Sustainable Finance in Europe

The aim of this book is to collect the views of expert academics and practitioners on the latest regulatory developments in sustainable finance in the EU. The volume deliberately includes a wide range of cutting-edge issues. Although it focuses on the green transition, it also addresses social and governance issues. The individual contributions deploy different methods of analysis, including theoretical contributions on the status quo of macrofinancial research as well as law and economics approaches, encouraging interdisciplinary readership. The book chapters are grouped in a thematic way, covering the following areas: (i) general aspects (Part I); (ii) sustainable finance and corporate governance (Part II); (iii) sustainable finance, systemic risk and monetary policy (Part III); and (iv) sustainable finance and financial markets (Part IV). This chapter provides a summary and overview of the chapters.

Since the publication of the European Commission’s 2018 Action Plan and—similarly—the 1st edition of this book, significant progress has been made on the execution of the Action Plan and putting into effect the actions identified in the Plan. The actions respond to five broad strategies that can be defined as ‘public incentives’, ‘standardisation’, ‘disclosure’, ‘corporate governance’ and ‘financial regulation’. The first strategy consists of fostering investments through financial and technical support for sustainable infrastructure and other projects. The second strategy includes the establishment of an EU taxonomy of sustainable activities which should help shifting capital flows towards them. It also includes the setting of standards and labels for green financial products, which should enhance the trust in the market of these products and ease investors’ access to them. The third strategy covers both corporate disclosure and third party information and assessments. The fourth strategy combines sustainable corporate governance with attenuating short-termism in capital markets and assumes that boards should develop their own sustainability strategies and act in the company’s long-term interest. The fifth strategy implies at least three types of regulatory reform. Sectoral requirements have been amended in the sense that investment firms and insurance distributors should consider sustainability issues when offering financial advice. Second, fiduciary duties of asset managers and institutional investors have been clarified so as to include ESG factors in the investment processes. Third, ESG is being incorporated in prudential requirements of financial institutions so that they channel their investments towards a more sustainable economy, while reducing the risks deriving from unsustainable economic development. Building on the fundamentals of the 2018 Sustainable Finance Action Plan, the European Commission has adopted a renewed sustainable finance strategy in 2021. The European Commission observes that, since 2018, its understanding of what is needed to meet the sustainability goals has evolved, and the global context has changed. Accordingly, the European Commission is taking significant steps in the further development of a European Sustainable Finance framework, building on the foundations of the 2018 Action Plan. These foundations are formed by three building blocks: (1) the EU taxonomy of sustainable activities, (2) a disclosure framework for non-financial and financial companies and (3) investment tools, including benchmarks, standards and labels. The renewed sustainable finance strategy identifies four areas in which additional action is required: (1) financing the transition of the real economy towards sustainability; (2) developing a more inclusive sustainable finance framework; (3) improving the financial sector’s resilience and contribution to sustainability (under a double materiality perspective); and (4) fostering global ambition. Within these four areas, the European Commission has formulated six actions, divided into a number of specific action points and proposals, to achieve the sustainability objectives. The related actions are discussed in the second part of this chapter. These actions generally require regulation and/or supervision often at EU level, but private incentives and cultural developments towards an environmentally sustainable economic system will also be important in furthering the success of the Action Plan and the renewed sustainable finance strategy.

In recent years technology and sustainability emerged as two main drivers for economy and finance, each with its own characteristics and following independent paths of development. The general discourse on the relationship between technology (more recently financial technology-fintech) and sustainability tended to emphasize the role of technology as a tool for pursuing sustainability mostly from the perspective of financial inclusion. Therefore the relationship with environmental sustainability was less often considered. This chapter tries to answer the question on the role of digital finance as a tool for pursuing environmental sustainability, and the way specific policies might contribute to pursuing this goal. Adopting this perspective, this chapter considers the emergence of sustainable digital finance as the clearest result of the interplay between technology and sustainability, assessing its potential for contributing to environmental sustainability. In doing this, this chapter considers the most relevant public initiatives at the international level and provides a brief overview of the technologies involved in sustainable digital finance, assessing their own specificities and complementarity. Finally, this chapter makes some critical considerations and proposes some policy suggestions to strengthen sustainable digital finance in a view of achieving ambitious societal goals.

