By Sören Hilbrich and Kathrin Berensmann / Part of the European Development Policy Outlook Series
The EU has set itself the goal of reducing greenhouse gas emissions by at least 55% from 1990 levels by 2030 and becoming climate-neutral by 2050. Currently, financial markets are clearly not aligned with this goal as investments in environmentally harmful economic activities are still taking place at a large scale. For instance, according to a recent report of the International Energy Agency, the global energy investments in fossil fuels still amounted to more than USD 1 trillion in 2023 and have even significantly increased since 2020 after a dip during the pandemic.
While the investments in environmentally harmful economic activities must be stopped, substantial investments in the transformation of the economy are also necessary. For instance, the European Commission estimates that Europe will need additional investments of around EUR 350 billion per year in the energy sector in the current decade just to meet the 2030 emissions. To achieve climate neutrality and reach other sustainability goals, capital flows thus have to be redirected from unsustainable to sustainable economic activities.
Against this background, the European Commission launched the “Action Plan: Financing Sustainable Growth” in 2018 and, building on this, the “Strategy for Financing the Transition to a Sustainable Economy” in 2021. Since then, the EU has implemented several policy measures with the intention of redirecting capital flows towards sustainable investments, to better manage financial risks associated with sustainability issues, and to increase transparency and long-termism in financial markets. For instance, the EU has developed a complex taxonomy as a classification system for sustainable economic activities. In addition, it has enacted new disclosure obligations that specify what sustainability information real economy actors and financial markets participants have to report (Corporate Sustainability Reporting Directive (CSRD) and Sustainable Finance Disclosure Regulation (SFDR)). A novel regulation (amending the Markets in Financial Instruments Directive) requires providers of financial advice,among others, to ask their clients about their sustainability preferences. Furthermore, the EU has prepared measures to improve the supervision of sustainability rating agencies and reduce conflicts related to their business models.
The EU strategy and policies on sustainable finance have important implications beyond the EU member states. Obviously, reducing the global environmental footprint of investments in the EU and by European investors is an intended impact. However, EU policies in this area also affect international capital flows and emerging international norms, for instance on sustainability disclosure. As many transnationally operating financial market participants are active in the EU market, EU regulations for this sector have the potential to influence global market practices.
While several sustainable finance measures of the EU have come into force by now, most of them are still at an early stage of implementation and have yet to prove their effectiveness in steering financial markets onto a more sustainable path. For instance, a delegated act that amended the EU taxonomy with criteria related to four environmental objectives was only published in November 2023 – adding to the delegated acts on climate of 2021 and 2022. Depending on the size and type of the economic entity, companies only have to start reporting according to the CSRD between 2024 and 2028.
Internal and external influences on EU sustainable finance policies
From the beginning, the EU sustainable finance policies received considerable attention from interest groups and were a matter of contestation among EU member states. Take, for instance, the EU taxonomy: Drafts of the taxonomy were developed by an expert group consisting mainly of representatives of financial market participants and a small number of civil society representatives and researchers. The different interests shaping the taxonomy became visible, for instance, when several NGO representatives temporarily suspended their participation in the expert group to protest against the design of taxonomy criteria in the areas of bioenergy and forestry which they considered – as a result of lobbying activities – to be too weak. Explicitly against the recommendations of the expert group, the EU made the decision to classify electricity generation with natural gas or nuclear energy as taxonomy-aligned under certain conditions. This decision was apparently driven by the German and French governments which pushed for these classifications based on the structure of the energy systems of their countries and their plans for the future development of these systems.
It is to be expected that EU sustainable finance policies will remain in the focus of private-sector interest groups and politicians from liberal and conservative parties that resist the allegedly overly centralised form of economic steering that they associate with sustainable finance policies such as the EU taxonomy and many other policies that are part of the European Green Deal. In addition, these groups claim that, in light of the burden that the European economies face following the war in Ukraine and other geopolitical and economic turbulences, red tape needs to be reduced (which is frequently also emphasised by European Commission President Ursula von der Leyen) and that additional regulatory strains on the private sector should be avoided. Sustainable finance will thus remain a contested field of EU policymaking in the coming years.
The current debates on geopolitical changes and the related EU interests might be one of the reasons why the EU is actively seeking to export (elements of) its sustainable finance strategy. This includes initiatives to disseminate EU standards related to sustainability disclosure and the EU taxonomy to other jurisdictions. If the EU is successful in this respect, this will allow it to shape the global sustainable finance architecture in line with EU interests, which might facilitate financial flows, recognised as sustainable, to and from the EU. As in other policy areas (consider, for example, the Carbon Border Adjustment Mechanism (CBAM)), the weight of the European market is used to achieve a spread of EU regulations or standards to other parts of the world.
