On 8 March, the European Commission -EC- released its Action Plan -AP- on Financing Sustainable Growth under the Capital Markets Union initiative. The AP significantly relies upon the Final Report of the High-Level Expert Group released on 31 January.
The final goal of the EC is fully embedding sustainable finance at the core of the EU financial system from an economic and financial rationale with a long-term perspective. It will allow for channelling funds towards the improvement of a stable economic growth. That will ultimately foster the aggregated social welfare function of the EU people thanks to more and better jobs in an enhanced environmental, social, economic and governance context.
The AP is built on three main pillars: realigning savings and investment in the pursuit of a sustainable and inclusive growth; considering climate-related, environmental and social risks -and opportunities- from a financial view and enclose them in the business as usual of the companies; and encouraging transparency and long-term thinking in both.
The three aforementioned building blocks lean on the following ten specific actions for the 2018-2020 period:
- To set up an official EU classification to include sustainable activities and to progressively introduce them into the EU enactment. That will bring certainty, stability and will allow for a single common language to be used by all the actors.
- To formulate standards and labels for green financial products through a technical expert group newly founded. Firstly, a green bond standard will be built on the base of already existing practices (such as the Green Bond Principles and the Climate Bond Initiative) and after a public consultation. Afterwards, the EC will work in a prospectus for green bond issuances. Finally, an EU Ecolabel framework is expected.
- To promote the investment in sustainable projects underpinning advisory and some other measures.
- To include sustainability into financial advice. MiFID II is expected to be amended and the ESMA has been invited by the EC to take into account sustainability preferences in its guidelines on the suitability assessment.
- To develop sustainability benchmarks that will increase their transparency, improve and harmonize their current heterogeneous methodology.
- To enhance the integration of sustainability in ratings and market research. Among other things, the ESMA is expected to consider environmental, social and governance (ESG) issues in its guidelines on disclosure for credit rating agencies (CRAs) during next year. CRAs will have to embed these factors in their assessments.
- To make clearer institutional investors’ and asset managers’ duties on sustainability. They will be subject to embed sustainability in their decision making and to explain the rationale to end-investors in a more transparent manner. That would allow the latter to better include their sustainability preferences in their investment choices.
- To include sustainability issues in banks’ and insurance companies’ capital requirements. It has to be based on a financial risk justification and in terms of financial stability. Furthermore, it has to rely on data and being consistent with the aforementioned taxonomy.
- To boost sustainability disclosure and accountability. The EC will evaluate the possibility of: i) including the recommendations of the Task Force on Climate-related Financial Disclosure (TCFD) of the Financial Stability Board into the Non-Financial Information Directive during the next year; ii) the effect of a new or revised international financial reporting standards (IFRSs) on sustainability.
- To strengthen sustainable corporate governance and mitigating short-termism in capital markets. The boards are expected to be required to implement and to make public the companies’ sustainability strategy and targets. Directors will have to shed more light on how they proceed according to their businesses’ long-term goals.
A brief analysis from a financial regulation and a supervision perspective
The EC’s AP is a solid step in the right direction towards the fully integration of sustainable finance in the EU financial system. Three reflections can be inferred:
- The meaningful cultural change occurred in the understanding of sustainable finance with a long-term perspective and with a financial risk viewpoint. Sustainability has significantly evolved from its original conception in terms of corporate social responsibility.
- The utmost importance of a common and a solid accepted framework that promotes financial stability and that spurs transparency for the development of sustainable markets. Stability and transparency contribute to the internalization of the externalities and towards a greater risk management allowing for a more efficient price formation.
- The growth of sustainable financial markets is key to compare activities and products in terms of price, expected returns, volatility and liquidity. Indeed, it could be worthwhile to separate sustainable financial markets from non-sustainable ones to truly measure their respective performances in relative terms (one against the other).
In a nutshell, sustainable finance has evolved from a reputational issue to a catalyzer that is bolstering an unprecedented change in the financial arena and in economic growth models. A mighty flame follows a tiny spark (Dante Alighieri).