Category: Financial Services

By Robin Hamaker-Taylor

In the years since the Paris Agreement, the European Commission has sought to create the enabling conditions for the EU to meet its targets under the Paris Agreement and goals of the 2030 Agenda for Sustainable Development. The Commission developed their Action Plan for Financing Sustainable Growth in March 2018 and established a Technical Expert Group on sustainable finance (TEG) shortly after to assist in the development of proposals which advance the action plan.

Recognising that the investment industry often uses taxonomies to drive capital towards objectives, the TEG developed the EU Sustainable Finance Taxonomy (‘the EU Taxonomy’). The EU published its Technical Report on the Taxonomy in June 2019.

The EU Taxonomy helps translate the EU’s commitments to the Paris Agreement and the Sustainable Development Goals (SDGs) for investors. The Taxonomy bridges the gap between international goals and investment practice, clearly signalling the types of activities that are consistent with the low-carbon transition, adaptation and other environmental objectives.

What does the EU Taxonomy cover?

The EU Taxonomy provides a common language on what constitutes sustainable activities. It is a list of economic activities with performance criteria for their contribution to six environmental objectives, including:

1. climate change mitigation;

2. climate change adaptation;

3. sustainable use and protection of water and marine resources;

4. transition to a circular economy, waste prevention and recycling;

5. pollution prevention and control;

6. protection of healthy ecosystems.

To be included in the proposed EU Taxonomy, an economic activity must contribute substantially to at least one environmental objective and do no significant harm to the other five, as well as meet minimum social safeguards.

What does the EU Taxonomy mean for adaptation?

The EU Taxonomy holds that an economic activity makes a substantial contribution to adaptation objectives if: (i) all material physical climate risks identified for the economic activity are reduced to the extent possible and on a best effort basis; and/or (ii) it reduces material physical climate risk in other economic activities.  Economic activities can contribute to adaptation objectives in two different ways:

1. Adaptation of an economic activity: an economic activity is made more climate resilient by integrating measures to reduce all material physical climate risks to the extent possible and on a best effort basis; and

2. Adaptation by an economic activity: an economic activity contributes to adaptation of other economic activities to physical climate risks and must also be resilient to physical climate risks itself.

How is the EU Taxonomy useful for investors?

As set out in the TEG’s Taxonomy guidance document, a supplement to the technical report, the Taxonomy has various benefits for investors, including the following:

• Provide clarity via a common language for investors, issuers, policymakers and regulators. Investors can use it to express their expectations for their investment decisions. Companies and project developers can use it to plan and raise finance, developing the pipeline of sustainable investment opportunities. All can use it to avoid unintended greenwashing.
• Help translate commitments to the Paris Agreement and the SDG’s for investors. The Taxonomy bridges the gap between international goals and investment practice, clearly signalling the types of activities that are consistent with the low-carbon transition, adaptation and other environmental objectives.
• Save time and money for investors and issuers. The criteria have been developed by environmental and industry experts and references the latest EU and international thinking. This allows investors to focus on what they do best, understanding the risk and return of an investment.
• Support different investment styles and strategies. Investors marketing environmentallysustainable funds can invest in Taxonomy-eligible activities; engage companies on how they are progressing towards Taxonomy thresholds; or provide their own explanation for how they will achieve the fund’s goals. Investing in Taxonomy-eligible activities is not mandatory.
• Put environmental data in context. Investors need to understand which companies are contributing to the low-carbon transition and which are building resilience to climate change, not just carbon footprints.
• Avoid reputational risks. By screening out economic activities that undermine broader environmental, climate and social objectives, investors can avoid reputational risk and ensure that their strategy is robust.
• Deepen the conversation. By focussing on economic activities, the Taxonomy provides a tool to understand company business models. Some business lines may be delivering on sustainability objectives, while others may not. This allows a sophisticated discussion around strategy and consistency with sustainability objectives.
• Reward companies. A science and evidence-based framework to define what is environmentally sustainable provides companies with clear direction. It will help companies access finance for R&D while rewarding those undertaking environmentally sustainable activities.

What’s next after the EU Taxonomy?

