Sustainability is often called the theme of our time. It is increasingly impacting our daily lives in many different ways. Sustainability is changing the way we build our houses, the way we fulfil our energy needs, the way we travel, the way we grow our crops, the way we manage our companies as well as our investments, to name but a few examples.
While the concept is certainly not new, sustainability has come to maturity in the last few years, and its rise is being fueled by a number of different factors.
Most prominently, the increasingly visible effects of climate change have brought a sense of urgency to efforts to transfer to a low-carbon or even carbon-neutral economy. At the same time, the strains of the recent financial crisis have created a heightened awareness about the way in which banks, companies, and governments conduct themselves and how they seek to contribute to our society’s well-being and the “greater good”, beyond their own (profit) maximization.
Undeniably, a growing consensus is emerging - certainly amongst the younger generation – that “sustainability” is the way forward if we want to preserve both our planet and our society for the long term.
Major challenges, major costs involved
It goes without saying that pursuing a transformation of this magnitude brings with it major costs and investments.
For example, the European Commission has budgeted that an annual additional financial injection of roughly EUR 180 billion will be needed at EU level between now and 2050 to reach the set goals around carbon-neutrality. This is where sustainable finance has an important role to play, as a significant part of these funds will need to come from the private sector.
Much like sustainability, the concept of “sustainable finance” has been around for some time. Until fairly recently, sustainable finance - i.e. the allocation of financial resources through lending and investments by taking into account environmental, social, and governance factors - was considered somewhat of a niche market. However, it is quickly becoming a mainstream business practice.
By way of example, the issuance of green bonds is rapidly increasing and is expected to have exceeded EUR 200 billion for 2019. In addition, the types of financial products available in the financial markets are becoming more varied and flexible (e.g. the recent emergence of sustainability-linked loans). Perhaps most significantly, sustainable finance is attracting an increasingly diverse base of both institutional and retail investors.
The Action Plan on Sustainable Finance: the EU’s initiative to establish an effective legal framework
With sustainable lending and investments on the rise, there is an urgent need for a clear set of legal rules. The market for sustainable finance can only become truly successful if one can clearly determine what types of economic activities are indeed “sustainable” and if investors are effectively informed and assured of the right legal protection. These considerations have led to the launch of the EU Action Plan on Sustainable Finance.
What’s on the table?
Building on the report of the High-Level Expert Group, and with further cooperation of a Technical Expert Group (TEG), the EU Action Plan on Sustainable Finance is ambitious in its set-up and is centered on the following ten work streams:
- Creating a so-called “taxonomy”, i.e. a classification system to determine which economic activities qualify as sustainable;
- Creating an EU green bond standard;
- Fostering investments in sustainable projects;
- Using ESG [environmental, social and governance]-criteria when providing financial advice;
- Developing low-carbon benchmarks;
- Integrating sustainability in ratings and market research;
- Clarifying institutional and asset managers’ duties with regard to sustainability;
- Incorporating sustainability in prudential requirements;
- Strengthening sustainability disclosure and accounting rule-making; and
- Fostering sustainable corporate governance & combatting undue short-termism.
The road travelled in 2019 …
While the EU is sometimes criticized for not moving fast enough in responding to present-day challenges, this cannot be said about the pace of progress when it comes to sustainable finance. By all accounts, it’s fair to say that 2019 was a productive year.
By way of examples: a political agreement was reached on the EU taxonomy (December 2019), the TEG report on the green bond standard was published (June 2019), the European Commission published new non-binding guidelines on reporting of climate-related information (July 2019), a technical report was published on the development of an EU ecolabel for financial products (March 2019) and the TEG published its final report (September 2019) as well as a handbook (December 2019) on EU climate benchmarks and benchmarks’ ESG disclosures.
In addition, the European Investment Bank (EIB) adopted new lending policies, ultimately phasing out any new investments in fossil fuels as from 2022.