Towards a greener Europe: financing the low-carbon transition
The shift to a carbon-neutral economy requires expensive measures. How will the EU support its green transition and avoid greenwashing?
At the moment when I am writing this article, we still have 6 years, 250 days and roughly 13 hours left to achieve zero emissions and avoid a rise by more than 1.5°C in global temperatures. This level of warming is considered to be the “point of no return” as it represents our last chance to prevent and mitigate the worst risks related to climate change. However, according to the Intergovernmental Panel on Climate Change (IPCC), “some vulnerable regions, including small islands and Least Developed Countries, are projected to experience high multiple interrelated climate risks” even if we do meet the 1.5°C objective.
Planning the transition: the European Green Deal
The European Union (EU) has committed to the environmental and sustainability cause by implementing the UN’s 2030 Agenda for Sustainable Development and signing the Paris climate agreement in 2015. The former sets 17 Sustainable Development Goals (SDGs) that aim to achieve a more sustainable development within 13 climate action goals, and goal 13 (climate action) urges Member States to reduce global carbon emission and limit global warming to 1.5°C. This goal follows up on the Paris Agreement, an international treaty on climate change that was signed by 196 Parties on the 12th of December 2015 (the EU formally ratified it on the 5th October 2016). The Treaty aims to limit global warming below 2°C above pre-industrial levels, preferably to at most 1.5°C. On a financial level, the Paris agreement encourages States to redirect financial flows towards low-carbon and climate-resilient activities.
Four years later, on 11 December 2019, the European Commission presented the European Green Deal, a plan that will lead the EU towards a more sustainable and inclusive economy. The Commission has fixed several ambitious objectives: reducing greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels (initially, the reduction was set at 40%, but was later increased to the current level), reaching carbon-neutrality by 2050, shifting to a circular economy, and restoring biodiversity. On the 21st of April 2021, the European Parliament and the Council of the European Union reached a provisional agreement on the European Climate Law, turning the aforementioned political commitments into legal obligations.
On the 14th of January 2020, the Commission proposed the European Green Deal Investment Plan, that foresaw an investment of €1 trillion in sustainable activities over the following decade. Moreover, to achieve the 2030 climate and energy targets, it was estimated that the EU needs to place additional yearly investments of €350 billion between the years 2021 and 2030, compared to the previous decade. The Investment Plan will primarily source funding from: the EU budget (25% of the whole budget, roughly €503 billion), InvestEU (30% of it will be allocated to projects that fight climate change), the Just Transition Mechanism (€143 billion), and national co-financing structural funds (€114 billion). Additionally, it will have the support of the European Investment Bank (EIB) Group. Both public and private investments will also play a key role. However, the former are not going to be sufficient, therefore the private sector must be incentivized to contribute to the European sustainable transition. How will market participants concretely subsidize the European Green Deal? But most importantly, how will they be able to discriminate between “green” and “brown” investments?
Choosing investments: the EU Taxonomy
On 12 July 2020, the Taxonomy Regulation entered into force in the European legislation. It was the world’s first-ever “green list”, which is a classification system for sustainable economic activities. A couple of months later, on the 21st of April 2021, the Commission presented the so-called “April Package”, comprehending the EU Taxonomy Climate Delegated Act, the Corporate Sustainability Reporting Directive (CSRD) and six amending Delegated Acts.
The EU Taxonomy specifies which economic activities contribute to the meeting of the EU’s environmental objectives and will be formally adopted once the document has been translated into all the official languages of the EU. Article 20 of the Taxonomy Regulation established a permanent expert group, the Platform on Sustainable Finance (its predecessor was the Technical Expert Group or TEG on Sustainable Finance). It has the job of developing recommendations for technical screening criteria for the Taxonomy. Today, the screening criteria concerns 40% of EU-domiciled listed companies, in sectors that are responsible for almost 80% of direct greenhouse gas emissions in Europe. The Taxonomy does not currently cover nuclear power, even though related risks are being evaluated, nor natural gas, a potential transitional fuel which will be covered by a complementary Delegated Act in 2021 together with the agricultural sector. On the other hand, it does include bioenergy and forestry, though the screening criteria will also be revised in 2021. The EU Taxonomy is one of the first examples of a jurisdiction that scientifically sets criteria to define which economic activities are the most environmentally friendly. China is likewise developing its own taxonomy and it is also collaborating with the EU on the creation of a Common Ground Taxonomy.