Following the publication of its Technical Report on the Taxonomy, the TEG’s mandate has been extended to the end of 2019. The TEG is currently assessing feedback collected from July until September 2019. They are and refining incomplete aspects of the proposed technical screening criteria for substantial contributions and avoidance of significant harm. At the end of its mandate, the TEG will make further recommendations to the European Commission on the need to adjust and complement their work on an EU taxonomy. The TEG’s recommendations are designed to support the European Commission in the development of future regulation, as proposed in the taxonomy regulation.

In October 2019, the Commission published joint statement on the International Platform on Sustainable Finance (IPSF). The IPSF is part of the European Commission’s ongoing work to support a global transition to a low-carbon, more resource-efficient and sustainable economy. It was developed, in part, to realise greater international cooperation to join up efforts to scale up environmentally sustainable finance globally and promote the integration of markets for green financial products at international scale. To this end, the IPSF will act as a forum for facilitating exchanges and, where relevant, coordinating efforts on initiatives and approaches to environmentally sustainable finance, while respecting national and regional contexts. It remains to be seen how the EU Taxonomy will align or integrate with the platform, though this should be clarified in the coming months.

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Cover photo by WMO on Climate Visuals

By Robin Hamaker-Taylor

The central bank Network for Greening the Financial System (NGFS) has recently enjoyed continued momentum with the development of several new reports and the addition of new members. 

In July this year, the NGFS published a technical supplement “Macroeconomics and Financial Stability: Implications of Climate Change” to the April 2019 NGFS Comprehensive report. The supplement provides an overview of existing approaches for quantitatively assessing climate-related risks and identifies key areas for further research. It also sets out a menu of options for central banks and supervisors to assess the risks.

This month (October 2019) the group also published “A Sustainable and Responsible Investment Guide for Central Banks’ Portfolio Management”. The guide, aimed at central banks that wish to adopt Sustainable and Responsible Investment (SRI) practices, builds on the results of a recent survey of NGFS members. It includes case studies of first-hand experiences by some NGFS members and identifies common SRI strategies. The most prominent SRI strategies are green bond investments and negative screening for equity and corporate bond holdings.

Adding four new members and an observer in September 2019, the network has now 46 members and 9 observers, representing five continents, over half of global greenhouse gas emissions and the supervision of two thirds of the global systemically-important banks and insurers.

Also, worth noting is the recent invitation of NGFS to a roundtable session of US Senate Democrats’ Special Committee on the Climate Crisis. At Capitol Hill in Washington, D.C., Frank Elderson, chair of the NGFS and executive director of De Nederlandsche Bank, gave an opening statement followed by the other NGFS delegates.

Going forward, the NGFS plans to publish additional technical documents to better equip central banks and supervisors with appropriate tools and methodologies to identify, quantify and mitigate climate risks in the financial system. This will include publishing further details on the NGFS transition scenarios and guidelines on scenario-based climate risk analysis.

Launched at the Paris One Planet Summit on 12 December 2017, the NGFS is a group of Central Banks and Supervisors. The network shares best practices amongst themselves and contributes to the development of environment and climate risk management in the financial sector and to mobilise mainstream finance to support the transition toward a sustainable economy.

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Photo by Andrea Cau on Unsplash

By Laura Canevari

On September 30^th, the EU Technical Expert Group (TEG) issued its final report on climate benchmarks and environmental, social, and governance (ESG) disclosures. The report provides minimum requirements for two new climate benchmarks: the EU Climate Transition Benchmark (EU CTB) and the EU Paris-aligned Benchmark (EU PAB). The report also provides suggested recommendations on ESG disclosure requirements, applicable to all investment benchmarks (with the exception of currency and interest benchmarks).

These two measures (the two new benchmarks and requirement for ESG disclosures) were established as the result of a new EU regulation, passed in February 2019. The regulation, which amends EU Regulation 2016/2011, is part of the European Commission’s Action Plan for Financing Sustainable Growth.

