04 July 2019

Greening the EU’s financial system

The European peoples expressed their will in a number of ways in the May Parliament elections. Perhaps most significantly for the longer term, the Green political family leapt from 51 seats to 70 – turning it into a key power broker in a four-way split of the major party groupings. In each of the European Parliament elections this century, the Greens have been edging up steadily from the low-40s of seats. Now they are at the top table.

Though the Green wave did not wash into southern or eastern Europe, it swept the Greens into second place in Germany and third in France. In Germany, the 15-24 age group – the very future of politics – 34% voted Green versus 11% for the traditional CDU. In France, 22% of that age group voted Green. Some may argue that this was all a protest vote but the real consequences are well underway as the European institutions will have to rely on some accommodation with the newly-empowered Greens to get legislation enacted.

The June European Council recognised this new reality when laying down its “New Strategic Agenda 2019-2024”: Item 3 is “building a climate-neutral, green, fair and social Europe”. However, this is not a sudden, Damascene conversion – certainly as far as the financial system is concerned. In May 2018, the Commission adopted a package of measures implementing several key actions announced in its action plan[1] on sustainable finance. The package included:

A proposal for a regulation to facilitate sustainable investment. This would be the framework to gradually create a unified classification system ('taxonomy') on what can be considered an environmentally sustainable economic activity.  This is probably the necessary first step so that well-intentioned investors can be sure that they are genuinely funding sustainable activities.

A proposal for a regulation on disclosures relating to sustainable investments and sustainability risks. This regulation will introduce disclosure obligations on how institutional investors and asset managers integrate environmental, social and governance (ESG) factors in their risk processes. There will be further secondary legislation to spell out how to integrate ESG factors in investment decision-making processes.

A proposal to amend the benchmark regulationto create a new category of benchmarks for low-carbon and positive carbon impact benchmarks.

During the past year, the Commission has been active in following through with these ideas. For example, it has just published guidelines to improve how firms report climate-related information. So the 6,000 exchange-listed companies in the EU will have to disclose relevant information – as required by the Non-Financial Reporting Directive.

However, European Issuers – the `professional association’ of listed companies – published its vision paper for 2019-24 and commented that `in the current context’ companies refrain from remaining listed or entering the public markets. They want competitiveness to be a component of any sustainability assessment and want soft law to be used. So codes of conduct and best practice, rather than legislation. In the same vein, Accountancy Europe – the professional body of all EU accountancy bodies – published “10 ideas to make corporate governance a driver of a sustainable economy”. These ideas will push changes in boards’ roles and practices as well as pushing for action – legislative and non-legislative.

In the public sector, the FSB’s Task Force on Climate-related Financial Disclosures has issued recommendations and the European Commission has stated that these are the inspiration for its recent disclosure Guidelines. The central banks are not to be outdone so they (and supervisors) have set up the Network on Greening the Financial System (NGFS). Central banks now acknowledge that climate change is a source of financial risk.  As the Bundesbank’s Mauderer put it “this is no longer the hobby horse of eco-activists”. So climate-related risks must now be integrated into financial supervision.

The Technical Expert Group (TEG) recently published recommendations on the different types of economic activity within the `taxonomy’ that can make a real difference.   For the private sector, the International Capital Markets Association (ICMA) serves as the secretariat for the Green, Social and Sustainability Bonds Principles that put many of these ideas into practice for the capital markets.

In the banking sector, the EBA has just put out for consultation its draft guidelines on loan origination and monitoring. Importantly, this will cover credit under the Consumer Credit and Mortgage Credit Directives. Whilst these guidelines cover many facets of bank lending – most obviously to reduce the risk of future non-performance – they also require environmental, social and governance factors to be considered.

The new Green Members of the European Parliament may find themselves pushing at something of an open door as far as the financial markets are concerned. Once the `taxonomy’ issues are completely settled, the financial system may find itself being “greened” from many different technical angles. It will take time for new green standards to convert the massive existing base of financial obligations, but the process is now well underway.

© Graham Bishop