There'll be bumps in the road, but the EU Commission’s adoption of a new and updated sustainable finance package underlines there's no going back.
These developments follow the proposed revision of the corporate sustainability reporting directive (CSRD) and publication of the initial taxonomy criteria in April. That such announcements are coming thick and fast highlight the importance the Commission places in greening the economy. Indeed, in a recent ECOFIN meeting Commissioner McGuinness stated that the financial system is facing its biggest systemic challenge in recent years, citing environmental risks as both material and financial.
Robert Blackmore highlights the key points from the three publications..
1. A new sustainable finance strategy
In an update from the 2018 action plan, the Commission outlined its strategy to finance the transition to a more sustainable economy. An eye-catching element of the strategy is the Commission’s wish to place greater efforts on transitional efforts. This will apply mainly in the energy sector but, crucially, it could lead to the taxonomy extended to those activities that are rated intermediate in terms of their green performance.
While much of the focus of the green transition has fallen on Governments and large corporations, the Commission has recognised the important role SMEs can play. SMEs represent 99% of EU businesses and account for half of EU GDP. The Commission will encourage SMEs to access sustainable finance opportunities such as green loans. It also says that the European financial reporting advisory group (EFRAG) will prepare simplified, proportional and voluntary sustainability reporting standards for SMEs to help to facilitate financing from environmentally conscious investors.
Another ambition of the strategy is to improve the financial sector’s resilience and contribution to sustainability, in which the Commission deems “double materiality” to be integral. This concept implies material impacts go beyond simply what adds/reduces the value of a company. The Commission will therefore work with EFRAG, ESMA and IASB to assess whether current international financial reporting standards appropriately integrate sustainability risks. The Commission will ask EIOPA to consider the introduction of an obligation to consider sustainability impacts in the pension investment framework.
Finally, the Commission also wishes to contribute to raising the sustainable finance ambition globally. It understands any progress in Europe is futile without a broader consensus. A priority therefore is the development of ambitious global standards and principles for climate-related disclosures. Response to the strategy was mixed. It was broadly welcomed by member states in the ECOFIN Council meeting days after its publication. Ireland, for example, welcomed the proposed actions on digital finance and fintech, noting the sectoral impacts on the environment. On the other hand, Finland warned that the actions within the strategy must be coherent with each other, and in turn the strategy must be consistent with other EU frameworks. In the Parliament, Bas Eickhout MEP of the Greens/EFA Group said: “This strategy takes some steps forward but falls short of what is needed to ensure a bold EU sustainable finance agenda in line with the green deal objectives”.
The EPP Group’s Markus Ferber MEP suggested the strategy “comes with light and shadow”. He welcomed the potential classification of transitional activities, but also stated: “It is not bright to further mix sustainability aspects into prudential regulation. It is a risky endeavour. Something cannot be considered less risky merely because it is labelled as ‘sustainable’. Being green can be financially risky.”
2. A European green bond standard
The Commission considers green bonds as an integral source of funding for the green transition. Their purpose is to fund projects with positive climate benefits. The green bond market has grown dramatically since it was conceived in 2007. In December 2020, green bond market issuance was valued at $222.8 billion. However, they remain a junior player in the bond market. As the Commission notes, only 4% of corporate bonds issued in 2020 where green. The JRC suggested “green bonds are likely to attract higher demand from investors if issuers submit their securities and investment processes to external, independent review”. The Commission has adopted a regulation to create a voluntary green bond standard that it hopes will make it easier for investors and companies to identify environmentally sustainable investments.
The Commission’s proposal states that the new standard should:
• Improve the ability of investors to identify and trust high-quality green bonds.
• Clarify definitions of green economic activities and reduce potential reputational risks for issuers in transitional sectors.
• Standardise the practice of external review and improve trust in external reviewers by introducing a voluntary registration and supervision regime.
The green bond proposal has been met with general support among EU members, who agree a uniform, albeit voluntary, standard would be a positive development. However, a handful of member states including Italy and Germany have expressed concern at the decision to link the standard to the current taxonomy criteria. They argue that might overlook current market practice and lead to market fragmentation. Meanwhile, the EPP Group has warned the Commission it must convince businesses and sovereign states of the value of the green bond standard if it's to be successful.
The Commission has launched a consultation, the deadline for which is 2 September.
3. A delegated act on taxonomy disclosures
Sustainability disclosures are high on the Commission agenda. Greater transparency, it's argued, will help prevent greenwashing. Therefore, in the third and final part of the package, the Commission adopted a delegated act supplementing article 8 of the taxonomy regulation. It requires financial and non-financial companies to provide information to investors about the environmental performance of their assets and economic activities. It outlines rules and KPIs for a range of financial firms, including asset managers, credit institutions, insurance/reinsurance undertakings, as well as non-financial undertakings.
The important thing is, for 2022 financial and non-financial undertakings have to disclose only the taxonomy eligibility of their business, rather than taxonomy alignment. Taxonomy alignment disclosures for financial institutions were delayed by two years and start from 1 January 2024. It's worth noting that derivatives and sovereign assets are fully out of scope, at least until the next review of the regulation.
As this is a delegated act, it'll be transmitted for European Parliament and Council scrutiny for a period of four months. This can only be extendable once by two months.