EU Action Plan on Sustainable Finance
By deploying the most ambitious regulatory framework in the world, in order to support the European Green Deal, has the European Union achieved its objectives? Given the climate crisis, social inequalities and geopolitical instability that are transforming our world, financial institutions can play a key role.
Thanks to its European Action Plan for Sustainable Finance, the European Union now has the most advanced and extensive regulatory framework in the world. The regulatory issues related to sustainable finance, with the hopes they raise and the passions they crystallise, were, in 2022, a topic of primary importance for most financial institutions.
In order to judge whether the year 2022 has enabled concrete progress to be made in the transition to sustainable finance, or whether all the work undertaken and speeches are, in fact, nothing more than a "greenwashing" operation, it is appropriate to take a look at the initial ambitions and the first results obtained.
EU Action Plan on Sustainable Finance: an ambitious project
When the European Union launched its action plan in 2018, its ambition was to reorientate capital flows towards sustainable investment, in order to achieve sustainable and inclusive growth; manage financial risks stemming from climate change, natural disasters, environmental degradation and social issues; and foster transparency and long-termism in financial and economic activity.
As Commissioner Mairead McGuinness of the European Commission reminded us in the hearing conducted by the economic and environmental groups of the European Parliament on December 5: "We do not want to separate the economy and the environment and we want a regulation that must, at the same time, be used wisely by professionals and push sustainable finance to align itself with the European Green Pact".
In order to achieve these goals, the European Union has adopted a comprehensive set of laws, regulations and amendments to existing legislation. In recent years, we have been confronted with a true race of words and acronyms, that only process owners understand... SFDR1, CSRD2, NFRD3, ESRS4, MiFID5, IDD6, PAI7, EBA PILLAR III8, CBR9, GBS10, SDR11 and many others.
This legislative framework, at first sight complex, testifies above all to the complexity of the subject and the high level of expertise required to tackle these issues head on. And, like any academically complex subject, this one faced real challenges when it had to be launched from an operational point of view in 2022.
Indeed, the year 2022 has not been easy for financial market participants who were trying to start implementing the regulator’s new requirements. Between the challenges of the timetable, notably on European Taxonomy12, for which financial market participants had to disclose a percentage of green alignment from companies they invested in, even though the companies will only have the obligation to provide this information next year. A misunderstanding of the substance, since the regulator had not planned those Articles 8 and 913 could have been perceived as a kind of label that managers want to obtain, or different interpretations from one national regulator to another.
A path full of challenges
Another major challenge is the difficulty in defining a Sustainable Investment14, as requested by the SFDR regulation, for which multiple interpretations exist, even though the technical standards require Article 9 funds to be "100% Sustainable Investment". So much so that today, there seem to be at least as many definitions of the concept of sustainable investment as there are Financial Market Participants in the European Union. It is then up to the end investor (or their Wealth Manager) to sort out the percentage of Sustainable Investment whose methodologies differ from one institution to another.
More worryingly, it seems that the early enthusiasm, as clarifications and Q/A's were made, had to give way to a certain conservatism that may ultimately raise questions about the ability of this regulatory framework to be truly applicable. For example, we can quote the figure of 94%15 of the Article 8 and 9 funds disclosing taxonomy entered 0% or the recent downgrades of Article 9 to Article 8 funds by large asset managers. Indeed, they have downgraded billions of dollars of ESG funds, adding to the sense of disarray that is spreading through the European asset management industry, a strong signal of the inapplicability of the regulation, even for large players normally best qualified to solve this type of question.
Finally, the latest investigation published by a consortium of journalists on November 29, 2022, casts doubt on the probity of the sector. Entitled “The Great Green Investment Investigation”, it questions the practices of asset managers by comparing them with the reality of their portfolios: some funds, although committed to so-called "sustainable" themes, make investments in carbon-intensive sectors or companies subject to very severe controversies.
So, has the European Union failed in its mission?
That's what you might think at first glance, but it may not be true... Indeed, a clear climate objective will never prevent a social controversy; a strong social commitment will never allow a product or service to become non-polluting, and the diversity of the facets of sustainability will always generate a certain amount of mistrust from savers’ point of view.
Perhaps we should face the facts: it is complicated to build sustainable portfolios in a world that is not sustainable. Even with all the good will in the world.
However, many objectives have been met: ESG and climate issues, which were unknown to most asset managers a few years ago, are gradually becoming mainstream. The average level of knowledge among investors has increased significantly in recent years, which can reassure us that the financial system is better able to mitigate climate change and biodiversity erosion risks. Moreover, any major paradigm shift takes time: it was necessary to go through these steps to mature the ESG & Climate market, and thus move it forward. In addition, although the regulations are complex to apply, they are still under construction, so they will improve over time and many standards will emerge in the years to come. Finally, end investors are now increasingly aware of the power of their money to transform the world.
So, glass half full or half empty? It's up to you to decide!
Olivia Blanchard, Founder and President, Acteurs de la Finance Responsable
1Sustainable Finance Disclosure Regulation
2Corporate Sustainability Reporting Directive
3 Non-Financial Reporting Directive
4 EU Sustainability Reporting Standards
5 Markets in Financial Instruments Directive
6 Insurance Distribution Directive
7Principle Adverse Impacts
8 European Banking Authority Pillar 3
9Central Bank Reporting
10 Global Biodiversity Score
11 Sustainability Disclosure Requirements.
12 The European Taxonomy designates a classification of economic activities with a favourable impact on the environment. Its objective is to direct investments towards “green” activities.
13The SFDR regulation requires financial institutions that claim to manage sustainable funds to classify their ESG funds between Article 8 and 9 according to their characteristics, with associated reporting obligations.
14 Article 2
15 of the SFDR regulation defines “sustainable investment” as: “...an investment in an economic activity that contributes to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, on the production of waste, and greenhouse gas emissions, or on its impact on biodiversity and the circular economy, or an investment in an economic activity that contributes to a social objective, in particular an investment that contributes to tackling inequality or that fosters social cohesion, social integration and labour relations, or an investment in human capital or economically or socially disadvantaged communities, provided that such investments do not significantly harm any of those objectives and that the investee companies follow good governance practices, in particular with respect to sound management structures, employee relations, remuneration of staff and tax compliance”. (15) Source: As of September 2022, FE fundinfo.