The CSRD will substitute the current Non-Financial Reporting Directive (NFRD), a set of rules on the disclosure of non-financial and diversity information that apply to EU-based companies with more than 500 employees (roughly 11,700 large companies and groups). The NFRD required such companies to disclose information on how they operated and managed environmental and social issues (e.g. treatment of employees, anti-corruption, diversity on company boards). The new Reporting Directive amends the NFRD by extending its scope to all large companies listed on regulated markets except for micro-enterprises (the number of companies involved will increase to nearly 50,000) and implementing more detailed reporting requirements.
The Six Amending Delegated Acts on investment and insurance advice, fiduciary duties, and product oversight and governance 1) introduce the legal obligation for firms to discuss the client’s sustainability preferences, 2) clarify the obligations of financial firms when assessing sustainability risks, and 3) require manufacturers of financial products and financial advisers to consider sustainability factors when designing their financial products.
The aforementioned measures all aim to improve transparency and credibility, especially in the green market. They will help market participants direct their investments towards more sustainable activities. Ultimately, they will reduce the risk of greenwashing and hold companies accountable for their business choice if not in line with the sustainability objectives of the European Green Deal.
Making investments: green bonds and the Green Bond Standard
There are specific debt instruments used to finance projects that have positive environmental or climate effects: green bonds. This kind of bond is not exclusively issued by green companies. As a matter of fact, any company which desires to invest in green activities can resort to this instrument. Although economically speaking, green bonds are notmore convenient than regular bonds (yields are generally compensated for financial costs such as issuing costs), they can be used as signals for a company’s actual commitment to the environmental cause. Moreover, the issuance of green bonds enhances corporate visibility, diversifies the investor base and strengthens stakeholder relations. In any case, it has been proven that green bonds have a more positive impact on the environment than regular bonds: the average reduction of carbon emissions is assessed at 4%, and it increases to 8% in the case of new sustainable investment projects.
Resorting to green bonds has become more and more frequent. According to the Climate Bond Initiative (2020), new issues have reached €230 billion globally in 2019. The EU itself plans to raise 30% of the €750 billion to be borrowed under NextGenerationEU through green bonds, a decision that will make the euro the default currency for sustainable financial products. As it is easier to fall into the trap of greenwashing, the TEG was consulted for the development of an EU Green Bond Standard (GBS). Similarly to the EU Taxonomy, the EU GBS intends to enhance transparency, comparability and credibility of the green bond market. The adoption of the standard is voluntary, therefore green bonds could still be issued by any type of issuer. However, bonds that do not meet the characteristics of the EU GBS will not be referred to as EU Green Bonds.
To further stimulate private capital investments in sustainable activities and promote a dialogue between policymakers, on 18 October 2019, during the International Monetary Fund (IMF)/World Bank annual meeting, the EU was among those who launched the International Platform on Sustainable Finance (IPSF) — it also plays a relevant role in guiding market participants through sustainable investments on a global level. The 17 members of the IPSF represent 55% of greenhouse gas emissions, 50% of the world population and 55% of global GDP.
Is it enough?
You have come to the conclusion of this article, so let’s take another look at the Climate Clock: 6 years, 248 days and roughly 12 hours left. It is clear that time is running out, and our doomsday is nearer than ever. The European Green Deal is challenging for both European institutions and market participants. However, it will not be sufficient if the EU stands alone and there is not a vigorous and global joint effort in favour of the climate cause. Luckily, the EU advocates the green economic transition and actively promotes cooperative initiatives in international fora. Will we be able to meet the climate and environmental objectives? Or are we ready to live in a dystopian future?
by Silvia del Rizzo
