In December 2015, 196 countries signed the Paris Agreement, the first universal climate deal to adapt and build resilience to climate change and limit the increase in global warming to under 2˚C.¹ Signatories to the Agreement and the United Nations (UN) 2030 Agenda for Sustainable Development committed their governments to “a more sustainable path for our planet and our economy”.²

“Over the next 15 years, the goals set in the UN 2030 Agenda will guide us in preparing for a future that ensures stability, a healthy planet, fair, inclusive and resilient societies and prosperous economies,” the signatories announced.

A little more than four years on, awareness is dawning within society that more needs to be done. Extreme weather events signal that continuing profligacy with the world’s resources carries huge environmental costs.

Pressure on companies to improve the sustainability of their business is growing. Combined with individual and collective activism, this reflects the impact of a number of industry- and regulatory-driven initiatives that have emerged over the past decade.

More and more businesses are facing demands from their investors to be more proactive in adopting environmental, social and governance (ESG) policies and put sustainability at the heart of their operations. Norway’s Government Pension Fund Global, a major sovereign wealth fund, was an early adopter of an ethical policy that bans investment in businesses that produce nuclear weapons or tobacco, or cause environmental damage.³ Sweden’s central bank, the Riksbank, has headed in the same direction. In November 2019, it announced the sale of its securities in Australian and Canadian states whose greenhouse gas emissions it deemed to be unacceptably high.⁴

But it is not only government-related investors that have such concerns. The private sector also has this topic on its radar. Climate Action 100+ is an investor initiative, launched in late 2017, that lobbies the world’s major corporate greenhouse gas emitters to accelerate their efforts to combat climate change. One of its members is BlackRock, whose CEO, Larry Fink, warned in his annual letter to chief executives in January this year that the firm was withdrawing investment in companies that “present a high sustainability-related risk”.

Taking the initiative for specific actions in ESG to the next level, the European Commission (EC) released the European Green Deal in December 2019.⁵ Soon after she took office, the EC’s new President, Ursula von der Leyen, dubbed it “Europe’s man-on-the-moon moment”. The Green Deal is an integral part of the EC’s strategy to implement the UN 2030 Agenda and its Sustainable Development Goals.

This “resets the Commission’s commitment to tackling climate and environmental-related challenges”, declaring the target for “no net emissions of greenhouse gases in 2050 and economic growth decoupled from resource use”.

To ensure the Green Deal is more than aspirational, the EC outlines various policies, including the first European ‘Climate Law’. The proposal for this was published on 4 March 2020,⁶ with legally binding targets towards making Europe carbon-neutral by 2050 while ensuring that EU policies contribute to the climate neutrality target and that each sector plays its part.

In addition, the Green Deal suggests the revision, where necessary, of relevant energy legislation by June 2021 to support decarbonisation of the energy system, including the 2013 Trans-European Networks for Energy policy. This would aim to foster the deployment of innovative technologies and infrastructure – including smart grids; hydrogen networks; carbon capture; storage and utilisation; and energy storage – and sector integration. Complementing the changes in the energy system, the EU Industrial Strategy,⁷ published on 10 March this year, aims to further leverage digital transformation as a key enabler for reaching Green Deal objectives, and “to address the twin challenge of the green and digital transformation”.

The EU can use its influence, expertise and financial resources to mobilise neighbours and partners in joining its sustainable path

The Green Deal projects a figure of €260bn of additional annual investment (about 1.5% of Europe’s GDP) as the cost of achieving 2030 climate and energy targets. The European Green Deal Investment Plan – also known as the Sustainable Europe Investment Plan⁸ – proposed by the EC in January 2020 would provide at least €1trn of sustainable investments over the next decade.

To ensure sustainable investments become mainstream across Europe’s financial system, in September 2020 the EC will present a renewed sustainable finance strategy based on three pillars:

• Strengthening the foundations for sustainable investment, with the European Parliament and Council adopting the taxonomy for classifying environmentally sustainable activities.
• Improving opportunities for investors and companies to identify sustainable investments, and ensuring they are credible. This could be done via clear labels for retail investment products, and by developing an EU green bond standard.
• Better integration of climate and environmental risks within the EU financial system. This would particularly focus on integrating such risks into the prudential framework, and assessing whether existing capital requirements are suitable for green assets.

Europe’s main predecessor to the Green Deal in the financial sector is the March 2018 EU Action Plan: Financing Sustainable Growth (Action Plan),⁹ an update of which is envisaged later this year. This is a blueprint for incorporating ESG issues into the EU’s financial policy framework.

The Action Plan’s three basic aims were: to reorient capital flows towards sustainable investments; to manage financial risks stemming from climate change, environmental degradation and social issues; and to encourage transparency and long-termism in financial and economic activity.

