EU set to unleash a sustainable finance market


Creating a green and sustainable economy represents a global market opportunity for all investors, financial institutions and companies involved in the sustainable economy. It is estimated that Europe alone will need between EUR 175 to 290 billion[1] in additional yearly investment in the coming decades to meet the climate, environmental and social sustainability targets in the Paris Agreement and the United Nations Sustainable Development Goals.

Sustainability and the transition to a low carbon, climate resilient, more resource-efficient and circular economy are seen as crucial to ensuring the long-term competitiveness of the EU economy. Public money will not be sufficient and private capital will therefore very much be needed. Building a financial system that supports sustainable growth is therefore one of the key elements of the EU’s ‘green’ policies.

A unified legal framework is required so that common concepts regarding environmentally sustainable investment are used for the purpose of labelling financial products and corporate bonds as environmentally sustainable at the national and at the EU level when setting up requirements for financial market participants. This will facilitate raising funds for sustainable projects and attract investment across EU member states’ borders.

EU to set up a unified legal framework for sustainable finance

The EU Commission in 2015 highlighted the need to help investors analyse and price long-term risks and opportunities that come with the transition to a more sustainable and climate-friendly economy under its Action Plan on Building a Capital Markets Union.

From 2016, a series of regulatory measures in the area of sustainable finance have been prepared and implemented; and this is only the beginning. A number of new regulatory measures are being prepared that will come into effect over the next few years.

In March 2018 the European Commission adopted the 10-point Action Plan Financing Sustainable Growth with the goals of reorienting capital flows towards sustainable investment, mitigating the impact climate change, social and environmental issues might have on the financial system, and increasing transparency and long-term financing.

The EU’s aim is to provide financial market participants and consumers with a common sustainable finance language avoid market fragmentation and protect investors and consumers from ‘greenwashing’ and ‘bluewashing’.[2]

What is sustainable finance?

In the context of the EU initiatives, the term 'sustainable finance'[3] generally refers to the process of taking due account of environmental and social considerations when making investment decisions, leading to increased investment in longer-term and sustainable activities.

More specifically:

  • environmental considerations refer to climate change mitigation and adaptation, as well as to the environment and the related risks (e.g. natural disasters) more broadly;
  • social considerations may refer to issues of inequality, inclusiveness, labour relations, investment in human capital and communities;
  • the governance of public and private institutions, including management structures, employee relations and executive remuneration, plays a fundamental role in ensuring the inclusion of social and environmental considerations in the decision-making process.

All three components – environmental, social and governance ("ESG") – are integral parts of sustainable economic development and finance.

Sustainable finance also encompasses transparency on risks related to ESG factors that may impact the financial system, and the mitigation of such risks through the appropriate governance of financial and corporate actors.

Key pieces of EU legislation bringing important changes to the financial market

Three key pieces of legislation will introduce big changes to the EU financial markets by setting up key elements for the investment industry (measurement, verification and disclosure of ESG factors).

Defining ‘environmentally sustainable economic activity’

The Taxonomy Regulation[4] being prepared will create a unified classification system (taxonomy) and define whether an economic activity counts as ‘environmentally sustainable economic activity’[5]. The taxonomy will act as the foundation for the EU Green Bond Standard and the EU Ecolabel for retail investment products.

Enhanced disclosures imposed on financial market participants

Financial market participants (financial product manufacturers, providers, and managers and financial advisors) will need to follow transparency requirements with enhanced disclosures for environmentally sustainable investments, financial products that promote environmental characteristics, and other financial products introduced by the Disclosure Regulation[6] and Taxonomy Regulation. Regular reporting will be required on the financial market participant’s websites and in the annual reports, amongst other places.

Under the new regulation, financial market participants will be required to disclose the impact of sustainability on financial returns, and the negative effects of their investment decisions or advice on sustainability factors (the principle of ‘do no significantly harm’) to end investors. The principle ‘do not significantly harm’ will have an impact on the financial institutions’ approach to risk assessment, and they will have to publish on their website their policies on the integration of sustainability risks in their investment-decision process.

Reliable and relevant information on ESG factors is needed to ensure these factors are taken into account when assessing the risks, returns and value of investments.

