Fighting climate change through sustainable finance

28 November 2019

Fighting climate change has quickly become the defining challenge of our generation and the European Union is taking steps to finance sustainable economic growth towards a low-carbon, resource-efficient economy.

Following a European Commission legislative proposal in May of 2018 on establishing an EU-wide classification system, or ‘taxonomy’, on what classifies as sustainable finance, the European Parliament and Council remain in inter-institutional negotiations to find a compromise. But what is sustainable finance and how may it help fight climate change? Why is an EU-wide classification system needed and what is holding back the negotiations?

Here we give you a brief introduction:

What is sustainable finance?

To deliver the EU’s transition to a low-carbon economy, major investment projects are needed. Sustainable finance makes sustainability criteria a key investor consideration in the final decision-making process on project financing. Under the EU-plan, investment projects would have to abide by clear ‘green’ standards.

How does it help fight climate change?

The EU is committed to significantly cut its energy and greenhouse emissions by 2030. However, according to the European Commission and the European Investment Bank, up to €270bn of annual investment may be needed across the transport, waste and water, and energy sectors to achieve that goal. Through its actions, the EU aims to reorient private sector capital flows towards investment in sustainable growth and infrastructure projects as well as improving transparency and managing the financial risks stemming from the effects of climate change on investments.

Why is an EU-wide classification system needed?

In order to assist investors in choosing sustainable investment projects, it is fundamental to provide them with clarity, transparency and guidance on what may be considered a ‘sustainable’ investment project. In the absence of any existing EU or international standards, the EU’s approach aims to provide businesses and investors with a common language, or taxonomy, to identify to what degree economic activities can be considered environmentally sustainable.

Overall, the EU’s taxonomy would aim to address two key challenges: reducing market fragmentation as a result of market and member state initiatives; and preventing so-called green washing i.e. the practice of marketing financial products as ‘green’ or ‘sustainable’ without them adhering to basic environmental standards. By setting clear guidelines at the EU-level, the European Commission is hoping to establish Europe as a global standard-setter.

What is delaying progress?

Following the European Commission’s 2018 proposal, the European Parliament and Council of the EU adopted their respective positions on the file earlier this year, with inter-institutional negotiations (trilogues) beginning in late October.

With significant divergences in positions between the two co-legislators, Parliament and Council negotiators are especially divided on questions around regulatory scope. Parliamentarians want to expand the scope of the legislation to include more financial products and more market participants. While member states and the Commission argue that the rules should only apply to products marketed as “environmentally sustainable,” Parliament argues that by the end of 2021 there should be a review on whether the taxonomy should also be used to define when an investment has “a significant negative impact on sustainability.”

In addition, contention remains between the negotiators with regard to the Parliament’s proposal to develop a scaled approach to ‘green’ projects in order to capture a broader market segment as well as whether to include only ‘low-carbon’ activities or also to recognise those considered as ‘transition’. Such an extension of scope, favoured by the Council, would potentially allow certain high-permitting activities that currently have no low-carbon alternatives to benefit from the same financing conditions as environmentally sustainable activities.

Next steps

With little to no progress in sight and timing running out on the Finnish presidency of the Council of the EU, it is expected that negotiations will continue into the new year and be finalised under the auspices of the upcoming Croatian presidency.

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