Europe’s forging ahead
The EU Commission’s action plan on financing sustainable growth
At the end of 2015, international governments met in a repeated endeavour to halt or maybe even reverse climate change and its impact on the environment. The UN Climate Change Conference lasted just under two weeks and hopes for a positive outcome were low. So the press, environmental activists and other parties were all the more surprised when virtually all the conference attendees adopted the Paris Agreement on Climate Change. The agreement’s objectives included limiting global warming to 1.5 degrees Celsius and increasingly channelling funding into sustainable and green projects in future. But two years on, disillusionment has set in. The EU Commission estimates that approx. €180 billion extra investment will be required annually by 2030 in order to achieve the objectives. It’s true that numerous government and private investments at an international level already exist and the market for sustainable investments indicates consistent growth, but according to rating agency Moody’s green bonds only accounted for 1.4% of bonds issued overall in 2016. One thing has been clear since the United States announced its withdrawal from the Paris Agreement at the latest: the green movement needs a compelling new force to drive it.
The EU Commission is prepared to meet this challenge and - based on the recommendations of an expert commission – (final report by the High Level Expert Group on Sustainable Finance of 31 January 2018) – published an action plan on funding sustainable growth on 8 March 2018. The report lists three core aims:
- Reorienting capital flows towards a more sustainable economy
- Mainstreaming sustainability in risk management
- Fostering transparency and long-termism.
The lack of a legal definition of sustainability is often the reason cited for insufficient investment in sustainable projects. The EU now wants to remedy this situation by offering a standardised classification system (called the EU sustainability taxonomy) that is to be gradually integrated into EU regulations. EU standards and indicators could then be developed on this basis to make it easier for investors to assess the sustainability of financial products. First of all, an EU label for green bonds is to be created for instance. However, the market for green bonds does already have some initiatives for fostering better transparency of financial products offered there. Examples are the Green Bond Principles from the International Capital Market Association (ICMA) or the Climate Bonds Initiative that issues its own certificate for green bonds. In order to devise uniform standards, the Loan Market Association has now also published Green Loan Principles based on the ICMA’s Green Bond Principles. The EU plans to publish its report on an EU standard for green bonds by the second quarter of 2019. This report is to reflect the results of a public consultation and be based on established practice. Furthermore delegated acts within the framework of the Benchmark Regulation are to improve the transparency of sustainability benchmarks. In addition to the lack of product transparency for investors, the EU believes that investment advisors need to take their customers’ sustainability preferences into greater account. The EU wants to confront this by amending MiFID II and Insurance Distribution Directive delegated acts to enhance sustainability in suitability assessment.
The EU believes that paying insufficient attention to sustainability factors in investment decisions will also mean that the financial risks run by banks and businesses due to climate change will increase. As a result, the action plan stipulates further steps that aim to embed sustainability in risk management at banks and companies. Providers of market analyses and rating agencies are to be required to take full account of sustainability factors and long-term risks. Furthermore, the EU’s legal requirements for institutional investors and asset managers are to be revised so that they bear sustainability aspects in mind when investment decisions are made. The EU will also examine whether changes might be required in the supervisory regulations for banks and insurance companies. Based on the EU sustainability taxonomy to be developed, capital requirements for sustainable assets could be adjusted to take the lower climate and environmental risks of these exposures into consideration.
In order to make sustainable action more visible in the economy and encourage companies and investors to think more in the long term, existing regulations for large companies to disclose information of a non-financial nature are to be revised and strengthened. What’s more, the impact of the new international accounting standard for financial instruments (IFRS 9) on sustainable and long-term investments is to be investigated and a requirement analysis for measures to encourage sustainable business management and curb short-term thinking on the capital markets is to be performed.
The schedule published by the EU Commission stipulates a gradual implementation of the measures by the end of the third quarter of 2019. However, the EU Commission emphasises that this process is about long-term change that can’t be brought about the EU alone. It believes that the financial system plays a pivotal role in this process, but measures will also have to be taken in other areas and all measures coordinated with one another across the world.