New benchmarks and ECG disclosures for all investment benchmarks

With the latest amendment to the Benchmarks Regulation,[7] which was published on 9 December 2019, two new investment climate benchmarks were introduced. The EU Climate Transition Benchmark ("CTB") and the EU Paris-Aligned Benchmark ("PAB") incorporate specific objectives related to carbon emission reductions and transition to a low-carbon economy.[8] These two investment benchmarks have a similar objective but differ in terms of their level of restrictiveness and ambition. For example, companies involved in coal, oil & gas are excluded from PAB, but tolerated in CTB.[9]

A benchmark serves a crucial role in investing, by serving as a reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined. In addition, benchmarks are used to measure the performance of an investment fund with the purpose of tracking the return of such an index or defining a portfolio’s asset allocation or computing performance fees.

Existing climate benchmarks (e.g. STOXX Global Climate Change Leaders; FTSE All-World ex CW Climate Index; MSCI Global Low Carbon Leaders; S&P 500 Carbon Efficient) do not always reflect investment beliefs and constraints of institutional investors, and they also lack harmonisation and clarity on objectives and methodologies. With the CTB and PAB, therefore, the European Commission intends to provide all investors with a ready-to-use tool for ‘climate-conscious’ asset allocation. For example, according to a study by Natixis, out of 6 climate benchmarks tested, none is aligned with the EU PAB, and very few are aligned with the EU CTB.[10] Currently only listed equities and fixed-income benchmarks (excluding sovereign bonds!) are concerned in the EU Climate benchmarks.

Further, ESG disclosure requirements have been defined that will be applicable for all investment benchmarks, with the exception of interest rate and foreign exchange benchmarks, since their underlying assets do not have an impact on climate change.

Benchmark administrators will now need to publish the methodology information they use to calculate benchmarks and how the benchmarks contribute to environmental objectives, and any change to them, while keeping an important level of flexibility in designing their methodologies. In that way, investors will get an appropriate tool for assessing their investment strategy.

For an efficient allocation of capital, it is essential that disclosure requirements are consistent across the whole investment chain, covering information from both investment firms and the companies they invest in. In this respect, while for investment firms the regulation is moving towards disclosure standardisation, for corporate disclosures the EU is still far from achieving that objective.[11]

What comes next?

The EU Technical Expert Group on Sustainable Finance set up a voluntary and non-legislative Green Bond Standard Usability Guide.[12] Further the European Commission will explore the possibility of a legislative initiative for an EU Green Bond Standard and there is ongoing work on extending the EU Ecolabel to retail investment products.

The EU Commission intends to create the first European Climate Law by March 2020 to enshrine the 2050 climate neutrality objective in legislation. With the European Green Deal Package, the EU Commission has agreed on the initiatives that will support the EU transition to carbon neutrality by 2050. Among other things, the aim is to present a Sustainable Europe Investment Plan to help support sustainable investment and to build on the International Platform on Sustainable Finance to attract more international investors.

The EU Commission intends to present a renewed sustainable finance strategy in September 2020, which will include a revision of the Non-Financial Reporting Directive.[13] It is important that companies give adequate and reliable information on the sustainability of their activities. There is a need for clear reporting standards that companies should apply. Better corporate information will allow financial market participants to disclose their sustainable investment to their clients and help establish standards and labels for sustainable investment products.

What does this mean for investors and for companies looking for investors?

Investors are increasingly looking to invest in clean and sustainable initiatives, with some major asset managers starting to put pressure on companies in its investment portfolio to implement changes or even looking to exit investments that present a high sustainability-related risk.

BlackRock for example on March 18 unveiled five areas in which it will put pressure on companies in its investment portfolios to act. These are:

  • greater disclosure of environmental risks and opportunities;
  • clearly laying out capital strategy and allocation using environmental sustainability guidelines;
  • compensation that promotes long-term performance;
  • ensuring boards are diverse, accountable and effective; and
  • devising policies to ensure a stable and engaged workforce.

Worldwide, the sustainable bond universe is fast approaching USD 1 trillion with green bonds making up over 70% of the total, while the issue of sustainable loans rose sharply in 2019-2020 bringing total stock to over USD 500 billion.[14]

With the rising interest in investing in the sustainable economy, companies that are involved or getting involved in the sustainability economy have an edge when looking for investors or financing. Resource-efficient companies have higher returns and are better placed than competitors to generate long-term results.

