Building a sustainable finance strategy in Europe: the why, the what, the how

Building a sustainable finance strategy in Europe: the why, the what, the how

Leonardo Da Vinci said: “Knowing is not enough. We must apply. Being willing is not enough. We must do.”

In his September 2016 State of the Union speech, President Juncker spoke about the range of continued threats Europe faces. Among other issues he drew attention to high unemployment and social inequality, and high levels of public debt. He noted that, more than seven years on from the financial crisis, questions are still being asked about whether Europe will still be able to shape economic, social and environmental standards for the world and whether its economy will finally recover or be stuck in low growth and low inflation for the next decade? His conclusion was that Europeans want concrete solutions to the very pertinent problem that the Union is facing. And they want more than promises, resolutions and summit conclusions.

Back in 2014, one of the first core objectives established by the European Commission was to increase investment to generate jobs and put the European Union on the path to sustained economic recovery. The Capital Markets Union Initiative (CMU) was launched with these aims in mind. Its focus is on mobilising private capital and channelling it to the small and medium sized businesses that need capital to expand and to the infrastructure projects that support the economy, create jobs and boost European competitiveness. The CMU has delivered some positive outcomes, such as the changes to Solvency II regulation that make it easier for insurance companies to invest in infrastructure. Its sister initiative, the European Fund for Strategic Investment (EFSI) has catalysed €116bn in public and private investment since its inception in 2015.

However despite these best efforts, investment levels in the EU remain significantly below their pre-crisis peak. Low levels of investment have limited the expansion of European employment opportunities and sustainable development. In turn, this has led to a weakening both of social cohesion and of investor confidence, with the knock-on effect that the EU now faces an estimated €428bn pension fund deficit. Finding a way to break out of this negative spiral will be vital to rebuild prosperity and confidence in the European project.

I agree. Facing these issues head on and placing the need to respond to Europe’s social but also environmental problems at the heart of the economic solutions proposed will be key to success. Recognising this, the European Commission has announced two new proposals. First, to double both the financial capacity and duration of the EFSI to provide at least €500 billion of investments by 2020: a minimum of 40% of projects will be dedicated to climate action. Second, a CMU refresh – including the establishment of an Expert Group to develop a comprehensive Strategy on Sustainable Finance.

This is much needed. As E3G’s ‘CMU sustainability score card’ shows, there is still a major gap between what the Commission can and has done to embed sustainability. E3G has given the CMU a ‘BB’ rating for sustainability. To date the focus on delivery of the sustainability objectives has been inadequate and additional policies are required to boost investment in sustainable infrastructure; help deliver the UN’s Sustainable Development Goals; and enable investors to better identify, price and manage climate and wider ESG risks. However, we give the CMU a positive outlook on the basis of recent announcements of the intent to establish the aforementioned Expert Group.

It is by identifying responses to Europe’s social and environmental problems – and in particular the risks to stability and cohesion that comes from dangerous climate change – that the European Commission can do most to reverse the European Union’s fortunes. So it is right that these aims should be at the heart of the Sustainable Finance Strategy. We suggest that in delivering solutions there should be a focus on three core areas:

  • Sustainable infrastructure: The Commission should use the current infrastructure investment gap as an opportunity to boost development and employment opportunities, shore up investor confidence in the European project.This will require creating clear links between the CMU, EFSI and Energy Union projects, harnessing them to deliver the EU’s 2030 and 2050 climate goals.
  • Responsible investing: The need to address social and environmental problems should be placed at the heart of financial reforms to drive sustainable growth. Promoting more responsible investment through requirements for asset owner to disclose their responsible investment policies and performance and engage with beneficiaries on these issues. We also need to see an end to the debate on fiduciary duties and climate and wider ESG risk.
  • Climate risk disclosures: An early focus should be of the Expert Group should be on how the FSB Taskforce on Climate-related Financial Disclosures recommendations can be best assimilated into the EU’s existing reporting framework and through what means decision-useful reporting can be best enforced to enable regulators at a national and EU level to fully understand the financial systems' exposure to climate risk.

With several Member States moving forward – on the basis of long-term growth and competitiveness concerns – with their own green and sustainable finance initiatives, some coordination at EU level looks increasingly necessary. Failure to do so risks fragmented regional capital markets regulation, which will undermine the aim of building a single market for capital in the EU. This gives the Commission a strong mandate to act and will put the EU on the front foot to respond both to the Hangzhou G20 Communiqué, which included a focus on Green Finance, and to the FSB Taskforce on Climate-related Financial Disclosures.

The Commission must now move quickly to look beyond mechanistic reforms to the functioning of Europe’s capital markets to look more at how they can be repurposed to explicitly address Europe’s social and environmental challenges. A renewed focus on delivering more sustainable development and inclusive prosperity through placing these issues at the heart of financial reforms would help to restore confidence in both the European project and in the financial system to deliver a climate-resilient, greener, safer and more equitable society.

This article first appeared in Responsible Investor.


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