EU Action Plan on Sustainable Economy

The EU action plan aims to gear European finance more towards financing longer-term, sustainable growth. This requires far-reaching measures, including legislative ones, in terms of reporting, accounting, regulation and corporate governance.

The action plan presented at the beginning of March 2018 is based on the final report of a high-level expert group on sustainable finance (HLEG) presented in January, whose recommendations were largely adopted. For a few weeks now, there has been a significant increase in interest.

Proposals of the expert group

In order to implement the proposals, far-reaching measures, including legislative ones, are necessary, involving accounting, corporate governance, risk management and regulatory steps. In particular, the time horizon for accounting and the recognition of risks must be significantly extended in order to adequately reflect the effects of climate change and the energy transition, for example.

The action plan in a nutshell:

In the following, an attempt to describe the twenty-page outline of the Plan of the EU Commission in brief and with regard to its practical implications for the banking industry:

1. Classification of economic activities in terms of their contribution to sustainable development ("taxonomy")

In particular, the criteria of climate change, environmental impacts and social impacts will be applied. Initially, a technical expert group will focus on climate change and the energy transition.

2. Standards/labels for "green" financial products

Initially, the Commission aims to standardise "green" bonds, so-called greenbonds. Later, other products will be tested on the basis of the taxonomy

3. Promotion of investments in sustainable projects

Building advisory capacity for sustainable infrastructure projects in the EU and neighbouring countries

4. Inclusion of sustainability in financial advice

Modification of the distribution directives for banks (MiFID II) and insurance companies (IDD, Insurance Distribution Delegated Acts). Note: These points were not so clearly included in the expert recommendation

5. Quality standards for sustainability

Creating more transparency and comparability of sustainability criteria

6. Better integration of sustainability in ratings and market research

Relevance for credit rating and methodology of sustainability ratings

7. Clarification of the obligations of investors and asset managers

The expert report clearly called for a "fiduciary duty" of investors for future generations. However, this is hardly anchored in constitutional law, e.g. corresponding sustainability requirements are missing in the German Basic Law

8. Consideration of sustainability criteria in risk management and regulation

The first step will focus primarily on climate risks and the energy transition. Specifically, this is the implementation of the proposals of the Task Force for Climate-related Financial Disclosures (TCFD) set up by the Financial Stability Board.

Some supervisory authorities, such as the German Bundesbank, have explicitly called for this, and the Dutch central bank has already announced a stress test for climate risks at banks.

9. Extension of reporting and accounting obligations

Far-reaching adjustments are required here with regard to materiality in reporting and, above all, to the time horizon or reference to the future.

10. Strengthening sustainability aspects in corporate management and capital market communications

Company managements should be obliged to formulate and publish sustainability strategies. According to the ideas of the action plan, the pressure of the capital markets to act in the short term in companies could be reduced by, among other things, holding periods and turnover limits for asset managers.

General acceptance increases

At first, it was said that more far-reaching requirements for risk management and possibly lighter capital requirements for "green" financing should first be carefully examined. Financial experts also believe that for the time being, fund providers will weigh the actual benefits between energy polluters and energy savers.

In addition, there are also typical "federal" positions that regulatory and supervisory interventions should be limited to the minimum necessary.

As can now also be seen in newspapers such as the Tages Anzeiger, there are positive developments, for example, to combat faster global warming (see the IPCC report of 8 October 2018). For example, the Climate Alliance Switzerland, an alliance of more than 70 organizations, wants to establish a Climate Future Fund. The alliance is trying to focus on the polluter pays principle of CO2 emissions.

The Swiss Climate Alliance calculates that the polluters would have to pay costs of CHF 200 per tonne of CO2, for example when buying products or already during the production and import of goods, energy and food. The fund would be accumulated to the tune of approximately 189 billion francs by 2015, assuming that Switzerland emits "only" 945 million tonnes of CO2 between 2021 and 2015.

New EU Innovation Fund

There are also other funding instruments such as the EU Innovation Fund. From 2019, this will use auctioning proceeds from EU emissions trading to promote innovative, low-carbon climate protection technologies of a demonstration nature in industry and power generation across Europe.

In 2018, a study commissioned by the German Federal Environment Agency (UBA) investigated which subsidies the fund can use to get the most out of climate protection. The report "The Innovation Fund: how can it support low-carbon industry in Europe" combines experiences from the predecessor fund ("NER300") with insights from expert interviews for three important industrial sectors:

Iron/Steel,

Cement,

Paper/pulp

One of the main results is that the innovation fund should concentrate on so-called "breakthrough" technologies, i.e. climate protection technologies that have a high potential for reducing emissions. It should deliberately promote technologies that are currently still far from being ready for the market. In doing so, it should help to close an existing gap and thus provide important impetus for decarbonisation.

Banking supervision: not "if?" but "how?"

European banking supervisors appear to be almost absolutely united on the question of whether sustainability is relevant to the banking industry and needs to become more relevant. Climate risks and the energy transition have been identified as risk drivers and need to be captured in reporting, accounting and regulation.

The proposals of the Task Force on climate-related financial disclosures (TCFD) set up by the Financial Stability Board were welcomed by the majority of banks.

For all investors and lenders, there is a risk of partial or complete devaluation of stranded assets. In the case of fossil-fuelled power plants, this idea is particularly obvious in view of the increased transition to renewable energies, which are now economically competitive.

However, these factors also affect small, only locally active credit institutions, as, for example, craft businesses are exposed to considerable operating and investment risks due to diesel driving bans and a transition to electric mobility. One thing is certain, there will still have to be some discussion about incentive mechanisms for "green" versus "brown" financing.

However, since 2018, the EU Commission has been showing with the Action Planor with the instruments for sustainable investment projects: The EU Commission's proposals are very far-reaching and require a wide range of interventions in legislation and economic practice, which is why the planned far-reaching implementation by autumn 2019 seems very ambitious.

Provided that the European Parliament follows the action plan, the measures may already take effect within a few months, e.g. through adjustments to MiFID II (banks) and IDD (insurance distribution). It was to be expected that the EU Commission would take action in this direction, but parts of the banking industry will probably be surprised at how quickly and far-reaching the interventions can be.