Technical Expert Group (TEG) to assist the Commission in developing:

• an EU classification system – the taxonomy – to determine whether an economic activity is environmentally sustainable
• an EU Green Bond Standard
• benchmarks for low-carbon investment strategies
• guidance to improve corporate disclosure of climate-related information.

The TEG will report on its taxonomy proposals by June 2019.  On energy efficiency, the latest iteration of the Energy Efficiency Financial Institutions Group (EEFIG), supported by the EC and UN Environment, will feed directly into the work of the TEG on the taxonomy.

The Commission is moving quickly to put in place a framework that will help steer investment into sustainable activities.  This first phase is focused on climate change mitigation and adaptation but future phases will also start to examine other aspects of sustainability including; healthy natural habitats, water resource conservation and management, waste minimisation, pollution prevention and control, agricultural and fisheries productivity, access to food, access to basic infrastructure and access to essential services.

To achieve improved levels of sustainability we need to increase investment flowing into sustainable projects, assets and sectors.  The investment needs can only be met from the private sector.  The EC is moving quickly and Europe is leading the world in building the enablers that will direct more capital into sustainable finance.  Ultimately however success will be measured by changes of direction and increases in the flow of capital into more sustainable activities.