In this chapter, I argue that corporate purpose is an old concept, which has been variously defined in different jurisdictions without determining great variations in practice. Continental European laws often consider the company’s interest rather than corporate purpose, i.e. the interest that a company should pursue which may pertain either to the company as such or to its shareholders. Corporate purpose is mostly identified with the pursuit of corporate profits, albeit with variations concerning the relevance of given stakeholders and of social values in general. On policy grounds, I ask whether EU company law should be reformed to reflect sustainability goals, or national laws should be left to decide whether corporate purpose and/or director duties need to explicitly refer to sustainability. Moreover, I analyse the proposed Corporate Sustainability Due Diligence Directive (CSDD) and try to assess its impact on corporate governance and corporate purpose. I conclude by highlighting the mounting role of regulatory and ethical constraints to business activities which derive from sustainability concerns.

The debate on sustainable finance seldom includes the perspective of shareholders. However, shareholders are important for the governance of publicly held corporations today because their holdings are concentrated in the hands of a few institutional investors. Institutional investors can therefore have an impact on the sustainability of the largest companies in the world. The question is whether institutional investors actually have such an impact. Recent changes in EU securities regulation can bring more clarity on this matter. For instance, the revised Shareholder Rights Directive requires companies, on a comply-or-explain basis, to disclose voting policies and behaviours concerning sustainability. More in general, EU law is increasing the supply of standard measures of sustainable investment, to be used in institutional investors’ communications with their beneficiaries. This chapter discusses how EU securities regulation can align the incentives of institutional investors to pursue sustainable corporate governance with the sustainability preferences of their beneficiaries.

There has been a notable increase in recent years in legislative developments with respect to corporate sustainability reporting, aimed at requiring companies to report not only on financial information, but also on Environmental, Social and Governance (ESG) aspects of their business operations. In 2021, the European Commission published the proposal for the European Corporate Sustainability Reporting Directive (CSRD). Outside the European Union (EU), in 2021, the IFRS Foundation announced the establishment of the International Sustainability Standards Board (ISSB). Furthermore, in 2022, in the United States, the US Securities and Exchange Commission (SEC) proposed rules to enhance and standardize climate-related disclosures for investors. Based on the CSRD, the European Commission adopted the first set of European Sustainability Reporting Standards in July 2023. Also in 2023, the ISSB issued two standards on sustainability-related and climate-related disclosures. As a result, the requirements on corporate sustainability reporting both in the EU and globally are emerging rapidly. This chapter describes the scope and core elements of the CSRD and the ESRS. Before discussing these requirements in depth, we will describe the background of the CSRD. We will also briefly compare these European initiatives to the initiatives of the ISSB and SEC, and to currently existing non-binding frameworks and standards on sustainability reporting. We will conclude with some remarks on the strategic and organizational impact of the CSRD for companies and on the question whether the CSRD is contributing to the evolution of global corporate sustainability reporting standards.

In the light of the strong commitment by the EU in undertaking a sustainable path toward the goals set by the Paris Agreement and the UN 2030 Agenda, and the prospected EU initiatives concerning the establishment of a sustainable corporate governance, it is more pressing than ever evaluating how companies can truly integrate a long-term sustainable approach in their strategies and operations, and therefore whether corporate governance codes could provide a useful tool toward such objectives. Many authors investigated the effective implementation of corporate governance codes, but a few considered the role of the codes in promoting environmental and social responsibility. The aim of the chapter is to comparatively evaluate the most recent attempts to integrate sustainability considerations in corporate governance codes of listed companies within the EU Member States, in order to understand if such progress is on the way and which best practices could be taken into consideration and disseminated by the EU authorities in the years to come. Although this chapter is the result of joint work, Paragraphs from 7.2 to 7.5.8 should be attributed to Shanshan Zhu.

There is broad acknowledgement amongst policymakers that climate change may give rise to material financial risk and impact financial stability. This chapter explores the specific features of climate-related financial risks (CRFR), drawing on a growing body of macrofinancial literature and policy work, and discusses the role of macroprudential policy in the face of such risk. It finds that macroprudential policymakers are confronted with significant challenges, epistemological and methodological as well as behavioural, when addressing CRFR. In light of the (partial radical) uncertainty in relation to the future dynamics of CRFR, the timing of policy action is of the essence. The chapter, in particular, discusses the merits and challenges associated with a precautionary approach to tackling the systemic effects of CRFR. It also assesses how CRFR could be fit into the existing macroprudential toolkit, with a focus on capital buffers and borrower-based tools.

