Why EU Climate Weapon Is in the Financial Fine Print

(Bloomberg) -- In the European Union’s fight against climate change, a potentially potent tool is the fine print of financial regulations. The EU is working to embed environmental goals in standards that could shape the spending plans of banks, money managers, insurers and member states, in the hope of directing trillions of euros to fund a radical revision of the region’s economy. Skeptics warn that some of the rules are being loosened in a way that could allow for “greenwashing.” And a fight that could pit member countries against each other is brewing over a proposal to grant natural gas and nuclear power a green label.

1. What’s happening?

The EU is aiming for a 55% reduction in greenhouse-gas emissions by 2030 compared with 1990 levels and to reach net zero emissions by 2050. As part of this effort, the EU wants to raise as much as 250 billion euros ($283 billion) using its first green bonds. But Europe needs as much as 350 billion euros per year in additional financing to reach its legally binding climate goals. Setting clear rules of the road for green investments is seen as a crucial part of generating the needed flow of private capital.

2. What kind of rules are involved?

A crucial component of what might be called a regulatory infrastructure is the development of a green finance taxonomy -- a set of categories and definitions. That may sound dry as dust, but markets require clarity and that requires a common language. In particular, that means defining what activities are considered “green” and what aren’t. That’s important for stamping out greenwashing -- when companies call products or investments sustainable even if they don’t really help fight climate change. Asset managers also have to disclose just how environmentally friendly their product offerings are, while companies are made to do something similar.

3. How will that work?

Policy makers in Brussels have announced or are working on a range of steps:

* The first set of criteria for green investments has entered into force; it will allow producers of rechargeable batteries, energy efficiency equipment, low-emission cars, and wind and solar power plants to earn a green stamp of approval. 

* A new “Sustainable Finance Strategy” targets greenwashing and aims to tighten measures on banks and credit rating agencies so that they properly take into account the risks posed by climate change.

* The bloc’s Green Bond Standard will provide a voluntary framework for issuers of environmentally-friendly debt to qualify for the EU’s stamp of approval. The bloc hopes that this will set the “gold standard” globally as demand picks up and as as some issuers take advantage of loopholes in existing rules.

* Rules for asset managers to enable them to properly categorize their ESG funds and make sure they live up to the bloc’s taxonomy.

4. What’s the fight about nuclear and gas?

A separate so-called complementary delegated act allowing for some natural gas and nuclear energy projects to be classified as sustainable investments is now in consultation, a process in which member states and civil society experts provide their views. This is an issue that’s dividing EU member states, with France leading a group backing nuclear and Germany taking the lead in support of gas -- and has become more pertinent during an energy crunch that has sent prices to record highs in recent months. While atomic energy produces no greenhouse gases, there are widespread concerns over its safety and how to store its waste, which lasts for thousands of years. After the 2011 Fukushima disaster in Japan, Germany put itself on a path to phase out nuclear power by the end of 2022. And while gas burns cleaner than coal, it still produces carbon dioxide that critics say will impede progress in meeting the bloc’s climate goals. The European Commission is due to adopt the delegated act in January before it goes to the European Parliament and national governments in the EU Council for scrutiny. 

5. What do their proponents say?

The European People’s Party, the largest group in the European Parliament, has given its backing to the proposal to label gas and nuclear power sustainable. Its members argue that promoting gas could accelerate emissions reductions by allowing the faster phase-out of coal-burning plants, particularly in Poland and other Eastern European countries. Along with France, the Czech Republic and Finland want to rely on reactors as part of a clean-energy transition, which Finland’s economy minister said must be done in a way that’s “realistic.”

6. Are there other criticisms?

Yes; many civil society groups are strongly critical -- five bodies comprising part of the EU’s platform on sustainable finance, an advisory body for the taxonomy -- suspended their work last year over worries that the bloc’s rules could open the door to greenwashing. The risk is that the inclusion of nuclear and gas undermines the EU’s ambition to set the gold standard on sustainable investment globally. By comparison, the U.K. has omitted nuclear from its own green bond standards. Other concerns center over the inclusion of bioenergy (organic matter used as an energy source) and forestry, including logging, as sustainable industries. Even Greta Thunberg has weighed in on forestry in her native Sweden, tweeting that “being referred to as the opposite of science is a clear sign that you’re doing something wrong.”

7. What’s the potential impact of the overall regulations?

The labeling system unveiled by the bloc is nothing short of a “re-engineering of the economy and re-engineering of the financial world,” according to Mairead McGuinness, the European commissioner responsible for financial services. With demand for green investment opportunities at record highs, the new system could be an incentive to shift economic activity toward sustainability. And since the continent is the first to put forward such a taxonomy, it could also be used as a template for other countries to follow.

8. What does business think of it?

After a decade of post-crisis regulations, many firms are happy to be at the table discussing sustainable finance with authorities -- and the possible new business opportunities the green road may offer. Investors are also keen to get green labels they can trust. The European Fund and Asset Management Association says it supports the commission’s sustainability reporting standards, though it also highlighted that a lack of data is a key barrier to realizing their full potential. On the other hand, the chair of sustainable finance for UBS Group AG, Huw van Steenis, wrote that the rules are too binary in supporting what is only the “purest shade of green,” an argument echoed by former Bank of England governor Mark Carney.

9. How else could investors and banks be affected?

• Money managers are being told to disclose how they incorporate sustainability factors into investment decisions. This is meant to increase transparency for investors who want their money to help -- or at least not hurt -- the environment.
• Low-carbon benchmarks -- indexes created to track companies with a low carbon footprint -- are being set up to make it easier to steer funds to environmentally friendly investments.
• To encourage green lending, bank regulators may lower capital requirements for these projects.
• Banking supervisors are scrutinizing the environmental risks that remain on balance sheets and could impose extra capital demands to offset possible losses.
• Banks may need to assess environmental risks facing borrowers before they lend.
• The Bank of England is testing banks and insurers, asking them to estimate the impact of global warming on mortgages, corporate loans and other parts of their balance sheets.
• The European Banking Authority wants each big European bank to disclose a “green asset ratio” showing the portion of total loans, equity holdings and fee income contributing to the fight against climate change.

10. When will all this happen?

Not immediately. One of the biggest hurdles to overcome is missing data. Companies don’t necessarily report all the information that the market needs to assess the environmental aspect of a bond or a stock. While euro-area countries are submitting their recovery plans to Brussels, the green bond standard has yet to be approved by parliament and the council. The taxonomy is also set to include areas like marine conservation and pollution control in the coming months. On regulations, the European Banking Authority says it anticipates “delivering a significant amount of work between 2019 and 2025.”

The Reference Shelf

• The European Commission’s sustainable finance strategy.
• The EU is eyeing a ‘re-engineering’ of global finance with green standards, according to its commissioner responsible for financial services.
• The EU agreed on its first criteria for green investments, in a move that could set a benchmark for the world to follow.
• How the European Union’s proposal to classify investment in some natural-gas and nuclear projects as sustainable has exposed deep divisions among member states.
• The EU’s greenwashing rules are already affecting around $2 trillion of investment funds and is set to go global.
• Europe’s rulebook is coming for the world’s green bond market.
• A European Commission portal to its legal proposals on sustainable finance.

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