The EU’s transition to climate neutrality depends on re-directing unprecedented investments towards sustainable activities, in the range of EUR 260 to 300 billion a year. These past five years, the EU has been at the forefront of crafting regulatory policies to facilitate and incentivise these financing flows, particularly in the domain of private sector financial regulation. Now, success lies on the EU’s ability to build coherence in this policy framework, shift focus from green towards transition finance, and make public finance work to catalyse the scale of investments needed.
Establishing sustainable finance and fighting greenwashing
The sustainable finance agenda was introduced in the EU in 2018. The first issues to emerge were the need to clarify what sustainable investments were, and how to enhance their transparency to underpin decision-making, especially as Environmental, Social, and Governance (ESG) investments began to pick up pace in the market. The methodology and logic behind the claims of sustainable investments varied significantly and lacked clear criteria to substantiate them. Therefore, to provide clarity and consistency in the European market for such investments, the EU introducedthe first sustainability disclosure requirements in 2019, and in 2020 launched the landmark EU Taxonomy to provide the market with guidance on genuinely sustainable investments and minimise ‘greenwashing’ – misleading claims about environmental impact.
In 2021, the European Commission took the agenda to the next level by publishing its Sustainable Finance Strategy, laying out a vision for new legislative proposals and revisiting existing ones under the umbrella of the EU’s European Green Deal. Since then, a number of policy developments have sought to increase the transparency and credibility of sustainable finance, while staying clear of punitive measures for environmentally harmful investments or imposing minimum requirements for green investments.
The EU’s efforts in sustainable finance have led to a multitude of policy developments with global implications. Many jurisdictions have followed the EU’s lead and developed their own taxonomies.
Broadening sustainable finance and fuelling businesses’ transitions
In 2022, the European Commission’s decision to include gas and nuclear in the EU Taxonomy was contentious and exposed its limitations, particularly concerning the financing of activities that are not yet green but can transition over time. This debate politicised the whole policy agenda and diminished the European Commission’s appetite to move ahead with further aspects of the taxonomy, such as introducing activities that cannot be transitioned and must be phased out. It also slowed down the momentum of sustainable finance regulation, although significant progress has been achieved.
The EU is collecting the information that investors need to allocate capital through the Corporate Sustainability Reporting Directive (CSRD). The EU is particularly championing the notion of double materiality which considers that information disclosed by a company can be material both in terms of its implications for the company’s financial performance, as well as the company’s impact on climate and the environment.
Simultaneously, the EU is striving to enhance transparency and promote mitigation measures for the adverse impacts companies might have on human rights and the environment through the CSDDD – the Corporate Sustainability Due Diligence Directive. Importantly, this directive contains a requirement for businesses to develop and disclose a “transition plan” to become aligned with the Paris Agreement. Transition plans are a critical sustainable financetool putting emphasis on the transition of businesses, and channelling investment to make such transitions possible.
What next: providing coherence and a strategic direction
Sustainability reporting contributes to bringing diversified funding to companies as well as better systemic risk management. Nonetheless, these new requirements are very data and assessment heavy. As businesses face them for the first time, there are a multitude of difficulties arising including data availability, comparability and coherence across different policies. To overcome the complexities of implementing various legislations and ensuring their compatibility, the EU will need to adopt a more coherent approach that integrates existing regulations and improves their alignment.
The ultimate goal is to mobilise capital effectively towards sustainable initiatives. For sustainable finance to thrive and ultimately support the transition to climate neutrality, the EU will need to look at finance in its entirety. The sustainable finance agenda must also enshrine public funding tools alongside private finance. Achieving this requires a clear direction of travel, ensuring that these measures collectively contribute to impactful change.
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