European Commission’s Renewed Sustainable Finance Strategy: broader and deeper

The European Union has not shown any slack in its drive for a more sustainable financial system in spite of the Covid-19-related crisis. In the search for solutions and new regulatory measures that will enable and accelerate the transition, it has continued to actively engage with stakeholders through various means including consultations.

On Wednesday 8 April 2020, a consultation on the Renewed Sustainable Finance Strategy was opened.
It consists in 102 questions and must be completed by the 15 July 2020.  It makes references to past, ongoing and future consultations (e.g. NFRD, Solvency II Directive, European Climate Pact).

This Renewed Strategy will provide enabling frameworks for the European Green Deal Investment Plan to achieve the envisioned target of reducing European Union’s GHG emissions by 55% in 2030 from their 1990 level.
It will feed the Sustainable Finance Regulatory Agenda during Ursula von der Leyen’s tenure.

Our overall opinion: it might be too early to gauge the recently appointed EU commission’s credibility and boldness on Sustainable Finance but the content of this consultation reveals ambition… On the top of this new strategy we see clear ambition to truly mainstream sustainable finance if necessary by adjusting accounting or prudential rules, creating new standards for nascent but promising products (KPI-linked instruments), a stringent oversight and supervision of intermediaries between companies and investors (specialized agencies offering ratings, research, scenario analysis, screening lists, carbon data services). While concerned by potential conflicts of interest or excessive levels of concentration, the Commission clearly wants to see third-party service providers reined in. Time is ripe for consistency and comparability. We laud efforts to create a single market for data by connecting existing databases through digital means. Sustainability-related data must be part of this common European Data. We believe open source could be instrumental especially once science-based classifications (like the EU Taxonomy) exist.  Freely accessible resources such as the ones provided by Transition Pathway Initiative (TPI) on climate change or the Sustainable Development Solutions Network (SDSN) on SDGs are invaluable. Lastly, one notices that the social question is not absent of the potential roadmap but specifics still lack, the document merely points to the need to upskill and reskill the labour force to enable a just transition for all (see our interview with Patrick Artus, “Low-carbon transition agenda: avoiding social quicksand”).

 

Climate finance: EU budget and associated instruments

Our view is that this Renewed Strategy is going to deepen and broaden the “2018 Action Plan on Financing Sustainable Growth”. To pick one example, the amended delegated acts of Markets in Financial Instruments Directive II (MIFID II) and Insurance Distribution Directive (IDD) will soon be published. They will require investment advisors to ask retail investors about their sustainability preferences. Rather than simply asking, the European Commission wonders in the consultation whether retail investors should be systematically offered sustainable investment products as one of the default options (however, there are some caveats: “when the provider has them available, at a comparable cost and if those products meet the suitability test”).

Standards and labels for sustainable financial assets & financial products

The Commission highlights that the market for sustainable financial assets (loans, bonds, funds, etc.) is composed of a wide variety of products, offered under various denominations that might be confusing.

While it acknowledges that a variety of products allows for different approaches that can meet the specific needs and wishes of those investing or lending, the Commission rightly points that it can be difficult for clients, in particular retail investors, to understand the different underlying degrees of climate, environmental and social ambition and compare the specificities of each product. One expects greater clarity on these definitions through standards and labels can help to protect the integrity of/trust in the market for sustainable financial products, enabling easier access for investors, companies, and savers.

As a result, one of the major issues addressed in the consultation relate to product categories & standards.
The Commission for instance seeks to know whether the EU should develop standards for sustainability-linked bonds or loans. It also asks whether such a potential standard should make use of the EU Taxonomy as one of the key performance indicators (KPI). The table below maps existing or underway labels or standards and potential ones.

 

 

Table 1 - EU standards, labels or definitions

Existing/underway

Potential new actions submitted for reactions

- EU Green Bond Standard (EU GBS) - EU Ecolabel for retail funds, savings and deposits - EU Climate Benchmark (PAB/CTB)

- Temperature scenario/climate-alignment portfolios disclosure  - Climate-related loss and physical risk data disclosure - Minimum standard for “sustainably denominated” EU investment funds (commonly referred to as ESG or SRI funds for retail and professional investors) - Label for Sustainability-linked bonds & loans (whose interest rates or returns are dependent on the company meeting pre-determined sustainability targets, KPIs linked to the Taxonomy) - Label or standard for energy-efficient mortgages - ESG Benchmark (aside from the “EU Climate Transition” and “EU Paris-Aligned” benchmarks) - EU framework for supply chain due diligence related to human rights and environmental issues - Standard on natural capital accounting practices within the EU and internationally

Source: European Commission (April 2020), Consultation on the renewed sustainable finance strategy

 

Unsurprisingly, several questions relate to the so-called EU Taxonomy of sustainable activities: its scope, suitability and/or necessary adjustments. We view them as evidencing the Taxonomy’s universal remit (see table 2).

