EU sustainable finance action plan: rules to change investment practices

World Environment Day is on 5 June. Having committed to reducing its greenhouse gas emissions by 55 % for 2030, the European Union has been rolling out for several years now its sustainable finance action in instalments. Taking them one by one, let’s have a closer look at how these 9 regulations are set to change the market.

Climate change mitigation has been a priority for EU countries over the last ten years. Promises and words have gradually been transformed into concrete goals on paper and into new laws geared towards the EU reducing its greenhouse gas emissions (by at least 55 % for 2030) and member countries increasing the weight of renewable energies in their energy mix. Nevertheless, efforts in industry, transport and energy come at a price. So, who’s going to foot the bill?

European Commission calculations expect the investment required to reach climate and energy goals to cost €180 billion a year. If, on top this you add the required reforms in the transport sector, waste management and efficient water use, the bill shoots up to €270 billion. All of which explains why since 2018 the European Union has been implementing its sustainable finance action plan to raise the necessary transformation funds.

Bringing markets on board the path to carbon neutrality

Following up on the recommendations of the high-level expert group on sustainable finance, which was commissioned to propose a roadmap for the financial sector to play its part in the transition to a low-carbon economy, the European Commission tabled its action plan for financing sustainable growth in March 2018. Accordingly, this constitutes the strategy plan for the 27 EU member countries to link financial and capital markets to European economy needs in its path towards carbon neutrality and low environmental impact.

The sustainable finance action plan seeks to achieve three major goals:

• Reorient capital flows towards a more sustainable economy.
• Mainstream climate change and environmental degradation in financial risk.
• Foster transparency and long-termism in financial activity.

These three goals are to be pursued through nine outstanding initiatives, including several new laws and a certain degree of regulatory reform, some which have not been fully developed as yet. Others, however, such as the new European green taxonomy (probably the most discussed reform in recent years), have already come into force. The state of play regarding the nine new EU regulations dealing with sustainable finance is discussed one by one below.

1. Taxonomy: a classification system for sustainable activities

The European taxonomy for sustainable activities, popularly referred to as the European green taxonomy, is a classification system that investors can use to distinguish between environmentally sustainable and non-sustainable projects. This document was drawn up to provide security to financial markets. After a lengthy debate process – in the course of which it was agreed to classify both nuclear and gas energy as sustainable transition energy resources –, the taxonomy was adopted definitively last July and came into force on 1 January 2023.

2. Labels and standards for green financial products

Through these measures, the action plan seeks to introduce a standard for green bonds and a voluntary labelling system for sustainable investment products. On 1 March last, the European Commission, Parliament and Council reached a definitive agreement regarding the regulation of green bonds. There are still some legislative process steps pending implementation, so this regulation is not expected to come into force until 2024. As far as broadening the green label to encompass financial markets is concerned – the EU Ecolabel has been available for other types of businesses and products for some years now – the debate is ongoing.

3. Reference indices for low-carbon assets

This was one of the first measures adopted. The European Union amended its Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds. This amendment added two new reference indices to be taken into account, namely, the EU Paris-aligned Benchmark and the new EU Climate Transition Benchmark. These were definitively adopted in 2020.

4. Sustainability in financial advice

This regulatory reform seeks to require insurance companies and investment advisers to advise customers to take sustainability factors into account with respect to their financial assets. In keeping with this measure, changes have been introduced into the MiFID Directive that regulate the provision of the investment services and into the Insurance Distribution Directive (IDD). These changes are expected to favour the acquisition of sustainable finance products.

5. Risks, sustainability and prudential framework

When the action plan was adopted, one of the stand-out measures was its introduction of sustainable factors in the EU prudential rules for banks and insurance companies. In other words, it will make it compulsory to take sustainable criteria into account in the way entities assess financial stability risks. Still under debate, it is unlikely to be adopted in the short term, particularly after the European Banking Authority published an article in 2022 pointing out that these changes could very well undermine the credibility of the prudential tools.

6. A new disclosure framework

The action plan also seeks to create a new regulation on sustainability‐related disclosures in the financial services sector (SFDR). This should serve to ensure that all parties throughout the investment chain publicly disclose their opinion on sustainability and the impact of their investments. The regulatory framework was approved in 2019, but technical specifications and standardisation are still under discussion.

7. Enhanced transparency in non-financial information

Work has been ongoing in recent years to introduce novelties into the NFRD, the non-financial information directive for large companies. These changes resulted in the Corporate Sustainability Directive (CSRD), which came into force last January and which will affect the information compiled by all listed companies (whether large companies or SMEs) as of 2024. Among other measures, the CSRD strengthens the disclosure rules concerning greenhouse gas emissions and the waste risk, while making it mandatory for companies to have sustainability audited externally.

8. Towards sustainable corporate governance and long-termism

Of all the proposals on the table, this one has been the slowest in making progress given that studies and debates to determine the short-termism level in capital markets are still ongoing. The end goal is to introduce a rule the fosters a long-term approach to investments and incorporates sustainability into corporate decision-making.

9. New guidelines for credit classification

Albeit not legislative reform properly speaking, the European Securities and Markets Authority (ESMA) issued a series of guidelines in 2019 to disclose information on sustainability in credit ratings to link the sustainability focus of companies in some way to the cost of capital.

In fine, with the adopting of the green taxonomy, new reference benchmarks and the new, non-financial information disclosure frameworks, the roadmap marked out by the European sustainable finance action plan is fairly advanced. Over the next few years we will see the effect of the plan on financial markets and whether or not the new regulations manage to raise the capital required for EU green transition.

BBVA’s sustainable finance drive started back in 2007. Ever since, it has striven, as part of its sustainability-related strategic priorities, to accompany customers in the energy transition to combat climate change and opt for inclusive growth. Aware as the bank is of the importance of this major transformation for society, it continues to play a key role in helping people, businesses and institutions to commit to the transition towards a greener and more inclusive world.