Strategy for Financing the Transition to a Sustainable Economy published

The Strategy was announced as part of the European Green Deal in 2019 (originally billed as the “Renewed Sustainable Finance Strategy”). It is less comprehensive in terms of new concrete actions than the 2018 Sustainable Finance Action Plan (the 2018 Action Plan). However, the Strategy seeks to cast its net wider than its predecessor, with more focus on issues beyond climate, a broader range of products in scope and an eye to the international stage.

The Strategy is stated to be based around four main issues:

• Financing the transition to sustainability: focusing particularly on the transition of the whole economy to implement climate and environmental objectives.
• Inclusiveness: increased access to sustainable finance opportunities for individuals and small and medium-sized enterprises (SMEs).
• Financial sector resilience and contribution: how the financial sector can contribute to the European Green Deal targets, become more resilient and combat greenwashing.
• Global ambition: fostering of international consensus on sustainable finance.

The Strategy is a mixture of new actions and restatements of work already in progress. The key actions are discussed below.

EU Taxonomy: revised timetables, transition taxonomy report, significant harm taxonomy report, social taxonomy report and expanded Climate TSC

The Taxonomy Regulation was the centrepiece of the 2018 Action Plan, primarily aiming to establish a common classification framework for what activities can be considered to be environmentally sustainable in order to facilitate sustainable investment.

The Commission will report by the end of 2021 on the possible extension of the Taxonomy framework to recognise activities with “an intermediate level of performance” (also known as transition activities). The current framework contemplates a limited number of transition activities, but it is expected this report will look at a wider range of activities that do not meet the “environmentally sustainable” thresholds but don’t significantly harm the objectives. The Commission indicates that this could help boost transparency and mobilise capital for economic activities on a credible transition pathway.

The Commission also notes that it will report by the end of the year on a possible extension of the framework to economic activities that significantly harm environmental sustainability, and as well as reporting on the possibility of a social taxonomy. This essentially restates the mandate to report set out in article 26(2) of the Taxonomy Regulation.

The timing for delivery of the Technical Screening Criteria (TSC) for the remaining four environmental objectives has been also been revised. These were originally due to be adopted by the end of 2021, but will now be adopted in the first half of 2022. The application date of 1 January 2023 does not appear to have changed however.

There were a number of activities that were not included in the Climate TSC in the first instance, including agriculture, natural gas and nuclear. The Commission has reaffirmed its intention, originally announced in April 2021, to adopt a second delegated act to expand the scope of “green” activities, subject to further review and potentially subject to a sunset clause. We discuss this in more detail in our article on the Climate TSC.

The Commission will also consider expanding the Climate TSC to include more activities for developing sustainable digital solutions and using sustainable crypto-assets.

Potential support for financing of transition activities

Reiterating its Communication on directing finance towards the European Green Deal, the Commission will consider proposing legislation to support the financing of particular economic activities that will contribute to reducing greenhouse gas emissions in line with 2030 climate neutrality targets. These activities will be principally based in the energy sector, including gas. No timing for this potential support is specified at this stage.

Review of the RTS under the SFDR

The Commission will engage with the European Supervisory Authorities (ESAs) to review the regulatory technical standards (RTS) under the Sustainable Finance Disclosure Regulation (SFDR). This will include clarification of the climate and environment-related principal adverse impacts (PAIs) and PAIs related to social and employee matters, respect for human rights, anti-corruption and anti-bribery matters. This work is due to be completed before December 2022.

Sustainability strategies and sustainable corporate governance

Expanding on Action 10 of the 2018 Action Plan, the Commission intends to promote enhanced transparency on sustainability transition and decarbonisation plans via:

• the proposed Corporate Sustainability Reporting Directive, which includes a requirement to report on sustainability targets and progress against them. We discuss the proposal in our article.
• building on the SFDR RTS to “strengthen the disclosure and effectiveness of decarbonisation action” by financial market participants for all investment products.
• possible guidance on voluntary pledges by financial institutions to adopt strategic science-based climate and environmental targets.

The Commission has also confirmed that it will publish a proposal on sustainable corporate governance, following on from its consultation last year which we discuss in our article. The detail and form of this proposal is not specified, but is expected to be published later this year.

Biodiversity/natural capital

Biodiversity loss, ecosystem degradation and the impairment of natural capital (i.e. the world’s stock of natural assets, including geology, soil, air, water, flora and fauna) more broadly is becoming an increasing focus across the globe. The Commission will prepare a report on approaches to measuring such risks, how prevalent they are and outlining next steps for risk management.

The Commission will also encourage the development of standards for assessing natural capital, both within the EU and globally, and the development of biodiversity and natural capital accounting.

