GREEN FINANCE? IT IS STILL FAR TOO GREY

The 2015 Paris climate agreements set the goal of making global financial flows “consistent with a pathway towards low greenhouse gas emissions (GHG) and climate-resilient development”. But more generally, the aim of sustainable finance is to combine the assurance of a financial return for those who invest their resources with the benefit of collective well-being produced by their use. These so-called ESG criteria determine the course to be followed and steer capital towards activities that comply with the three areas of sustainability: Environmental, Social and Governance.

If, however, the theory is clear, in practice, to speak of sustainable finance is to speak of a process that is still being developed, yet far from straightforward and full of pitfalls, which is also being defined by an increasingly structured regulatory framework.

THE EU REGULATORY FRAMEWORK

Redirecting financial flows towards activities that have less impact and are beneficial for the climate, biodiversity, the preservation of water resources, and respect for human rights means first of all recognising the specific nature of these activities and separating them from those that cannot be construed as sustainable. In order to make this distinction, the EU first intervened with an Action Plan on sustainable finance adopted by the Commission in March 2018, and then with the launch of the EU Taxonomy, a classification system that helps companies and investors determine if an economic activity is environmentally sustainable.

The Taxonomy Regulation (2020/852/EU) was accompanied by intense work by the EU Commission, which defined technical screening criteria for each environmental objective through delegated and implementing acts. At the same time, during the last EU legislation, a process was started to define a “social taxonomy”, so as to clearly identify activities deemed “socially sustainable”, but this process has not yet resulted in a regulatory act.

COMMOND STANDARDS FOR MEASURING SUSTAINABILITY

In order to regulate the communication and disclosure of information concerning sustainable finance in the financial services sector, Regulation (EU) 2019/2088, also known as the Sustainable Finance Disclosure Regulation (SFDR), was developed. This regulation accompanies the revised Non-Financial Reporting Directive (NFRD) and the subsequent launch of the Corporate Sustainability Reporting Directive (CSRD), which requires large non-financial companies to disclose information on the risks and impacts of their activities by publishing a sustainability report. These reporting obligations will be phased in from 2024 for large public interest companies already subject to the “Non Financial Reporting Directive”, in 2025 for all other large EU companies, and in 2026 for all listed SMEs.

The ability to access reliable environmental, social and governance information makes it possible to increase the share of investment, but there must be a common benchmark to be able to measure and compare performance.

Implementing the CSRD Directive, the European Financial Reporting Advisory Group (EFRAG) developed the first set of European Sustainability Reporting Standards (ESRS). The use of these Standards - which complement those that are already in use, such as the Global Reporting Initiative (GRI) - was gradually introduced, and the obligation scheduled for June 2024 was postponed to June 2026 to allow companies enough time to adapt to the new system. 

THOSE GREEN FUNDS ARE FAR TOO GREY 

While the regulatory bureaucracy continues to evolve, however, the activity of banks, finance companies, pension funds and insurance companies in the field of sustainable finance progresses but not without risks and contradictions. “Green funds” are used to invest in activities considered to be of low impact and to promote the reduction of impacts in the most polluting and climate-changing sectors. The risk of greenwashing, especially in this second area, is always prevalent and the adjective “green” is often used to cover up a grey area that is still too present. A recent Voxeurop investigation showed that the top 10 investment managers holding more than 25% of EU-regulated “green funds”, or €87bn, invest in 200 companies operating in carbon-intensive sectors. The Sustainable Finance Disclosure Regulation (SFDR) classifies the 4,342 funds in Europe that invest in fossil fuels and other polluting sectors as “green”.

It was the European Securities and Markets Authority (ESMA) that reaffirmed in its greenwashing report that it is difficult to find and sanction conduct such as this because definitions in this area are “unclear or ambiguous”. It was also opposed in its attempt to impose limits on the negative impacts of assets financed by “green bonds” or to introduce a requirement for funds to have at least half of their portfolio in sustainable investments in order to disclose this fact.

Even the recent “transition finance” category, which explicitly identifies the investments needed to decarbonise the most impactful sectors, risks becoming a greenwashing tool, as there are still no indicators to monitor the actual achievement of impact reduction and decarbonisation targets.

Given the importance of the players in the field, it won’t be easy to stem attempts to exploit the necessary boost towards sustainable investments so as to continue with “business as usual”: to ensure that sustainable finance really is sustainable, independent information and legislation, European and otherwise, free from the pressures of the most impactful companies, will play a fundamental role. 

Article written by Raffaele Lupoli - Director in charge of EconomiaCircolare.com