Europe provides international yardstick for sustainable finance

EU policy package looks to refine its sustainability framework

Among 2023’s landmark climate talks, the sustainable finance landscape has continued to exhibit encouraging signs of maturity. Despite the dampening effects of macroeconomic headwinds on green investment levels, the sector has demonstrated resilience. Progress has been particularly notable in the evolution of financial products and regulatory frameworks. Yet, recent policy and regulatory developments underscore the global commitment to addressing issues of greenwashing and mislabelling, emphasising the need for stringent measures.

The European Union has been at the forefront of these developments, establishing itself as a global hub for sustainable finance and a benchmark for environmental regulation. Since its publication in 2020, the taxonomy regulation has provided the backbone of Europe’s strategy. Policy-makers are now looking to enhance this framework, with the primary objective to simplify the usability of the framework for market participants, encouraging private funding for transition projects and technologies.

The EU’s sustainable finance package – first outlined in June 2023 and later passed in November – stands out as a comprehensive effort to bolster its sustainable finance apparatus, providing more opportunities for investment in taxonomy-aligned companies. Chief among the developments is the broadening of the EU taxonomy, including a wider set of criteria for economic activities, as well as expanding existing activities covered under existing climate mitigation and adaptation objectives.

Transition finance growing in importance

Emphasis on transition finance has gathered momentum in 2023. The distinction between greening portfolios and driving transition was a key message at OMFIF’s Global transition finance summit. Significant private sector funding is needed. The European Commission has taken these considerations into account with its recommendations on definitions for transition finance and guidance on the complementary role played by existing sustainable finance tools.

The Commission suggests using the EU green bond standard, which entered into force in November, as a framework for issuing green bonds to finance activities which will attain taxonomy-alignment over the medium term. To date, transition bonds have played only a supporting role in capital markets, relative to green, social and sustainability bonds. Further development in sustainable finance products could unlock future sources of financing. For instance, in November 2023, Japan published its climate transition bond framework in advance of its plans to become the first sovereign issuer of transition bonds in 2024.

Emphasis on taxonomy comparability, not convergence

The global nature of sustainability challenges lends itself to collaborative efforts. Panellists at a roundtable hosted by OMFIF’s Sustainable Policy Institute on ‘Navigating the EU taxonomy’ highlighted the importance of participation in international forums, such as the G20 Sustainable Finance Working Group.

The EU plays an integral role in this global effort as a founding member of the International Platform on Sustainable Finance. The platform provides opportunities to identify areas of convergence between taxonomies, such as through the ‘common ground taxonomy’, focused on comparisons of eligible activities by Chinese and EU taxonomies. The IPSF intends to build on this exercise to encompass a wider scope of activities and jurisdiction and promote a shared understanding of sustainable finance frameworks.

An example is the expansion of the CGT, which is expected to include coverage of the Singapore-Asia taxonomy, published in December 2023. It features a significant transition component, designed to be interoperable with the regional baseline set by the Asean taxonomy. Elsewhere, other national taxonomies are increasingly providing for a regional context, sparking questions about convergence and interoperability.

Convergence of taxonomies appears to be an elusive – arguably, undesirable – goal. Efforts are now shifting towards achieving comparability and interoperability between taxonomies. Without wishing to compromise on crucial standards, policy-makers recognise the inherent differences in regions’ economic and climate realities.

Different institutions have presented various design solutions to strike this balance. The Asean taxonomy, released in March 2023, has a working group that promotes and coordinates with different private sector and public sector entities within Asean member states to ensure everyone is aware of, and working on, the interoperability aspects of national taxonomies.

The Abu Dhabi Global Market has proposed a framework that allows some flexibility as to which green taxonomy, disclosure and reporting standards companies adhere to. There is ongoing work to create a United Arab Emirates finance taxonomy which takes into consideration the details of taxonomies from the EU, China, Asean and other regions.

Promoting usability and strengthening data availability

Investors welcome the usability of the taxonomy yet challenges persist, particularly in meeting reporting requirements and product obligations.

Despite these challenges, positive data are emerging, with around 1600 companies reporting taxonomy alignment. The taxonomy’s role is emphasised as a signalling mechanism guiding capital flows and highlighting areas at risk.

Availability of data is crucial for investing in sustainable assets. In OMFIF’s 2023 Global Public Investor report, 72% of central bank reserve mangers highlighted the lack of information and data as the main barrier to further environmental, social and governance adoption. This was noted as the biggest hurdle, echoed by panellists at the launch event, who noted that central banks lack the resources to audit performances and have to rely on third-party verifications.

However, the EU strives to strengthen data transparency. The delegated acts on disclosures lay the groundwork for increased transparency, aligning with the phase-in of the International Sustainability Standards Board’s global baseline. The focus on disclosure and reporting standards, as evident by the European Sustainability Reporting Standards is pivotal in providing standardised data. Additionally, proposals for enhanced regulation on the transparency and integrity of ESG ratings aim to address the current lack of clarity in this space, which should strengthen belief in the reliability of these metrics.

As the EU pushes for more comprehensive, data-driven insights, the hope is that this abundance of information will democratise access for smaller investors and foster transparency on capital flows. Panellists at the SPI roundtable underlined that larger companies with more capacity lead the way in complying with regulations, while smaller enterprises may find compliance challenging. In its efforts to strengthen data transparency and availability, and promote international engagement, the EU remains well positioned to maintain its leadership in sustainable finance.

Edward Maling is Research Analyst and Arunima Sharan is Senior Research Analyst at OMFIF.

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