20 Dec 2018

Better define ‘sustainable finance’ to boost investment

Creating a clear and responsive classification framework for sustainable finance is a vital first step in the development of an overall greener and more transparent financial system

Europe has made a good start on its ambition to be a global leader in sustainability issues. For instance, 37% of total green bond issuance in the last 10 years was done in Europe - more than North America, Asia-Pacific or any other global region, according to Climate Bond Initiative data. And France is leading the EU nations with over 4%, by value, of bonds issued in the country in 2017 classed as sustainable.

By publishing its Sustainable Finance Action Plan the European Commission has also provided an ambitious and much needed roadmap for putting sustainability at the heart of the financial system - European Parliament and Member States too have also pushed this issue high up their agendas.

To meet the EU’s level of ambition – for instance its commitment to reduce greenhouse gas emissions by 40% by 2030 –a significant increase in private sector investment in sustainable economic activities will be required.

But at present a major obstacle to attracting such investment is a lack of agreed definitions about what exactly qualifies as ‘sustainable’. Although some industry frameworks do already exist e.g. ICMA’s green bond principles, market participants lack a universally agreed and applied framework. A common workable, flexible and dynamic language is needed to better identify, compare and invest in sustainable economic activities.

As a result it can be difficult for would-be investors to judge whether an investment opportunity is genuinely ‘sustainable’ or rather whether it is ‘greenwash’. This not only deters investors, but also prevents meaningful measurement and understanding about the size and make-up of the European sustainable finance sector.

In order to tackle these issues AFME is supportive of the European Commission’s proposals to create a harmonised EU-wide ‘taxonomy’ for classifying whether an economic activity is environmentally sustainable, as part of its Sustainable Finance Action Plan. We believe it is a fundamental building block in the development of the EU’s sustainable financial system. But for it to have its full intended impact, we believe it must be sufficiently flexible. This need for flexibility is clear in a number of areas.

For instance, while we welcome the intention behind the European Commission’s proposals to only implement the taxonomy once it is ‘stable and mature’, the reality is that in this very fast-moving area such a definitive taxonomy may never exist. There must be arrangements in place to enable the taxonomy to be regularly refreshed, to take new developments and technologies into account.

The framework should also be international in scope, looking at activity both within and outside the EU. We believe it could encourage improvements in market practices worldwide. Calibrating it appropriately, so that it can be adaptable to global economic activity and also doesn’t impede the competitiveness of European markets will be hugely important.

Additionally, there are many economic activities which could on some level be labelled ‘sustainable’ and a range of factors will need to be considered when making such an assessment. For example, even for something that seems fairly obviously to be ‘environmentally-friendly’, like an energy company establishing a wind farm to generate electricity, there could be complicating factors - such as if the construction of the windfarm had a negative impact on local wildlife or the local population in some way. A sustainable finance categorisation framework will need to be sensitive to such circumstances, including to the fact that many businesses will include both ‘sustainable’ and ‘non-sustainable’ elements.

These is no disputing that coming up a widely-accepted and adaptable framework will be challenging. Building on existing examples of best practice could help – a number of organisations such as ICMA, the Climate Bond Initiative, and the European Investment Bank have already undertaken considerable work in this area. A range of sustainable investment strategies have also already developed in the market. Yet as proposals for the taxonomy currently stand, only investments which have a stated positive environmental or social objective would be included. This approach, known as ‘impact investing’, currently only makes up a relatively small part of the sustainable finance ecosystem.  It is essential that the Taxonomy proposal allows for sufficient flexibility for “transition” investments – meaning investments in companies that are taking meaningful strides towards environmental sustainability, rather than to focus exclusively on investments that are already fully sustainable.

Creating the flexible and effective categorisation framework that has been described here may seem like a tall order but achieving it is fundamental to the building the first steps towards a sustainable financial system and unlock the financing necessary to achieve sector and must remain a priority, no matter how complex the task may seem. 

This AFME view was originally published in L'Agefi