New climate benchmarks

As noted in the TEG’s final report, a climate benchmark is an investment benchmark that incorporates specific objectives related to greenhouse gas (GHG) emission reductions and the transition to a low-carbon economy. These specific objectives are incorporated next to financial investment objectives and are based on the scientific evidence of the IPCC, through the selection and weighting of underlying benchmark constituents.

The main objectives of the new climate benchmarks are to:  

1. Allow a significant level of comparability of climate benchmarks methodologies while leaving benchmarks’ administrators with an important level of flexibility in designing their methodologies;
2. Provide investors with an appropriate tool that is aligned with their investment strategy;
3. Increase transparency on investors’ impacts, specifically with regard to climate change and the energy transition; and
4. Disincentivize greenwashing.

The EU CTB and EU PAB benchmarks build on existing low-carbon benchmarks, while also having broader climate action ambitions. Not solely limited to being used to fulfill a risk reduction objective, they can also fulfill objectives relating to opportunities, helping to increase the share of investments in climate-related opportunities.

As noted in the final report, investors can use climate benchmarks in the following ways:

• To underly passive investment strategies;
• As an investment performance benchmark for GHG emission-related strategies;
• As an engagement tool; or
• As a policy benchmark to help guide strategic asset allocation (SAA).

Investors may wish to use the final report to investigate the differences of these benchmarks and to understand the criteria that have to be met to qualify as an EU CTB or an EU PAB. The following table sets out which types of financial institutions would use the two types of benchmarks:

EU Climate Transition Benchmark (EU CTB)	EU Paris-aligned Benchmark (EU PAB)
The  main  users  of  EU  CTBs  are  institutional  investors  such  as  pension  funds  and  (re)insurance companies with the objective of protecting a significant share of their assets against various investment risks related to climate change and the transition to a low-carbon economy, labelled as transition risks by the TCFD.	The main users of EU PABs are institutional investors which aim to display more urgency than CTB investors and want to be at the forefront of the immediate transition towards a +1.5°C scenario.

Environmental Social and Governance (ESG) disclosure requirements

Alongside establishing the two climate benchmarks, the EU has also introduced requirements for ESG disclosures for any category of index, excluding interest rate and currency benchmarks. Index administrators are now required to provide information on both the methodology and benchmark statement. Regarding the methodology, the index administrator is required to deliver an explanation of how the key elements of the methodology reflect ESG factors for each benchmark or family of benchmarks. Regarding the benchmark statement, it is now required that the published benchmark statement contains an explanation of how ESG factors are reflected in each benchmark or family of benchmarks.

The new disclosure requirements apply to a wide range of indices available on the market and the final report sets out recommendations on minimum disclosure by asset class. For some asset classes, market practices have already been established and are expected to be applied (e.g. corporate and sovereign bonds and listed equities). However, many disclosure requirements apply to a wide variety of asset classes, including consolidated ratings for each element of ESG, a rating for ESG as a whole, and disclosure on alignment with the Paris Agreement.

Requirements relating to physical climate risk

The EU’s new climate benchmarks have been designed to inform the transition to a low carbon economy (e.g. broadly including products and services related to energy efficiency and renewable energy). They do not encompass the opportunities that stem from tackling physical climate risks. Physical risks are nonetheless included under the ‘E’ (Environmental) element. Physical climate risk exposure is expected to be reported for equities, fixed income and commodities asset classes.

Much work is still needed in order to set adequate disclosure requirements on physical climate risk exposures. The guidance on methodologies allowing investors to calculate physical climate risk exposure presented in the TEG’s final report also needs to be refined.

New regulations on the horizon and future developments

Apart from describing the minimum requirements for the new climate benchmarks and ESG disclosures, TEG’s final report serves as a basis to the drafting of further regulation by the Commission. The timeframe for proposed regulations is likely by the end of 2019. Regulations are expected to be adopted in early 2020 following a public consultation. A number of areas for improvement are also outlined by the TEG, which suggest what might comprise further guidance in the future. These areas include the further alignment between benchmark disclosures and emerging regulations on sustainability-related disclosures in the financial services sector. Furthermore, there could also be alignment of benchmarks and ESG disclosure requirements with the EU Taxonomy in the future.

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Cover photo by World Meteorological Organisation / ClimateVisuals