European policymakers are tasked with the challenge of advancing the sustainable finance framework, ensuring it adheres to its foundational principles while also preserving the financial sector’s competitiveness. This requires regulatory innovation that harmonizes with environmental objectives without diminishing financial services’ global stature.
All eyes are firmly on 2030, which is the deadline by which the European Commission has been committed to implementing the Green Deal, its set of policies aimed at reducing greenhouse gas emissions by at least 55%.
The European elections of June 2024 will play a pivotal role in this, as the team appointed for the next European Commission will be the last to put in place the final milestones of the Green Deal that crucial 2030 date.
And the capital needed for transition is gargantuan, the European legislator has identified the need for an annual mobilization of €620 billion from both public authorities and the private sector.
Investment surge
As the deadline approaches, investments must still increase. In its interim report of April 2024, the Platform on Sustainable Finance, an advisory body to the EU Commission, reminded us that the EU needs to boost its investments by at least two-thirds by 2030 compared to the average levels mobilized over the last decade. Undoubtedly, a significant portion of the financial flows should come from the private financial markets.
In this vein, it was with a forward-looking vision that the European Commission unveiled the initial version of its Sustainable Finance Action Plan in 2018, aiming to enhance the transparency of markets and issuers in matters of sustainability. Indeed, this Action Plan aims to create investment opportunities for private investors, to include regulatory drivers, market incentives and risk management measures.
Assessing the regulatory package
Since 2018, the European legislator has embarked on a comprehensive array of regulatory initiatives, including the corporate disclosure of climate-related information, sustainability-related disclosures in the financial sector, EU labels for benchmarks and benchmarks’ ESG disclosures, EU taxonomy for sustainable activities, European green bond standard, sustainability due diligence rules, and more.
Thus, the European sustainable finance package is now richly equipped with tools for measuring and categorising. It’s essential, however, not to lose sight of its primary goal, which is to facilitate the flow of capital towards sustainable investments. For this purpose, experts from the EU Platform on Sustainable Finance have developed a model to assess this regulatory package. The goal is not only to evaluate its impact but also to identify ongoing market reorientations and keep policy makers informed.
Competitiveness concerns and international divergences
And we need to make sure that there is something to measure left in Europe. At the global market level, shifts and divergences in perspectives are increasingly becoming noticeable. The European Banking Federation (EBF) highlighted aptly in April the risk that European ESG regulations could make European banks less competitive than their American counterparts.
The EBF noted the contrast with the situation across the Atlantic, where American credit institutions are not subject to similar ESG regulations as in Europe. The United States is experiencing an ESG backlash due to strong political opposition in the Republican camp. An example of the divergence in sustainable finance policy views is the Federal Reserve’s limitation of climate risk in its banking regulations, echoing Chairman Jerome Powell’s statement in October 2023: “The Federal Reserve is not and will not be a ‘climate policymaker’.”
As we move into a new phase of ESG rules, one of the European industry’s concerns is that the ECB might urge eurozone banks to calculate ESG risks in their loan loss provisions, potentially leading to lower valuations of European banks compared to their North American peers. An ECB stress test in 2023 concluded that most institutions were not prepared for such a risk.
A January study by OMFIF, in partnership with Luxembourg for Finance, reveals a decline in European financial services’ market share over the last 15 years. In 2007, European banks led globally in market capitalization but have since fallen to about half the value of their North American and Asia Pacific counterparts. Additionally, Europe’s share of the world’s top 100 asset managers’ funds decreased from 47.1% in 2007 to 21.9% in 2022.
Legislative adaptations and market realities
One of the identified reasons for this decline in competitiveness remains the traditional European regulatory burden, of which the European executive is well aware. In October 2023, the Commission recalled its intention to reduce administrative burdens to maintain European businesses’ competitiveness and set a goal to reduce the burdens associated with reporting requirements by 25%, without compromising the original objectives of the texts concerned.
In the realm of sustainable finance, the legislator has indeed taken measures, postponing certain documents, seeking to educate on some existing ones, and considering lowering thresholds for upcoming texts.
Strategic imperative
The challenge of regulatory overload in sustainable finance is not just a matter of competitiveness among the world’s regional financial sectors. Failure to act on reducing the regulatory and administrative burden on financial institutions could amplify and accelerate the ongoing decline in green finance issuance. As reported in April by a New Financial report, in collaboration with Luxembourg for Finance, there was a 7% decline in value terms in Europe between 2022 and 2023.
If this decline continues, it could compromise the financing of the Green Deal and cause the European Union to lose its leadership status in the field of sustainable finance. A status that, after all, benefits certain segments of the European financial industry, such as asset management. This would only exacerbate the current loss of competitiveness in the European financial sector.
The challenge for the European legislator will thus be to adopt an evolving sustainable finance package without betraying the original essence of the texts while preserving the competitiveness of the financial sector. Last but not least, it is essential to incorporate developments that enable the regulation to support market transition, as opposed to merely imposing it in a challenging market environment. Ensuring compliance with the rules is one thing; it necessitates the flow of money to where it’s needed.