With the 2030 Climate Target Plan, the Commission proposes to increase the EU’s ambition to reduce greenhouse gas emissions to at least 55% below 1990 levels by 2030. This increase in ambitions as set out in the original 2018 plan also affects the financial sector in many ways. For the banking sector, the new targets have already led to the introduction of far-reaching transparency obligations. Besides the issue of transparency, there are other developments of importance for the banking sector. The qualitative risk management organisation of banks needs to be radically adapted to meet the standards launched by the various authorities. These include the ECB Guide on climate-related and environmental risks, the European Banking Authority’s major 2021 study and the Basel Committee's principles on qualitative risk management and the role of the supervisor published in the first half of 2022. With the adoption of the Banking Package 2021 proposals on revisions to the Capital Requirements Regulation and Directive, further elements will be added to the regulatory framework to introduce, apart from qualitative risk management rules, also quantitative capital requirements in the form of bespoke rules to be added over time to the calculation of the Total Risk Exposure Amount of banks. EBA conducted important preparatory work to establish such further rules. It is noted that developments in laws, regulations and policies applied by supervisors follow a reverse order to some extent. Banks should anticipate on these developments and come up with independently and in-house developed refinements to existing risk management, risk management strategies and how banks will (be able to) respond to the financial-economic impact of climate and environmental risks thus identified.

This chapter addresses the role of prudential supervision in sustainable finance from the insurance sector perspective. The ability of the insurance and reinsurance sector to contribute to the objectives of the sustainable finance agenda, such as its role in the green transition, is closely intertwined with prudential considerations, such as the ability to (continue to) take insurance risk, its exposure to sustainability risk through its investments and its ability to include sustainable investments in its investment portfolio, while safeguarding a prudent level of policyholder protection. The European Commission and society more generally attribute a crucial role to the financial sector in the green transition. This includes certainly the insurance and reinsurance sector and fits within the broader efforts to connect finance with the specific needs of the European and global economy for the benefit of the planet and our society. This chapter focuses on the manner in which the prudential challenges, connected to sustainable finance, are addressed for the insurance and reinsurance sector, in particular through the Solvency II framework. A key role in respect of sustainability risks is attributed to the Own Risk and Solvency Assessment (ORSA), a crucial element within Solvency II. To the extent risks are not captured by solvency capital requirements, they might be captured, at least partly, by the ORSA that takes a longer-term perspective to the capital needs of insurance and reinsurance undertakings than the capital requirements do, which is a relevant notion in relation to sustainability risk.

Furthermore, as institutional investors, insurance and reinsurance undertakings may represent an important source of funding for the sustainable transition. While, certainly under Solvency, insurance and reinsurance undertakings enjoy freedom of investment, they are, at the same time, bound by the prudent person principle, which compels them to invest in the primary interest of policyholders and beneficiaries. In addition, investment and underwriting risk should be reflected in the capital requirements. Therefore, it is crucial that insurance and reinsurance undertakings are conscious of the risks they accept, be it through their underwriting activities or through their investments. In recent years, significant efforts have been made to make progress in this respect, initially within the existing Solvency II framework, which has been designed in essence as agnostic to the types of risks and should therefore be capable of addressing sustainability risks as well, and gradually as well through amendments to the Solvency II Delegated Regulation, focusing on pillar 2 requirements and gradually exploring ways to incorporate sustainability in pillar 1 as well, including in capital requirements. In particular in this last area, further efforts are still required to appropriately capture sustainability risks, while maintaining a sound prudential framework for insurance and playing a significant role in the sustainability transition.

The global climate crisis as one of the greatest challenges of our time (actually or potentially) affects all policy areas. This includes monetary policy, not least because climate change impacts the ability of central banks to achieve their mandate. Under its new monetary policy strategy, the European Central Bank (ECB) has thus vowed to take comprehensive account of climate factors and to gradually adjust the monetary policy framework accordingly. This chapter analyses (legal) constraints and limits, as well as opportunities and potential further steps of a green monetary policy, including the incorporation of other environmental and sustainability factors, such as biodiversity. To this end, the premises, objectives and content of the ECB’s new green monetary policy are analysed. This analysis sets the scene for a thorough assessment of limits and opportunities of green monetary policy in the Eurozone. After analysing the legal framework the ECB operates in—namely its mandate as defined by EU primary law, the limits for the use of competences by the ECB contained therein, as well as requirements pointing in the opposite direction of obligations to pursue green monetary policy—the chapter goes on to scrutinize concrete measures and instruments as to their compatibility with said framework. Finally, the results obtained are placed in a broader context by asking what we consider appropriate aspirations for the future role of the ECB in the fight against climate change.