Labels for sustainable/ESG financial products, changes to the Prospectus Regulation and anti-greenwashing

The Commission will consider developing further labels and standards for sustainable financial products, including:

• A general framework for labels for financial instruments.
• Transition bond or sustainability-linked bond labels.
• An ESG benchmark label.
• Minimum sustainability criteria for financial products that promote environmental or social characteristics.

These may be accompanied by changes to the Prospectus Regulation to create minimum requirements for information on all ESG securities.

Together with the ESAs, the Commission will also assess whether the supervisory framework and enforcement powers and mechanisms available to national competent authorities are adequate to address greenwashing.

Green retail financial products

The Commission will explore different tools to encourage uptake of green retail banking and investment products. This will include:

• mandating the European Banking Authority (EBA) for an opinion on the definition of, and possible tools to support, green retail loans and green mortgages by 2022.
• exploring support for energy efficient mortgages under the Mortgage Credit Directive review.
• strengthening sustainability expertise and qualifications for financial advisors.

Sustainability/ESG in ratings and research

The Commission will consult on whether to introduce an initiative to improve the reliability, comparability and transparency of ESG ratings, which currently exhibit low correlation compared to credit ratings. The consultation will also assess whether the ESG research market requires intervention.

Building on the European Securities and Markets Authority (ESMA) assessment of how credit rating agencies factor ESG into their ratings under Action 6 of the 2018 Action Plan, the Commission will request that ESMA undertakes a further assessment of the effectiveness of existing measures. It will then consider introducing requirements to improve transparency and ensure that relevant ESG factors are included in credit ratings and credit outlooks.

Integration of sustainability/ESG risk into prudential regulation and supervision

The Commission will introduce requirements to ensure that ESG factors are considered both in the risk management systems of banks and insurers and at a macroeconomic level, similar to the approach pioneered by the Bank of England in relation to climate financial risk and promoted by the Network for Greening the Financial System. Specific proposals include:

• amendments to the prudential framework for banks and insurers to ensure that ESG factors are consistently included in risk management systems.
• clarifying and strengthening the role of supervisors in assessing sustainability risks.
• introducing climate change stress testing for banks and climate change scenario analysis for insurers.
• bringing forward the date of the EBA’s assessment of prudential treatment of environmental and social risk exposures from 2025 to 2023.
• targeted stress testing of the financial system more broadly on the Fit for 55 package (the measures introduced to implement a 55% emissions reduction by 2030).
• considering whether macro-prudential rules are fit for purpose to address climate and environment-related financial stability risks.

Sustainability impact of investment decisions and clarifying fiduciary duties

Following on from the six amending delegated acts adopted in Q2 2021 relating to sustainability preferences, fiduciary duty and product governance, the Commission intends to work with the ESAs to consider whether further measures are needed to ensure all financial market participants and advisers consider the sustainability impacts of their investment decisions, and the products they advise on, on a systemic basis.

The Commission will also ask the European Insurance and Occupational Pensions Authority (EIOPA) to assess whether the concept of the “long term best interest of members and beneficiaries” needs to be broadened to better reflect their sustainability preferences as well as broader social and environmental objectives.

Investor engagement/stewardship

The Commission will seek to support investor engagement and stewardship. This will involve a review of the existing frameworks, including a review of the Shareholder Rights Directive II to determine if it could better reflect both the EU’s sustainability goals and align with global best practices in stewardship.

Calls for international cooperation

Since 2018, many countries have advanced significantly in their position on the need to address climate change and environmental issues in the financial and real economies. The Strategy seeks to position the EU as a leader within the emerging global debate, with the Commission proposing a number of international actions:

• The development of a set of common objectives and principles for taxonomies, further to the work the EU has undertaken with 16 other member countries under the auspices of the International Platform on Sustainable Finance (IPSF). It will also call for an increase in the comparability and consistency of taxonomies metrics and thresholds.
• A call for the Financial Stability Board’s mandate to be expanded to cover the contribution of the financial system to global climate and environmental objectives, and to take into account the impact that financial institutions have on the climate and environment.
• A call for international standards and principles for sustainability disclosure which build where appropriate on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and include a “double materiality” perspective – that is, organisations must not only report on how sustainability considerations impact them, but how they impact the sustainability considerations.
• Support for the work of the Basel Committee on Banking Supervision’s work to identify and address potential gaps in the Basel framework.

Next steps

We can expect to see more detail about the specific actions in the Strategy in the countdown to COP26 and its equivalent for biodiversity, CBD COP15, and beyond, as well as in the future work plans of the EU policy actors. The Commission has committed to reporting on the Strategy implementation by the end of 2023.

^{Author: Kelly Sporn}