These companies can use their advantage to attract more interest in their shares and debt instruments. This is especially the case in the EU, where the Benchmarks Regulation introduced two new investment climate benchmarks (the EU Climate Transition Benchmark and the EU Paris-Aligned Benchmark), which will pave the way to better regulated and transparent investing in the shares and bonds of companies involved in the sustainable economy.

In order to be considered under the Benchmarks Regulation, companies will need to disclose relevant information on how they are following the ’decarbonisation trajectory’ and not significantly harming ESG objectives with their activities.[15] If the companies fit this profile, they will be well positioned to attract investors who want to invest in sustainable economy.

With the transition to a more sustainable and climate-friendly economy and increased interest in investing in clean and sustainable initiatives, combined with the unified legal framework being proactively set up, we are probably looking at big changes in the financial markets.

[1]Financing Sustainable Growth,
[2]Greenwashing' is the process of conveying a false impression or providing misleading information that a company's products are more environmentally sound than they actually are. Greenwashing is considered an unsubstantiated claim to deceive consumers into believing that a company's products are environmentally friendly. 'Blue-washing' is a technique employed by corporations and companies to form collaborations and associations with various United Nations Agencies to portray themselves as being compliant with the ten principles of United Nations Global Compact, while not being so in reality.
[3]The term 'sustainable finance' as described on
[4]Proposal for a regulation on the establishment of a framework to facilitate sustainable investment, agreed on 19 December 2019.
[5]For an activity to be considered an ‘environmentally sustainable economic activity’ under the Taxonomy Regulation, it needs to, (A) contribute to one or more of the following six environmental objectives: (i) climate change mitigation, (ii) climate change adaptation, (iii) sustainable use of water and marine resources, (iv) transition to a circular economy, waste prevention and recycling, (v) pollution prevention and control, and (vi) protection of health ecosystems; (B) not significantly harm any of the environmental objectives; (C) comply with technical screening criteria to be adopted by the EU; and (D) comply with the minimum social safeguards as defined by documents adopted by the Organisation for Economic Co-operation and Development and the UN.
[6]Regulation (EU) 2019/2088, which applies from 10 March 2021. Disclosure Regulation is the farthest-reaching sustainable initiative adopted by the EU to date. It affects existing mandatory obligations under the 12 most significant EU-wide financial normative frameworks, such as the Capital Requirements Directive, Insurance Distributions Directive, Institutions for Occupational Retirement Provision Directive II, Markets in Financial Instruments Directive II, and Solvency II.
[7]Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending the Regulation (EU) 2016/1011 applicable as of 1 January 2018 as regards EU Climate Transition Benchmarks, EU Paris-Aligned Benchmarks and sustainability-related disclosures published on 9 December 2019. Benchmarks Regulation that first entered into force on 1 January 2018 introduced a regime for benchmark administrators that ensures the accuracy and integrity of benchmarks. European Securities and Markets Authority coordinates the supervision of benchmark administrators performed by national competent authorities.
[8]The objective of the Paris Agreement is to hold the increase in the global average temperature to well below 2 °C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5 °C above pre-industrial levels.
[9] ”EU Climate Benchmarks, Reality and consistency check”, Natixis, November 2019.
[11] Sustainable financial markets: translating changing risks and investor preferences into regulatory action. ESMA32-67-642, 12 February 2020.
[12]Note that International Capital Market Association Green Bond Principles, Social Bond Principles and Sustainability Bond Principles are in place.
[13]In June 2019 European Commission adopted new guidelines for companies on how to report climate-related information, consistent with the Non-Financial Reporting Directive (2014/95/EU) and integrating the recommendations of the Financial Stability Board's task Force on Climate-Related Financial Disclosure.
[14]IIF Green Weekly Insight, What if? A closer Look at Climate Scenarios, Institute of International Finance, 20 February 2020.
[15]How companies will be categorized under the Benchmarks Regulation is yet to be seen. There is certainly a grey zone related to how to categorize a company for example, where a SubCo is 100 % involved in a sustainable economy, whereby HoldCo is still investing in oil and gas.