The author provides an overview of ESG in the financial markets. She sets out that sustainable finance has been around for years. After publication of the Sustainable Finance Action Plan by the European Commission in March 2018, sustainable finance rose to the top of the EU legislative agenda for the financial markets, as well as the regulatory and supervisory agenda of EU and national supervisors and competent authorities of the financial sector. The author provides an overview of various sustainable and ESG products that have been a feature of the international financial markets, such as green, ESG and sustainability-linked loans, bonds and derivatives. The author also discusses the current legal framework in which these financial products are issued, with a focus on EU-level legislation, including the non-financial disclosure requirements of the Corporate Sustainability Reporting Directive and the European Sustainability Reporting Standards, the Taxonomy Regulation, the Sustainable Finance Disclosure Regulation, the Benchmarks Regulation and other financial market legislation. The author also considers legal and regulatory developments on the horizon, such as the EU Corporate Sustainability Due Diligence Directive, the EU Green Bonds Regulation, the ESG Rating Regulation, sustainable securitisations, ecolabelling for retail financial products, as well as greenwashing and climate litigation. The author concludes with a few remarks on general trends in ESG and sustainable finance developments in the financial markets.

The EU Taxonomy Regulation (TR), adopted in 2020, is a key milestone in defining legally environmentally-sustainable economic activities. It should be viewed within the context of the climate and energy targets set by the EU for 2030 to become climate-neutral by 2050, and constitutes, along with the 2019 Sustainable Finance Disclosure Regulation (SFDR) and Low Carbon Benchmarks Regulation (LCBR), the regulatory “trilogy” implementing the CMU Action Plan in relation to sustainable finance. It substantially builds on the 2020 Report of the Technical Expert Group on Sustainable Finance (TEG), which developed the “EU taxonomy” classification system to determine whether an economic activity can qualify as environmentally sustainable. The system of its rules is anchored in the definition of six specific environmental objectives, which constitute the benchmark on the basis of which an economic activity can be assessed to qualify as environmentally sustainable and, hence, the degree to which a financial investment is environmentally sustainable is established. The main purpose of this Chapter is as follows: First, it thoroughly analyses the subject matter and scope of the TR, with an emphasis on its environmental objectives. It sets out the primary EU law limits within which it applies, while also explaining its contribution to internal market-making as a harmonisation measure. Second, it examines the criteria for determining whether an economic activity qualifies as environmentally sustainable, while also delving deeper into the requirements of the technical screening criteria. Third, and in connection to the above, the Chapter assesses the delegated acts adopted on the basis of the TR and mentions those yet to be adopted. It also discusses the Commission Communications in relation to said delegated acts. Fourth, the Chapter presents in detail the disclosure requirements for environmentally sustainable investments and sets out the role played by, inter alia, the Platform on Sustainable Finance and the Member State Expert Group on Sustainable Finance. Finally, it remarks on the impact of the TR so far and on the next steps forward, while also briefly commenting on TR-related litigation before the EU Courts, which is already underway.

This chapter analyses and discusses the European Union (EU) Sustainable Finance Disclosure Regulation (SFDR). The aim is twofold. On the one hand, it explores the main features of the SFDR. On the other hand, it tries to assess whether the SFDR is likely to succeed in harmonizing sustainability-related disclosure rules and fiduciary duties, not only across Member States, but also across financial products and distribution channels. The author concludes that there is still a long way to go. Research shows that the phenomenon of greenwashing is still widespread among investment funds. Also, the EU is not an island. The author argues that there are roughly two opposite scenarios. In a pessimistic scenario, the more lenient or even non-existent sustainability agenda of other geopolitical powers gives them a competitive edge that is detrimental to the EU. In a positive scenario, the EU becomes a global standard-setter in the area of sustainability. The USA’s re-entry in the Paris Climate Agreement under the Biden Administration and its success in delivering a climate bill as part of the Inflation Reduction Act (IRA) may give us some hope. Finally, on 9 December 2022, the UK Government announced a major reform of its financial services regulation ‘to drive growth and competitiveness in the financial services sector’ (the Edinburgh reforms). In this context, the UK Government ‘is ensuring that the financial system plays a major role in the delivery of the UK’s Net Zero target and is acting to secure the UK as the best place in the world for responsible and sustainable investment’. Will these developments contribute to the EU becoming a global standard-setter in the area of sustainability? Time will tell.

