The last of our 4 part Philip Lee Green Finance Series looks at the integration of the EU Green Deal measures. In Part 3 we touched on the importance of preventing greenwashing to ensure investor trust and the implications the measures have for the banking sector in particular. The Taxonomy and disclosure framework under the SFDR and NFDR are fundamental to achieving this.
The ethical finance and ESG movements have grown in strength and importance since their emergence as primarily a negative screening criteria and largely being viewed as a PR tool for companies. Institutional and retail investors are now demanding more than simply the exclusion of munitions or tobacco as part of ethical portfolios. Investors now want to know the extent to which a company integrates ESG, climate and other ethical factors, such as the SDGs into the decisions it makes. But they also want qualitative and quantitative evidence of the impact this is having. Divestment from fossil fuels, reductions in GHG emissions and carbon footprints for energy intensive businesses, and more broadly the consideration of the environmental impact of a business and its operations throughout the supply chain are now demanded. The Green Deal package of measures seeks to establish a framework to codify, structure and deliver this transition on a scale never seen before.
The UNEP Finance Initiative Principles for Responsible Banking (the "Principles") provide a framework for institutions to progressively implement measures whereby they commit to:
- Conducting an impact analysis of the bank's core business areas, its sectors, and the scale and intensity of social, economic and environmental impacts;
- Aligning their business strategy, so as to be consistent with the SDGs, Paris Climate Agreement and relevant regional frameworks;
- Setting milestones, increasing positive impacts, and reducing negative impacts from their activities;
- Developing sustainability with their clients and customers;
- Consult and engage with stakeholders to achieve these goals;
- Adhere to the Principles with effective governance and culture;
- Conduct regular reviews of implementation of the Principles and be accountable for performance through public reporting.
It is clear when you look at the UNEP Principles, the scale of the challenge facing institutions transforming from the "business as usual" approach and the importance that the UNEP are attaching to adherence to the Principles by each individual signatory organisation in terms of periodic review and accountability measures throughout the implementation process, which must be fully completed within a maximum 4 year period.
As noted above the move to incorporate ESG has moved beyond equity screening and has converged with the climate change imperative and green stimulus efforts. From a regulatory perspective in the EU it is clear that, "Green" is going to guide every policy initiative with every EU institution mandated to take into account climate change in its actions and legislative measures. In a similar fashion the Irish Climate Action Plan seeks to incorporate a "whole of government approach" and under its 'Ireland for Finance' strategy document has ambitions for Ireland to become a green finance hub. Both Bank of Ireland and AIB have published green bond frameworks. In the case of AIB, it was the first Irish bank to issue a green bond raising €1billion for green lending in September 2020. Both AIB and Bank of Ireland have also become signatories to the UN Principles of Responsible Banking in the past 12 months.
The EU Action Plan measures, for banks in particular, have the potential to transform how financial institutions and in particular how banks approach the strategic direction of their business, develop products and assess risk as part of their lending activities, including:
- the revised banking package (Capital Requirements Directive (CRD V) and Capital Requirements Regulation (CRR)) mandates the European Banking Authority (EBA) to assess incorporation of ESG risks into the supervisory process1, assess the prudential treatment of assets associated with environmental or social objectives2, require large institutions publicly disclose ESG related risks3, and provide specifically for the EBA to take account integration of ESG related factors in carrying out its tasks4.
- focus on an institution's Green Bond Ratio and Green Loan Ratio.
- recent confirmation by the ECB that it will accept sustainability-linked bonds as eligible collateral where they are linked to a performance target of one or more environmental objectives in the Taxonomy or one or more of the UN sustainable development goals (SDGs).
- From a regulatory perspective there will be an assessment of
impact on institutions portfolios by:
- volume of collateral exposed to climate-related risks;
- volume of real estate collateral by energy efficiency rating;
- climate-related risk to overall solvency of insurance companies; and
- scope 3 GHG emissions of banks and insurance companies in terms of the average weighted carbon intensity of portfolios.
A recent survey by Triodos Bank demonstrates the value of implementing the uniform sustainability standards and labels such as the Taxonomy and disclosure requirements, by identifying that over a fifth of investors have been motivated as a result of Covid-19 to explore investment in ethical funds with the same report finding that transparency remains a concern with only 11 per cent of investors confident they understand where their money is invested . The "Impact Investing" survey by Triodos Bank estimated that £22bn a year could be mobilised for green/ethical investing from equity ISA contributions in the UK alone5.
The expressed intention is to drive a green circular economy (as shown in the diagram below "Visualisation of the Actions" – European Commission Action Plan: Financing Sustainable Growth COM(2018)97 Final) and the package of measures through disclosure, benchmarking, standard setting and providing technical guidance seek to drive green transition from the top of the capital market through to institutions and in turn through product innovation, customer engagement and ultimately disincentivising the financing of carbon intensive and polluting industries and projects as a consequence of the disclosures and regulatory stress testing.
As with everything in finance, it comes down to the numbers and institutional reputation. Investor expectations and regulatory requirements will drive alignment with the measures and disclosure by institutions of their green credentials. This will set a benchmark for individual institutions, products, industry performance and ultimately market and product transparency to maintain investor trust.
1 Article 98 of amended CRD
2 Article 50da of amended CRR
3 Article 449a of the Capital Requirements Regulation EU575/2013 (and implementing technical standards (ITS) in Article 434a)
4 Article 8(1)(a) of amended [EBA Founding Regulation]
5 Triodos Bank Impact Investing Survey October 2020
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