Balancing Ambition with Pragmatism - Europe’s Sustainable Transition | AFME

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Balancing Ambition with Pragmatism - Europe’s Sustainable Transition
06 Jul 2021
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The world is in a race against climate change and, while there is still a long road ahead, the EU is confidently leading the pack. With the publication of the EU Renewed Sustainable Finance Strategy, Europe continues to power ahead with regulatory reform that will lay the foundations to accelerate its sustainable transition and reach its net-carbon neutral 2050 goals.

However, while the EU’s rapid progress on sustainable finance is positive, it is important to ensure that the quality and usability of regulatory frameworks, as opposed to the speed of regulatory development, remain the central considerations in the next stages of the work programme. Crucially, the new regulatory frameworks should balance ambition with pragmatism.

Data quality should be prioritised

Time is of the essence in tackling climate change, but data quality and usability should not be compromised. The existing and upcoming ESG disclosures rules require banks to produce and report a highly granular quantity of ESG information, requiring the tracking of hundreds of data points against potentially thousands of companies. To meet these obligations, banks have to use estimates, proxies and data from third-party vendors, which means their quantitative disclosures are less reliable. This undermines one of the key objectives of the EU in supporting the transition, which is to develop a solid reporting framework to fight greenwashing. There is unquestionably a need for banks to share details on the ESG impact of their activities but avoiding unnecessary complexity and granularity would go a long way towards helping firms’ transparency efforts.

Additionally, there have been many concerns surrounding the sequencing between financial institution and non-financial institution reporting obligations. We appreciate that the Commission has taken them into consideration in the recently published legislation on disclosures under the EU Taxonomy Regulation. Still, from 2023 banks will need to start preparing new ESG regulatory disclosures (so called Pillar 3) based on data supplied from their borrowers and investee companies whilst non-financial corporates will not start reporting relevant information until later in 2023 or when the Corporate Sustainability Reporting Directive will enter into force. Corporates are therefore unlikely to provide the data necessary for banks to fulfil their reporting obligations in full, leading to less transparency and possibly penalties.

There is also an issue of supervision. With the enormous challenge for the financial services sector to provide regulators with these vast amounts of data, ESG data and rating service providers will often have to help fill in the gaps, but financial institutions are concerned about a lack of transparency over the methodologies used by such providers. Therefore, the quality, reliability and comparability of these services will be key to Europe's sustainable transition and should be appropriately supervised. An EU level supervision of ESG service providers would ensure that a consistent supervisory approach is adopted, and that financial and non-financial companies can build on reliable and comparable data.

Support companies in transition

For the global economy to meet the goals of the Paris agreement, there also needs to be greater recognition of what are considered as “transition activities”. These are activities that help contribute to reducing carbon emissions in the economy. Presently, the definition and screening criteria that determine a “transition activity” do not include many of the sustainable actions companies are in fact taking. Such activities still make a meaningful contribution to decarbonization, but are currently not recognised as such. If such activities are missed out, then less capital or a higher cost of funding will be applied to financing these activities which disincentivises further sustainable activity, when in fact they should be supported. Moreover, financing transitioning companies could be expanded by broadening taxonomies to capture entity-level activities. Both of these changes would go a long way to helping accelerate Europe’s pathway to achieving net-zero carbon emissions by 2050.

As the European Commission unveils a Renewed Sustainable Finance Strategy it should continue to appreciate that the speed of regulatory development is not the only priority.  EU authorities need remain focussed on the availability of relevant, reliable and comparable information that helps facilitate capital flows towards sustainable activities. Europe is a global leader in sustainable finance and if authorities can balance ambition with healthy pragmatism and close cooperation with other jurisdictions, Europe will remain the global leader for many years to come.