Walking the convergence tightrope
12 January 2022
To flourish, reach maturity, and attract more capital from investors, sustainable finance must be equipped with an appropriate regulatory framework. This is necessary not only to inform investors of the ESG risks, but also appropriately assess the sustainability impact of companies and investment products. In an increasingly globalised financial world, there is a clear interest in ensuring the widest possible comparability to facilitate international uptake. So, the question then is are we moving towards convergence or fragmentation?
In Europe, the choice is for a top-down approach, whereas in the United States it is the opposite. It’s highly likely that the solution that emerges will sit somewhere between these two approaches, but we need to get everyone on board first.
“In Europe, the choice is for a top-down approach, whereas in the United States it is the opposite. It’s highly likely that the solution that emerges will sit somewhere between these two approaches, but we need to get everyone on board first,” insists Luxembourg’s former Finance Minister Pierre Gramegna.
At the forefront of the fight to bring sustainable finance into the heart of the global financial system, the European Union has developed various tools to ensure what constitutes a green investment, as well as imposing reporting requirements relating to sustainable financial products. The key advantage is that these rules will be the same across all 27 member states. For Mairead McGuinness, the EU Commissioner for Financial Services, Financial Stability and the Capital Markets Union, “the number one priority is ensuring that businesses and projects that do good for both the planet and people get the financing they need. This starts with making sure we are all on the same page regarding what is green. That’s where the taxonomy comes in.”
With a common language, companies will have standardised tools for publishing sustainability reports which will soon be required across the EU. Essentially a test case across the globe, the development of this model is being scrutinised across all corners of the globe, and the EU itself is advocating for standardisation wider than just its member states. “The EU cannot tackle the climate crisis alone,” states McGuinness, “therefore we are strong promoters of both convergence and ambition when it comes to sustainable finance at a global level. Tools and metrics must be compatible internationally if we are serious about change.”
The number one priority is ensuring that businesses and projects that do good for both the planet and people get the financing they need. This starts with making sure we are all on the same page regarding what is green. That’s where the taxonomy comes in.
Convergence however remains a major challenge as currently various reference frameworks or common languages for non-financial information are being developed in parallel. To bring about its objective of a standardised framework on the widest possible scale, the EU is promoting the further development of the International Platform on Sustainable Finance (IPSF). Although currently an informal organisation, the 18 IPSF members include the EU, China and various other Asian countries, and account for approximately 50% of the world’s population, and 55% of both global GDP and greenhouse gas emissions.
“It is within this platform that we are trying to explore issues such as taxonomies and dual materiality. We are also pushing for the increased exchange of information, as well as consistency and convergence,” explains Peter Wagner, Deputy Head of the Unit for International Affairs at the European Commission. The IPSF also feeds into the G20’s work on sustainable finance.
It is within this platform that we are trying to explore issues such as taxonomies and dual materiality . We are also pushing for the increased exchange of information, as well as consistency and convergence,.
One of the IPSF workstreams focuses on comparison between China’s and the EU’s taxonomies (Common Ground Taxonomy exercise). Tracy Wong Harris, Head of Sustainable Finance for Greater China and North Asia at Standard Chartered Bank, and Vice President of the Hong Kong Green Finance Association, is hopeful that the first draft of this project is soon published. “Harmonising the EU-China taxonomy will be the centrepiece of a common standard to accelerate sustainable finance globally,” she states. “It will allow for an easier portfolio comparison than if each follows national standards and will facilitate the international dissemination of products,” notes Wong Harris.
However, is it truly necessary to achieve similar regulation at an international level? Richard Lacaille doesn’t necessarily think so. The Global Head of ESG at State Street, Lacaille notes that while achieving a certain level of comparability in investment products to reduce both effort and time spent on correctly defining products, “it’s wrong to say that we cannot function without this comparability. Minimum common standards can be achieved, but some difference in national approaches is acceptable.” Rather than the top-down regulatory approach followed in Europe, for example, the US is expected to take a far more market-based one, with the SEC taking a lighter touch and only implementing certain transparency requirements.
Harmonising the EU-China taxonomy will be the centrepiece of a common standard to accelerate sustainable finance globally.
Critically, looking at the desire for absolute convergence from across the Atlantic, Lacaille believes that room must be left for different national interests and specific investor preferences. For example, the response relating to the inclusion of gas or nuclear power into the taxonomy, which provokes significant debate in Europe, is unlikely to get a similar response in other places around the world. “National interests differ radically, especially between developing and emerging economies. The latter face significantly more complex challenges than Europe for example.”
While full harmonisation may seem utopian, Stephen Nolan, Managing Director of the UN-convened Financial Centres for Sustainability strongly emphasises the notion of interoperability. “If we were to draw a parallel with technological developments, we would see that this notion of interoperability has allowed mobile communications to work by creating a fluid network across the globe, despite different standards.” For Gramegna, the ultimate arbiter in this attempt to pool standards could be the OECD. “It has shown, for example, that in the transformation of the international tax landscape that it is capable of negotiating global frameworks and agreements.”
Whether it be full harmonisation, interoperability or the broadest possible convergence the issue is moving forward, reducing the looming spectre of fragmentation. Nonetheless it will take time to bring the right parties to the table, and critically, every moment counts.
National interests differ radically, especially between developing and emerging economies. The latter face significantly more complex challenges than Europe for example.