Europe uses sustainable finance initiative to curb climate change

Europe is using its Sustainable Finance Initiative to fight climate change. But will it work? VitalBriefing Editor-in-Chief Simon Gray shares his expert insights on the matter.

With much fanfare, the new European Commission president, Ursula von der Leyen, has unveiled the continent’s “man on the Moon moment”: Europe’s Green Deal plan to to achieve carbon neutrality by 2050.

True, details of just how the EU plans to meet this challenging target will be revealed only in June. And Poland, where 80% of the electricity comes from coal, is holding back on committing to carbon neutrality until the EU earmarks more financial assistance to ease its transition.

Crucially, though, as the Trump administration sneers publicly at climate science, the EU is now formally on board for taking a global lead.

The Commission declared that to become the world’s first climate-neutral continent is “the greatest challenge and opportunity of our times”.

Its plan, announced in mid-December, includes investment in green technology, sustainable solutions and the creation of new businesses, acting as a catalyst for economic growth through a transition that’s “just and socially fair …[and] designed … to leave no individual or region behind”.

Immediate impact

Arguably, though, a less high-profile decision earlier that month may have a more immediate impact on carbon emissions and the environment.

On December 5, EU finance ministers and representatives of the European Parliament reached agreement in principle on the “taxonomy” of the Commission’s sustainable finance initiative: a common set of rules governing how to determine which activities can and cannot be counted as green investments.

The finance ministers’ accord still must be formally endorsed by EU leaders. But the road now appears clear for the full sustainable finance package to become EU law – and it could start influencing corporate behaviour in Europe and beyond well before the European Green Deal takes effect.

The Commission’s initiative features three elements, two of which were endorsed last year by the European Parliament and member states.

The first would require institutional investors and asset managers to reveal how they integrate — or fail to integrate — environmental, social and governance criteria into their risk management processes.

Green benchmarks

A second measure would amend the EU Benchmark Regulation by creating  a new category of standards comprising low-carbon and positive carbon impact measures to provide investors with better information on the carbon footprint of their investments.

The Commission also has proposed changes to subsidiary legislation to MiFID II and the Insurance Distribution Directive that would incorporate ESG criteria into the advice that investment firms and insurance distributors must offer individual clients.

But taxonomy has always been the most critical element. The biggest issue in sustainable or green finance is how exactly it’s defined. Critics argue credibly that the lack of standard definitions has led to an epidemic of ‘greenwashing’ – investment firms and other businesses spouting green principles without adopting meaningful changes to their energy use, carbon emission or waste practices.

Universal classification

The proposed taxonomy regulation would set the conditions and framework for a unified classification system that defines an environmentally-sustainable economic activity.

But it hasn’t been without dispute and controversy — which explains the delay in approval from EU member states.

Most notably, France sought to have nuclear power deemed a low-carbon source of energy. But Paris appears to have admitted defeat in the face of vehement opposition from Austria, Germany, Luxembourg and the European Parliament.

However, the finance ministers agreed to a “do no harm” provision expected to exclude nuclear power when detailed rules are drafted.

The deal would create three categories for sustainable investments: “green”, “enabling” and “transition”, obliging companies with more than 500 employees to reveal the extent to which their activities fit these categories.

Cost of capital

How will all this affect businesses? By intensifying pressure on fund managers and institutional investors such as insurance companies and pension funds to focus their investments on companies that meet the Commission’s criteria — and to withhold their money from businesses that can’t or won’t do so.

So, expect the cost of capital for fossil fuel-oriented companies to rise, affecting their profitably and undermining their ability to compete with rivals that embrace renewable energy.

Yes, there’s already plenty of activity in the green investment sphere. But the lack of common standards has proved a major drawback. With the possibility that EU standards become widely adopted around the world, the Commission’s taxonomy could become the gold standard that, at last, vaults the green economy to global acceptance.