Looking ahead
Given the constellation of interests and the important role of financial markets for the socio-ecological transformation described above, it will be crucial that the new EU leadership shows a firm commitment to further develop sustainable finance policies. To advance the stated objectives of the EU Sustainable Finance Strategy, the EU will have to take additional measures:
- Given the novel nature of many of the policy instruments of the strategy, the EU should closely monitor its sustainable finance measures and further develop and adjust them based on experiences and insights gained in the first years of their implementation. For instance, currently financial market participants often struggle with vague regulations that allow for different interpretations. Moreover, some of the key performance indicators (KPIs) that have to be reported by financial market participants have, in their current form, turned out to be not very meaningful. In addition, it should be evaluated if some bureaucratic burdens could be reduced without harming the objectives of the respective policies The “do no significant harm”-criteria and social minimum safeguards included in the EU taxonomy might, for instance, be revised in this light. Alongside this, the level of ambition of the policy measures will have to be substantially increased over the years, if the financial sector is supposed to be transformed from a hindering to a supporting factor for the EU’s sustainability goals. Thresholds and criteria for sustainable economic investments should be raised over the years in line with an ambitious transition pathway.
- So far, EU sustainable finance policies mainly aim at creating transparency on what investments contribute to sustainability goals. However, in order to achieve a rapid phase-out of harmful economic activities, it is also important to increase transparency on investments in these sectors. In this respect, it might, for instance, be beneficial to complement the EU taxonomy on sustainable activities with a so-called “dirty taxonomy” of investments that are not consistent with the EU’s sustainability goals.
- More generally, it is not to be expected that the current focus of EU sustainable finance policies on creating transparency alone will be sufficient to achieve a large-scale redirection of capital flows. The EU should thus also enact policies that set incentives for market participants to react to the information provided on the sustainability impacts of investments and change their investment decisions accordingly. Measures in this respect might, for instance, make use of mandatory prudential transition plans; credit guidance policies, or subsidised loans whose interest rates depend on sustainability indicators.
- Finally, in close coordination with partner countries, the EU should make efforts to improve the interoperability of sustainable finance frameworks of different jurisdictions. This is important to simplify cross-border transactions and minimise transaction costs, particularly in the form of information costs for investors. However, at the same time, it is important to take country-specific circumstances into account. For instance, sustainable finance strategies for countries with large capital markets might require different strategies than countries in which bank financing dominates. Furthermore, differences in data availability and prior experiences with sustainability reporting complicate the alignment of sustainable finance standards. This is evidenced, for instance, by the challenges that South Africa faces in implementing its Green Finance Taxonomy, which closely follows the example of the EU taxonomy. While aiming for an international interoperability of sustainable finance regulations is important, it is thus also necessary to adapt regulations to local conditions. In this respect, we recommend that the EU continues the dialogue in inclusive fora with countries in various circumstances. Ideally, this dialogue would, for instance, lead to a mutual recognition of taxonomies of a similar level of ambition as equivalent.
These reform proposals vary in terms of their level of ambition and therefore in their likelihood of being implemented in the short term. While the new EU Commission can be expected to be very open to evaluating existing policies and taking steps to make them more user-friendly, ambitious expansions of the EU Sustainable Finance Strategy may currently face more resistance. After all, the widespread shift to the radical political right associated with scepticism towards environmental policies and additional restrictions on private sector actors is clearly affecting also the EU’s policy agenda.
However, if the EU Commission is still honestly committed to the climate and sustainability goals that it has set itself (and that it has also affirmed in international agreements, such as the 2030 Agenda or the Paris Agreement), it will have to be ambitious in its sustainable finance policies. The policy measures implemented so far are simply not enough to bring about the fundamental change in the financial sector that is necessary to make it an enabler rather than an obstacle to the socio-ecological transformation of our economies.
Sören Hilbrich and Kathrin Berensmann are researchers in the Programme “Transformation of Economic and Social Systems” at the German Institute of Development and Sustainability (IDOS).
This blog post was adapted from a new IDOS publication with contributions on priorities for the next EU leadership: Hackenesch, C., Keijzer, N., & Koch, S. (Eds.). (2024). The European Union’s Global Role in a Changing World: Challenges and Opportunities for the New Leadership (IDOS Discussion Paper 11/2024). Bonn: German Institute of Development and Sustainability (IDOS). https://doi.org/10.23661/idp11.2024. It gives the views of the author, not the position of the EADI Debating Development Blog or the European Association of Development Research and Training Institutes.