The European Commission’s action plan on “financing sustainable growth” outlines a series of necessary steps towards aligning financial markets with climate goals. However the Commission’s ambition is extremely weak when it comes to kickstarting sustainable investments as well as mitigating climate-related financial risks.
Today the European Commission presented an action plan on “financing sustainable growth” which broadly aims at improving the information available in financial markets in order to allow investors and consumers to know which assets are ‘sustainable’. This would be achieved through the creation of a taxonomy and eco-labels. Building on the work of the HLEG report published last month, the report also looks at ways to improve corporate governance and asset managers duties. Finally, the action plan paves the way towards incorporating climate risks into credit ratings, and into capital requirements.
Overall, the action plan lays out a series of necessary steps towards aligning financial markets with the sustainability goals. However, the Commission’s approach also presents important risks and limitations which all stakeholders should acknowledge.
First, there is a considerable risk that building up a taxonomy for sustainable finance will involve a long and cumbersome process, thus delaying other measures. Although such a taxonomy is a necessary step for the proper functioning of a series of incentive measures and to avoid greenwashing risks, we also believe the taxonomy should not be seen as a prerequisite for other measures. While it is difficult to define what is green or sustainable and to calibrate metrics on it, we know quite clearly which sectors and activities are not.
This lead us to our second point. The use of capital requirements in making sustainable finance happen should be solely use for risk management purposes, contrary to the Commission’s idea of using macroprudential tools for subsidizing green loans through lower capital requirements. As we and a number of other stakeholders have voiced, this is a wrong approach. First, because assessing green assets would require having the taxonomy in place, which, as pointed above, will take time. Second, because green assets are not necessarily less risky meaning such “Green-Supporting Factor” would undermine the very purpose of macroprudential policy.
A more pragmatic and efficient approach would be to use capital requirement to counter excessive credit growth in unsustainable sectors and activities through the introduction of a ‘brown penalizing factor’. Countercyclical capital buffers — which are still set at zero percent in the whole Euro area — could also serve the same purpose.
It’s not a secret: the European Stability Risk Board (ESRB) estimates exposure to climate-related risk are at half of the assets of banks in the Euro area. Nevertheless, and against all logic, there is no mention in the action plan of the crucial role of this structure — in which the ECB plays a key and central role — on the containment of this systemic risk.
Third, we have to recognise that providing better information and changing investors’ behaviour is an herculean task which will take time to achieve the intended results. The market’s mismatch of horizons is the product of decades of financial deregulation. It is unrealistic to expect to fix this issue on the short run.
Fourth and foremost, the Commission omits the role of public investments and the potential for coordinating the EU’s investment strategy with the ECB’s monetary policy.
Commission VP Dombvroskis once again repeated the estimate that “around €180 billion of additional investment a year is needed to achieve the EU’s 2030 targets agreed in Paris.”.
Yet the Commission’s action plan is extremely weak when it comes to boosting investment in the short run. Section 2.3 of the action plan, dedicated to “fostering investment in sustainable projects,” amounts merely to self-congratulation over the Investment plan for Europe (aka the Juncker plan or EFSI) – in spite of the lack of evidence that this programme has contributed to sizeable additional investments in Europe, even less so in the field of the transition.
The EC also outlines its intention to propose “a single investment fund integrating all EU market-based instruments to further increase the efficiency of EU investment support” in the context of the next multiannual framework (after 2020). While some simplification and integration of the numerous investment policies of the EU could be useful, this does not eliminate the need for a much larger funding envelope, dedicated to those investments. Europe needs to increase its investment spending to somewhere between 1.5 to 2% of the EU’s GDP.
Being serious about climate change: we need public investment
Simply relying on the existing Juncker plan is not enough. Public investment has still not yet recovered since the financial crisis: having declined by more than half over the past 30 years, it is still far below pre-crisis levels. There is no way around fixing this issue, which is partly caused by the legacy of the austerity-minded mis-management of the crisis, and also the flaws of the rules under the Stability and Growth Pact, which prevent member states from investing.
Fortunately, the European Central Bank’s quantitative easing programme provides an opportunity to overcome this challenge. The ECB could allocate a significant size of its public bond purchases (and future reinvestments) towards green sovereign bonds issued by member states or public development banks, such as the European Investment Bank (EIB). While a political process would be needed to define the overall framework of such an investment plan, the contribution of the ECB’s monetary policy could be limited to incorporating a preferential treatment for sovereign green bonds. Even if the expansion of QE comes to an end, the ECB could continue rolling over the stock of bonds according to those criteria, when bonds already purchased under these programmes reach maturity.
Only a fraction of the 2.5 trillion euro quantitative easing programme is necessary to make a difference. Let’s be clear as well that the ECB’s involvement only needs to be temporary. What matters is to give an impetus for green investments in Europe. An ambitious public investment plan would have strong positive spillover effects on private markets, as well as on the overall economy, as some preliminary macroeconomic research in this field indicates.
To amplify the impact of such an approach, it is time for the EU to adopt a “golden rule” for green infrastructure investments across Europe, by exempting specific and commonly agreed green investments from debt and deficit calculations. Together, those two measures would provide a massive incentive for governments to intensify and shift their investment spending towards long-term green infrastructure investments.
The Commission’s proposals are welcome, but by focusing too much on the private sector, the Commission neglects more ambitious ways of filling the investment gap as soon as possible. If we agree that climate change is by nature a “market failure”, then it makes little sense to rely only on the private sector to fix up the mess. Public institutions must take the lead as well.