Implementing sustainable finance in Europe will have major positive benefits for the sustainable economy at large. The road to recovery from the economic impacts of COVID-19 will not be quick or easy. Our current crisis presents an opportunity to direct large-scale investment toward creating a sustainable European economy.
Sustainable finance is defined as investment decisions that take into account the environmental, social, and governance (ESG) factors of economic activity or project.
As a report, A Vision for Sustainable Finance suggests; “For ambitious financial reforms to be achievable and sustainable they must be fair and inclusive; their long-term success will be dependent on Europe’s ability to guide international standards. Reforms must address public as well as private finance norms, including institutional architecture and governance.”
However, the current crisis in Europe is making sustainable finance in Europe challenging. In order to manage trade-offs between short- and long-term economic support Europe will need to further develop its approach to financing climate transition. It will need to balance the transition risk and challenges faced by Central and Eastern Europe with the physical risks and impacts faced by Southern Europe, to ensure that no region is left behind during the economic transformation of the coming decades.
Financial flows towards a sustainable economy
Large pools of public and private capital will be required to make the investments that are needed for Europe’s economic transformation. The European Investment Bank and other national and regional public banks have a crucial role to play in the recovery. With the support of national and local governments, they can both ensure that capital flows to the right places.
The European Commission is assessing the potential development of a taxonomy of environmentally harmful activities to reallocate capital away from activities that are not in line with sustainability objectives. A growing number of financial institutions including the European Central Bank have voiced their support for the development of such a taxonomy.
The framework for sustainable finance can make it easier for public authorities to raise sustainable capital. The EU is already taking significant steps in this regard. Under the 2021-2027 Multiannual Financial Framework (MFF) and Next-Generation-EU (NGEU)5, the Union aims to spend up to EUR 605 billion on projects addressing the climate crisis and EUR 100 billion in projects supporting biodiversity. Of the EUR 750 billion allocated for NextGeneration-EU, 30% will be raised through issuance of NGEU green bonds. As the ‘EU climate bank’, the European Investment Bank Group has also taken important steps to support the transition.
Some Member States are still to be convinced that the transition is viable without further investment in fossil infrastructure, notably in Central and Eastern Europe where coal continues to play a key role.
Sustainable Finance Trends in Europe
In recent years, there has been a steady increase in sustainable investments in Europe, driven by both the public and private sectors. Incorporating sustainability considerations into investment strategies and business decisions has accelerated in the past few years. This is reflected in the steady increase in green bond issuance and in the growing integration of ESG assets into investors’ portfolios. Green bonds from private-sector issuers are still a small proportion of the broader corporate bond market in the EU (2%), though. In equities, there is evidence that ESG-oriented assets have outperformed conventional shares in the last two years. Barriers to ESG investment remain, however, with a lack of standardised information and risks of greenwashing.
Investor interest in sustainable finance has continued to rise: investors are increasingly integrating ESG assets into their portfolios and are considering ESG factors alongside traditional financial factors.
We expect a shift in asset allocation and bond selection toward investment strategies and companies that transparently disclose their ESG profile, risks, and opportunities. This is the time for everyone to pilot test the Sustainable Finance proposals in the market, for investors to ask and for corporates to disclose guidelines and build internal ESG experts on the many facets of EU Sustainable Finance.