Explaining the EU Action Plan on Sustainable Finance

Sustainable finance is a fast-changing area and the European Union is at the forefront of developing a financial system that supports sustainable growth. The EU’s Action Plan on Sustainable Finance is a blueprint on how the financial industry will transform, and includes a number of legislative and non-legislative actions that will require financial actors to consider and disclose how they are working with sustainability. Although the actions are at different stages of development, and some are delayed – the direction is clear and financial actors will have to adjust their practices and prepare for this paradigm shift in the financial sector.

Background and context

How did this come about? Let us begin back in 2015 at the signing of the Paris Agreement and the adoption of the UN Sustainable Development Goals (SDGs).The year marked a noticeable shift in global attitudes towards climate change and sustainable development, and sent a powerful signal: the necessity of a transition to a system that supports sustainable development can no longer be ignored. The financial sector has a key role to play in reaching a more sustainable society, as large amounts of private capital could be mobilised towards sustainable investments. These were the motivations behind the EU Commission’s Action Plan on Sustainable Finance.

The first action by the EU Commission was to set up a High-Level Expert Group on Sustainable Finance (HLEG), comprised of 20 experts from the financial sector, civil society, academia and observers from international institutions. The HLEG developed a comprehensive blueprint for necessary reforms to transform the financial sector. Based on the recommendations, the EU Commission presented an Action Plan on Sustainable Finance in March 2018. Included in the EU Action Plan on Sustainable Finance are the EU taxonomy, the regulation on disclosures relating to sustainable investment and sustainability risks and the guidelines on reporting climate-related information.

The action plan – an overview

The action plan constitutes of actions which will contribute to three main objectives:

Re-orienting capital flows towards a more sustainable economy

Clarification: The current levels of investments in sustainable activities are not enough. Further measures are required to channel more investments into activities that contribute to sustainable development. There is a lack of clarity on what constitutes a sustainable investment, which is a contributing factor to the investment gap (the gap in financing to achieve the Paris agreement and the SDGs) and the risk of “greenwashing”.

Mainstreaming sustainability in risk management

Clarification: Sustainability risks are not always sufficiently taken into account by the financial sector. By requiring financial market participant to disclose how sustainability factors are considered in the investment and advisory processes, the transparency towards the end-consumers will increase.

Fostering transparency and long-termism

Clarification: Transparency and long-termism are essential to a well-functioning financial system. Increased transparency will enable consumers to compare the sustainability performance of companies and allows investors to make better informed, and more responsible, investment decisions.

When the Action Plan on Sustainable Finance was presented in 2018, the EU Commission presented five upcoming key actions from the Action Plan, covering all actors in the financial system. The five key actions correspond to the following main objectives:

Objective: Reorienting capital flows towards a more sustainable economy.

Key actions:

  • EU Sustainable Taxonomy
  • Standards and labels for green financial products

Objective: Mainstreaming sustainability into risk management

Key actions:

  • Clarification of institutional investors and asset managers’ duties regarding consideration of ESG issues in their investment decision processes
  • Incorporation of prudential requirement

Objective: Fostering transparency and long-termism

Key action:

  • Strengthen sustainability disclosures and improve accounting rule-making

The key actions – Status

The EU Taxonomy

The EU Taxonomy will be the cornerstone for all the present and future measures of sustainable finance. The taxonomy will define what a sustainable investment is and will provide a classification on what economic activities are considered to be sustainable. Why? Until now there has not been a common understanding of which economic activities that are to be considered sustainable. During the summer of 2019, the TEG presented its first technical report on EU Taxonomy (18th June 2019), including technical screening criteria for 67 activities across 8 sectors, which sets out the basis for a future EU legislation. The report is now under open consultation, after which the TEG will analyse the feedback and then provide guidance to the Commission on the development of the delegated acts. The legislative procedure for EU taxonomy is still ongoing since the EU Parliament will have to reach an agreement with the Commission and the Council.

Clarification of institutional investors and asset managers’ duties regarding consideration of ESG issues in their investment decision processes

Also known as the Disclosure-regulation, this adopted regulation requires transparency on how financial market participants and advisors are integrating ESG risks (and opportunities) in their investment decisions, as well as how ESG risks are expected to impact the return on the product/service provided. Simply put, all financial market participants will need to disclose how they are considering ESG. If they claim to pursue a sustainable objective (e.g. green investments or investment with a social objectives) they need to explain how the financial activity is contributing to the sustainable objective and relate it to the coming taxonomy.

Strengthen sustainability disclosures and improve accounting rule-making

A few years back, the EU Commission adopted non-binding guidelines on non-financial reporting. The aim was to guide companies on how to report on non-financial disclosures (such as environmental disclosures). In June 2019, the EU Commission modified its guidelines and integrated the recommendation made by the Task Force on Climate-related Financial Disclosures (TCFD). The updated guidelines will further support the reporting of climate-related information.

Standards and labels for green financial products (benchmarks and Green Bond Standard)

Together with the EU Taxonomy, creating standard and labels for green products will protect the integrity of, and trust in, the sustainable financial market. Why? The lack of well-defined standards makes it more difficult to invest in sustainable assets and as well as for consumers looking to invest in sustainable products. On 18 June 2019, the TEG published two reports: A report on an EU Green Bond Standard and a report on EU climate benchmarks and benchmark’s ESG disclosures. The report on EU Green Bond Standard is based on current best practices and the new Commission will be deciding on whether to take the recommendations forward. The report on EU climate benchmarks and benchmark’s ESG disclosures suggest minimum technical requirements for two types of climate benchmarks, “EU Climate Transition” and “EU Paris-aligned” benchmarks. The Commission’s benchmark regulation is expected to be published by the end of the year and adopted early 2020.

Prudential requirements

The EU Commission are also currently exploring and discussing possible measures to incorporate sustainability into prudential requirements. There are no further updates within this area at this moment.