After its publication there was a series of legislative proposals, which include the following:

1. EU taxonomy for determining whether an economic activity or investment qualifies as environmentally sustainable. The consistency for labelling a product as ‘green’ will allow for improved reliability and avoid unsubstantiated claims, or ‘greenwashing’. Political agreement was only reached in December 2019, so it is unclear when this measure will become effective. The EC has signalled that the EU should work towards establishing the taxonomy by the end of 2021, with full application by the end of 2022. Many other initiatives within the Action Plan will rely on this taxonomy.
2. The Disclosure Regulation – adopted in December 2019, and with most of its provisions to apply from 10 March 2021 – establishes a set of rules on how financial market participants inform investors on the integration of ESG risks and opportunities. This addresses the widely documented problem of inconsistent reporting of ESG issues to date.
3. The introduction of a new category of low-carbon benchmarks in the EU Benchmarks Regulation,¹⁰ driving greater uniformity among existing low-carbon indices.
4. Amending the MiFID II Delegated Acts and the Insurance Distribution Directive (IDD) to help investment firms and insurance distributors incorporate ESG factors into the advice process. From 24 May to 21 June 2018, the EC sought feedback on amendments to delegated acts under MiFID II and IDD to include ESG considerations into the advice that investment firms and insurance distributors offer to individual clients. Following this, on 30 April 2019, the European Securities and Markets Authority (ESMA) published technical advice to the EC on integrating sustainability risks and factors in MiFID II,¹¹ and on 3 May 2019, the European Insurance and Occupational Pensions Authority published technical advice on the integration of sustainability risks and factors in the delegated acts under Solvency II and IDD.¹²

To further support the EU Action Plan, in December 2019 the European Banking Authority (EBA) set out its own action plan on sustainable finance.¹³ In addition to addressing risk management, the EBA will develop a dedicated climate change stress test and explore the prudential treatment of green exposures. The latter, although yet to be seen, could potentially lead to more favourable capital treatment of sustainable investments.

Gerald Podobnik, CFO of Deutsche Bank and a long-term advocate of greater sustainable finance practices,¹⁴ notes: “The industry has only recently come to terms with the fact that sustainable finance will transform more of its business model than just the product offering. Exposure management, disclosure, risk management and capital allocation are all getting impacted by the megatrend and these are the areas where we have seen industry activity picking up substantially.

“Generally, there is substantial demand in the industry for definitions and standardisation – areas where the EU Action Plan is delivering clear progress,” he adds. “The elephant in the room is the question of regulatory incentives for banks to re-channel substantial parts of their loan books within a short period of time towards sustainable assets.

“Conference rooms can get quite emotional when this topic comes up, both on the proponents’ and opponents’ sides, which is showing how important it is to answer that question for the banking industry in particular.”

Podobnik is nonetheless hopeful on the prospects for progress over the decade ahead: “I am convinced that we will witness the mainstreaming of sustainable finance. In 10 years, we will most likely not clearly segregate sustainable finance from brown (carbon-intensive) finance any more, but look back on a decade where sustainability aspects were engrained in almost all areas of finance.”

Whatever the means – be it regulation, investment policy or simple persuasion – the overall goal is to protect the planet and minimise the damage inflicted on it. That ambition will be helped, but not fully achieved, by individual acts, as the Green Deal stresses at the outset.

The environmental target of the Green Deal will not be attained by Europe acting alone. Persistent divergence from the EU’s ambitions illuminates the risk of carbon leakage. The drivers of climate change and biodiversity loss are global and not limited by borders. Should this risk materialise, there will be no reduction in global emissions, which will frustrate the efforts of the EU and its industries to meet the Paris Agreement climate objectives.

The EU can use its influence, expertise and financial resources to mobilise neighbours and partners in joining its sustainable path, continue to lead international efforts and look to build unions with like-minded allies. But in the grand scheme of things, to stand any chance of success, any measures targeting carbon neutrality must be more than aspirations and have the buy-in of the global community. There will be no second opportunity – and no second Earth to decamp to – if these efforts do not succeed.

This article was completed on 10 March 2020 and does not cover subsequent developments

Sources

¹ See unfccc.int
² See sustainabledevelopment.un.org
³ See forbes.com
⁴ See ieefa.org
⁵ See commission.europa.eu
⁶ See ec.europa.eu
⁷ See edie.net
⁸ See ec.europa.eu
⁹ See commission.europa.eu
¹⁰ See eur-lex.europa.eu
¹¹ See esma.europa.eu
¹² See eiopa.europa.eu
¹³ See eba.europa.eu
¹⁴ See db.com