 

 

Table 2 - Taxonomy as a cornerstone of the Renewed Strategy  

Options or challenges discussed	Rationale or explanations
Suitability of the Taxonomy for public sector	Adaption of the Taxonomy to the public sector for various purposes: - Issuance of sovereign green bonds (and subsequent adaptation of the EU GBS) - Green public procurement - Public spending frameworks at EU level (i.e. EU spending programs such as EU funds, Structural and Cohesion Funds and EU State aid rules)
Suitability of the Taxonomy for development banks	Relevance for activities in emerging markets/developing economies (when crowding in private finance, e.g. guarantees or blended finance)
Creation of special category for research & innovation (R&I) in the EU Taxonomy	To enable rapid commercialization of promising and transformational R&I solutions, including possible disruptive and breakthrough inventions or business models
Creation of a brown Taxonomy (activities that do significantly harm environmental sustainability)	Various possible purposes: - Help supervisors to identify and manage climate and environmental risks - Create new prudential tools, such as for exposures to carbon-intensive industries - Make it easier for investors and financial institutions to voluntarily lower their exposure to these activities - Identify and stop environmentally harmful subsidies
Creation of a neutral Taxonomy	Covering economic activities that lie in between the two ends of the spectrum, and which may have a more limited negative or positive impact

Source: European Commission (April 2020), Consultation on the renewed sustainable finance strategy

 

The consultation would also be investigating market barriers in the market of sustainable investments and possible incentives to support market players (see table 3).

 

 

Table 3 – Potential incentives to boost the market for sustainable investments

Issuers	Investors
- Revenue-neutral subsidies for issuers - De-risking mechanisms such as guarantees and blended financing instruments at EU-level - Technical Assistance	- Revenue-neutral public sector incentives - Adjusted prudential treatment (e.g. dedicated prudential framework for ‘green securitization’) - Public guarantee or co-financing

Source: European Commission (April 2020), Consultation on the renewed sustainable finance strategy

Data, disclosure, accreditation or authorization of verifiers

Data and disclosure are some other important areas that the consultation addresses. There is no doubt that the different methodologies adopted by many third-party service providers like credit rating agencies, market research firms and verifiers lead to inconsistencies and makes comparisons difficult, not to mention the dearth of transparency in some of the approaches. In order to overcome these hurdles, the Commission aims to determine i/ whether third-party service providers should be subjected to an accreditation process and ii/ what respondents think of how effective credit rating agencies have been thus far at integrating ESG.

Because of their critical intermediary role, third-party service providers and any kind of so-called verifiers are to be more regulated (a report on the market structure of third-party service providers is due for autumn 2020 and it is a central question in the ongoing NFRD consultation). Several questions relate to their accreditation and oversight (see table 4).  Regarding ESG data and scoring limited comparability and reliability, we laud efforts to improve consistency and create a single market.  

 

 

Table 4 - Data providers, verifiers & third parties

Challenges identified	Potential actions / submitted for reactions
Poor comparability, quality and reliability of  ESG data and scoring and  potentional need for standard	- Accreditation of verifiers & third-party service providers - Creation of a common, publicly available, free of cost and centralized access to company information reported under NFRD and other relevant ESG metrics and sustainability data point (a common database and single point of access to information relevant to investors in European listed companies).
Interim period for the accreditation system for the EU Green Bond Standard (EU GBS)	ESMA-led supervision for the EU GBS would require legislation and therefore take time, the TEG suggests the set-up of a market-based, voluntary interim registration process for verifiers of EU Green Bonds for a transition period of up to three years.

Source: European Commission (April 2020), Consultation on the renewed sustainable finance strategy

 

A number of other measures are submitted for reactions regarding the integration and management of climate and environmental risks into the financial system or to boost sustainability impact (see table 5).

 

 

Table 5 - Other envisioned measures

Areas	Potential actions / submitted for reactions
Governance & investor engagement	- A mandatory share of variable remuneration linked to non-financial performance for corporates and financial institutions (revising shareholder Rights Directive II – directors’ variable remuneration) - Adapting fiduciary rules and other risk management processes - Harmonization of voting frameworks across the EU to facilitate shareholder engagement and votes on ESG issues
Macro-prudential regulation	Incorporating ESG risks in prudential regulation to address financial stability risks related to climate change
Accounting Rules & stranded assets	- Financial accounting rules adjustment to price climate and environmental risks (depreciation and impairment rules for fossil-fuels related activities). - Right policy signals to corporate or financial institutions on the pace of phasing out certain assets that are likely to be stranded in the future.
Credit Rating Agencies	Actions (unspecified) to increase the effectiveness of ESG factors integration in credit ratings
Reporting / Disclosure	Compulsory disclosure for institutional investors and credit institutions of the temperature scenario of their portfolios
Retail investors	Requiring financial adviser to systematically offer sustainable investment products as a default option for pension, life insurance or personal savings (opt-out mechanism).

 

 

To go further:

• Links towards the consultation: A consultation on the Renewed Sustainable Finance Strategy
• Patrick ARTUS, Chief Economist and Executive Committee Member, Natixis, Low-carbon transition agenda: avoiding social quicksand