The purpose is to redirect capital flows towards sustainable investment. The new regulations may affect the financial market but also companies looking for financing from mid-2020. The financial services sector and investment entities should already be looking at the planned changes, and take them into account in their strategies.
On the way to the new EU Regulations
In March 2018, the European Commission published the Financing Sustainable Growth Action Plan, which set up a strategy on sustainable finance. Its goal was to reorient capital flows towards sustainable investment to achieve sustainable and inclusive growth, as well as to manage financial risks stemming from climate change, resource depletion, environmental degradation, social issues, and foster transparency and a long-term approach in financial and economic activity. These objectives resulted in legislative proposals for EU Regulations.
In May 2018, the Commission proposed three projects. The first was the Regulation on the establishment of a framework to facilitate sustainable investment, setting out the framework for the new approach. It is still in the legislative pipeline. Two other projects concerned the Regulation on sustainability-related disclosures in the financial services sector, and the Regulation amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks. These two proposals are awaiting signature at the moment and will be then published in the Official Journal of the European Union.
Framework to facilitate sustainable investment
The system proposed in the Regulation provides businesses with clarity on which activities are sustainable, so as to inform their investment decisions. An ‘environmentally sustainable investment’ means an investment that funds one or several economic activities that qualify under this Regulation as environmentally sustainable. An economic activity is environmentally sustainable if it fulfills the four conditions mentioned in the Regulation. It has to contribute substantially to one or more of the environmental objectives listed in the Regulation, without significant harm to them. And the economic activity should be carried out in compliance with the minimum safeguards concerning the basic principles and rights at work and should comply with technical screening criteria specified by the Commission.
The following actions are defined as the environmental objectives:
Sustainable use and protection of water and marine resources
Transition to a circular economy including waste prevention and recycling
Pollution prevention and control
Protection and restoration of biodiversity and ecosystems.
Example – energy generation from wind sources is carbon-neutral, thereby contributing substantially to the environmental objective of climate-change mitigation. However, if a wind project is implemented in a nature protected area in an irresponsible way it may significantly harm the objective of protection of biodiversity. Such a project will not be sustainable in the meaning of the Regulation. After the new Regulation comes into force, only an economic activity that relates to projects that meet the above-mentioned criteria may be described as environmentally sustainable in the financing context.
Sustainability-related disclosures and the EU Benchmarks
The Regulation on sustainability-related disclosures in the financial-services sector requires market participants and financial advisers to publish updated information on their websites about their policies on the integration of sustainability risks in their investment decision-making process or investment/insurance advice. The Regulation defines a ‘sustainable investment’ as an investment in an economic activity that contributes to an environmental objective or a social objective, for instance it contributes to tackling inequality or fosters social cohesion. Therefore, the investee companies should follow good governance practices and ensure the precautionary principle of ‘do no significant harm’, so that neither the environmental nor the social objective is significantly harmed.
Regulation 2016/1011 established uniform rules for benchmarks across the EU and catered for different types of benchmarks. The new act also sets up the EU Climate Transition Benchmarks (EU CTBs) and the EU Paris-aligned Benchmarks (EU PABs). The establishment of the new benchmarks would contribute to increasing transparency and would help prevent greenwashing.
Technical Expert Group’s Reports
To give a more practical aspect to the above described ideas, the European Commission set up a Technical Expert Group on sustainable finance (TEG). In June 2019, the TEG presented three reports. The first one introduces an EU Taxonomy, a classification system which helps determine whether or not an economic activity is environmentally sustainable. So far, the draft has concerned only two environmental goals out of six: climate change mitigation and adaptation. The report provides a list of 67 activities across several sectors, including manufacturing, energy, waste, transport and construction. The report does not include coal-powered electricity generation, as it is consistent with the aims of the EU Taxonomy. Nor does it include nuclear energy, as it was not possible for TEG to conclude that the nuclear energy value chain does not cause significant harm to other environmental objectives. However, more extensive technical work should be undertaken in the future. The draft taxonomy was subject to public consultation, which finished in September. The final version of the report is to be published in December 2019. The remaining reports concern EU Green Bond Standard and Climate benchmarks and benchmarks’ ESG disclosures.
Possible impact on business
The sustainable investment system is not ready yet. However, it must be noted that the EU Commission has moved very fast on this one – faster than with most other legal acts. Once the whole system comes into force, it will not rule out investing in and financing non-sustainable projects at this stage. But it will definitely create more pressure for serious consideration of what to finance. It will also impact on businesses which may show more caution when developing non-sustainable projects. Taking into account the EU’s focus on climate change, in the long run the new system may become more and more important, putting tools like the EU in the centre of any business strategy.