Large investment firms are required in the EU to integrate ESG risks in their investment process. At the same time, they have to carry out a due diligence process on their assets under management based on the measurement and monitoring of certain adverse impact indicators, applying a “double materiality” approach that is distinctive of the EU’s interpretation of the role of sustainable finance. This chapter investigates how the adverse impact indicators overlay the ESG risk management framework, arguing that conflating ESG risks and adverse impact indicators can be conducive to sub-optimal decision-making processes and inefficiencies. The planned review of the Principal Adverse Impact Indicators by the Joint Committee is an opportunity to consider how a revised approach can clarify and operationalize ESG risk management and adverse impact due diligence in the context of the Sustainable Finance Disclosure Regulation (SFDR).

The bourgeoning field of ‘ESG Ratings’ is at a crossroad in its development. Facing regulation for the first time, the utility of the service is being critiqued and considered especially as European Regulations push for increased and better disclosure. In this chapter, the field is surveyed as it continues to morph into an industry that provides for a useful service to investors, debt issuers, and regulators. However, the chapter incorporates foundational questions that provide for a novel understanding of this ever-developing field, including the impact of subjectivity that ESG-related considerations bring rather than financial considerations, the concept of ‘trust’ and the need for it in this new field, as well as the fundamental and structural purpose of the industry. The pioneering push by the European Commission to regulate this industry, and the factors that have and continue to affect that regulation serve as the anchor for this chapter.

Following its Sustainable Finance Action Plan, the European Commission has proposed amendments to integrate sustainable finance into the MiFID II and IDD investor protection frameworks. This contribution first sketches the behavioural problems explaining why retail investors do not always act upon their investment preferences and the potential role of the investment product distributor in bridging the gap between investors’ values and actual investment choices. Against this background, the author offers a critical overview of the revised MiFID II and IDD investor protection frameworks, from three perspectives: (i) their contribution to remedying the “value-action-gap” and to a more sustainable economy more generally; (ii) their contribution to the creation of a level playing field between economically similar investment products; and (iii) their coherence with other important sustainable finance measures, in particular the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation.

The author discusses the topic of emission allowances in relation to the MiFID II framework. While the structure and the mechanisms that underpin the functioning of the EU Emissions Trading System (ETS) system are, by now, well known, discussions on the protection of the environment and the development of secondary markets for emission allowances have stimulated a process of gradual inclusion of CO₂ allowances in the perimeter of financial markets regulation. A first, significant step in this direction was taken by MiFID I: building on the definition of commodity derivatives introduced by the Investment Services Directive of 1993, MiFID I enlarged and amplified the catalogue of derivatives that would be considered as falling into its scope. The catalogue included then derivatives on emission allowances. The landscape set by MiFID I was, however, just a first step towards the inclusion of emissions trading in the scope of financial markets legislation. A second step has been taken by MiFID II, as the latter directly classifies rights on emission allowances falling in the EU regime as financial instruments. The author argues that the reasons that led to the qualification of emission allowances as financial instruments in MiFID II are basically a consequence of the tremendous evolution that secondary markets of allowances have seen in the last few years. The growing amount of transactions and the need to preserve and ensure the transparency and integrity of secondary markets convinced the European Commission of the opportunity to include emission allowances in the scope of MiFID II and, therefore, in the scope of the Market Abuse Directive (now Market Abuse Regulation or MAR). Looking at the positive effects for environmental protection that may derive from the inclusion of emission allowances in the scope of capital markets legislation, these are basically linked to the fact that—as a consequence of the approach stemming from MiFID II—secondary markets should effectively become more transparent, efficient and secure. However, according to the author, some potential drawbacks must be considered. Trading in emission allowances has become more expensive after MiFID II, and transaction costs might impact negatively on the liquidity of the market. The application of the Capital Requirements Directive (CRD IV, now CRD V) prudential requirements might also require the absorption of important levels of capital that would be distracted from direct investments in the industry. The effect that this might have on the system is, at the moment, unclear. The landscape introduced by MiFID II is also quite complex: there are at least two, if not three, different sets of comprehensive legislation that may potentially be relevant for trading emission allowances, either on the spot, or on the derivatives market, i.e. the “old” EU ETS; MiFID II and MAR; more tangentially, the Regulation on the wholesale Energy Market Integrity and Transparency (REMIT). The author discusses the implications of each of them and argues that opting in and out of each of these systems, through a complicated system of exemptions and exclusions, does not benefit the overall coherence of the regulatory approach.