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June 13, 2023

EU issues final proposals for sustainable financing strategy

European Union: The European Commission estimates that the EU will need additional investment of around €700bn a year to meet the objectives of the European Green Deal (Photo: Cyril Marcilhacy/Bloomberg)
European Union: The European Commission estimates that the EU will need additional investment of around €700bn a year to meet the objectives of the European Green Deal (Photo: Cyril Marcilhacy/Bloomberg)

The EU proposals include guidance to ensure ESG ratings providers are reliable and transparent, and methodologies are robust – but some critics have called them “burdensome and bureaucratic”. 

The European Commission has published the final part of its sustainable finance package expected under this administration, as agreed in its 2021 strategy for financing the transition to a sustainable economy. 

The package includes delegated acts for the non-climate environmental objectives of the EU taxonomy; a proposal to make ESG ratings more reliable and transparent; and a recommendation for how companies and financial institutions can use EU sustainable finance policies to invest in sectors not – or not yet – considered green.

However, Mark Campanale, founder of the not-for-profit Carbon Tracker Initiative, suggested the EU needed to overhaul its sustainable finance strategy totally, not simply tinker around the edges. 

David Nemecek, senior associate at climate think-tank E3G, said in a press statement the proposed regulation “does little to reflect experts’ call for the comparability of ESG ratings”. It “requires providers to disclose methodologies and underlines the role of the International Organization of Securities Commissions principles, yet no operative provision makes any explicit link to existing tools and approaches like the EU taxonomy or double materiality”, he added. 

The commission estimates that the EU will need additional investment of around €700bn a year to meet the objectives of the European Green Deal, with the bulk of this coming from private funding. The EU executive hopes its latest package will help unblock this finance.  

More transparent ESG ratings

The commission’s ESG proposal aims to enhance the quality of ratings by ensuring that rating providers offering services in the EU are authorised and supervised by the European Securities and Markets Authority.

The proposal requires ESG rating providers to be transparent about the methodologies, methods and assumptions they use, and to review their methodologies on an on-going basis and at least annually. Providers should also use rating methodologies that are “rigorous, systematic, objective and subject to validation”, said the commission.

Under the proposal, smaller ESG rating providers could be exempt from some measures and subject to a transitional regime. The EU executive made it clear the proposal was not intended to harmonise methodologies and that ESG rating providers would remain in full control of their methodologies.

In itself, being regulated was “no bad thing”, Campanale told Sustainable Views. “However, it presumes the standardisation of metrics is in itself a good thing. I don’t think it always is; you can’t standardise something that is inherently subjective,” he added.

The transparency requirement is a good thing, he said, adding however the Esma regulation would “tend to create a market for the largest players, who can afford compliance and systems, but drive out the smaller, nimble and innovative players that find unique insights into companies that larger players don’t always find”.

The European Fund and Asset Management Association said it welcomed the proposals’ effort to improve transparency but that this and the general effectiveness of ESG ratings would be weakened by diverging standards across jurisdictions.

Mitigation, adaptation and SAFs

The EU has already agreed criteria for activities considered sustainable for the purposes of the EU taxonomy related to climate change mitigation and adaptation. 

The commission has now agreed criteria for the four remaining sectors, namely: the sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; and the protection and restoration of biodiversity and ecosystems. 

The main sectors covered by these criteria will be: environmental protection and restoration activities; manufacturing; water supply, sewerage, waste management and remediation activities; construction and real estate activities; disaster risk management; information and communication activities; services; and accommodation activities. 

The commission has also updated the sectors covered by the Climate Delegated Act to include: transport; manufacturing; disaster risk management; water supply, sewerage, waste management and remediation; information and communication; and professional, scientific and technical activities.

This update means aviation is now covered as a “transitional” activity with, according to the commission, the aim of incentivising the development of zero emission technologies, the manufacturing and uptake of last generation aircraft to replace earlier, more polluting models, and the increased use of sustainable aviation fuels (SAFs). 

To meet the new rules, SAFs will need to represent at least 15 per cent of planes’ fuel mix by 2030. Currently, this ratio is about 0.05 per cent, according to figures published in the Financial Times. The shipping industry will be subject to similar requirements.

The commission has also tasked the Platform on Sustainable Finance to analyse how to include mining and refining of critical raw materials in the EU taxonomy. 

Clarity on transition finance

The commission’s proposal on transition finance sets out recommendations on how existing EU tools can be used by companies and investors to finance activities that are less polluting, but not considered fully green.

Transition finance is another way of saying the move towards net zero is a journey with a destination goal, said Campanale. “Ratings and black and white labels tend to ignore this and [benefit] companies that ‘have arrived’ to the detriment of companies clearly investing in the road to net zero.”

Given such reasoning, the transition finance recommendations should be welcomed, he said, but suggested there was another way of viewing the situation. “I believe there is a fundamental error in the whole taxonomy theory,” he said. The idea that “by classifying and defining everything as to whether it is green or not, that somehow investors will be saved from greenwashing and capital will be driven towards green companies/sustainability outcomes” is flawed, he added.

“As someone who spent 1989-2009 managing sustainable investment portfolios, I gained just enough experience to realise this approach may be fundamentally misconceived,” said Campanale, who had previously covered various roles in asset management. “The EU has created a burdensome, bureaucratic and hazardous sustainable finance taxonomy that has raised complexity without much gain. The commission should have started by looking at what needs to be discouraged by, for example, creating appropriate disincentives for high carbon companies to raise capital.”

To support his theory, Campanale said that “in the last 10 years, there have been over 2,300 coal, oil and gas IPOs internationally and Europe’s fifth largest listing last year was an oil and gas company”.  

“The EU sustainable finance taxonomy creates growing costs on the green economy, while doing nothing to reform [a system that provides easy access to capital for] companies in the old economy of fossil fuels.” He called for the burden of bureaucracy to be reversed and for the commission to properly “turn its attention to how to reform financial markets to penalise polluters”.    

Jurei Yada, programme lead for EU sustainable finance at E3G, said the transition finance recommendations “provide welcome clarity on what this concept means in the EU, reducing confusion for market players”.

“It is only the start, however. We must build on the policy framework we have to ensure its coherence and effectiveness to support businesses’ transition to the decarbonised economy of tomorrow and achieve true competitiveness for the EU,” added Yada. 

The ESG research division of index provider MSCI, which also provides ESG scores, told Sustainable Views it was “assessing the potential impact of the legislative proposal on our business and products”, insisting it “maintains a strong culture of independence and transparency in providing ESG ratings to global investors”. 

A service from the Financial Times