The European Commission unveiled on Thursday (8 March) its highly expected action plan on sustainable finance, aiming to clarify what can be labelled as “green” investment and potentially lowering capital requirements on asset holders.
The action plan sets out a package of initiatives, including creating EU labels for “green” financial products or strengthening the role of asset managers and institutional investors to take sustainability criteria into account, and also on corporate reporting.
In order to shed light on what is really ‘green’ and avoid the misuse of the label, the executive launched a process to come up with a taxonomy to spell out specific criteria.
This taxonomy should play a critical role as it will decide what could fall under the sustainable category. Initially, it will cover climate mitigation and climate adaptation.
It will also indicate what products could benefit from lower capital requirements under the capital requirements rules for banks and insurers.
The Commission will explore the “feasibility” of a new risk calibration methodology if it doesn’t jeopardise the financial stability.
Commission Vice-President Valdis Dombrovskis warned in Dublin last week that any measure in this regard “would have to be closely calibrated, and based on a clear EU classification”.
The European Parliament introduced an amendment to the draft text of the Capital Requirement Regulation and Directive to include this ‘green supporting factor’.
Looking at the positive experience using a similar mechanism to redirect investment toward SME by lower capital provisions, officials said that “we know that it works”. And they added that it would not bring ‘greenwashing’ as it would be filtered by a solid taxonomy.
The executive has already set up an expert group to provide its input to draft the taxonomy. In May, the Commission will put forward a legislative initiative to create the enabling framework to create it, including the principles and values of the taxonomy.
The details will be finalised once the expert group presents its conclusions and the results are discussed with member states.
The Commission will also present in May a draft law to clarify the investors’ duties in regards to their advice and responsibilities on sustainable products.
Investors and environmental groups broadly welcome the step taken by the EU executive by emphasising environmental criteria and socially sustainable activities.
“The Action Plan undoubtedly makes the EU one of the global leaders in advancing a Sustainable Finance agenda,” said Benoît Lallemand, Secretary General of Finance Watch.
But activists considered that the plan fell short of amending decades of “massive market failure” attending to the negative externalities that were not priced in.
“Decades of damage prove that voluntary measures for Europe’s financial sector are not enough; the EU must regulate now,” said Rachel Owens, the head of EU Advocacy, Global Witness.
While these organisations welcomed the new rules for investment advisers to push sustainability preferences of retail clients, the finance sector highlighted the possibility of reviewing the capital requirements for banks.
The European Mortgage Federation – European Covered Bond Council – pointed at their Energy Efficient Mortgages Initiative and the forthcoming pilot scheme to prove that energy efficiency and financial performance can be correlated.
Insurance Europe supported a more tailor-made approach to the risks addressed. “If there is evidence that green and/or sustainable investments are less risky than other investments, prudential regulation has to recognise this on the basis of the actual risks, not on the basis of artificial incentives.”
Analysts and officials pointed out that the long-term nature of most ‘green’ projects makes them “less risky”.
But other voices remained sceptical, not only about their intrinsic soundness but also their societal benefits.
Invest Europe, an organisation that brings together private equity and fund managers, questioned this route.
“While it is important to consider ESG issues in all investment decisions, it remains unclear whether the risk calibration methodology in Solvency II or CRD is a suitable route to encourage this,” said the CEO, Michael Collins.
According to Standard and Poor’s, $60 billion out of almost $160 billion in green bond issuance last year came from Europe.
Over the last five years, green bonds issuance increased around 80% in the world, although this year the pace is expected to slow down to a 30% increase to $200 billion.
According to the credit rating agency, more than 150 initiatives related to responsible investment were drafted in Europe last year, half of the total of new rules and standards put forward in the world.
The Commission estimates that Europe would need €180 billion in investments every year to meet the Paris agreement pledge of limiting the global warming to well below 2 C .