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Europe needs clear standards to boost green finance, report says

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Europe needs clear standards to boost green finance, report says

Europe needs to introduce standards and labels to make the classification of green investments clearer as it seeks to boost green and sustainable finance, the European Commission's High-Level Expert Group on Sustainable Finance said Jan. 31.

The EU will publish an action plan on sustainable finance in March based on the group's recommendations, as part of its plans to build a capital markets union through Europe, as well as to meet its commitments under the Paris Agreement on climate change.

Demand is growing for green financing and bonds as issuers and investors seek investments in projects aimed at reducing carbon emissions and accomplishing other environmental goals. S&P Global Ratings projected Jan. 29 that green bond issuance will grow to $200 billion in 2018 from $155 billion in 2017 and $13 billion in 2013.

But the absence of a single, comprehensive standard for what is and is not green finance or a green bond is regarded as a potential obstacle to the market.

The expert group, which was set up in 2016 and whose members included representatives of stock exchanges, asset managers and the WWF, said there was a need for a common and clear classification system to define what exactly was green financing.

"If Europe is to mobilize capital at scale for sustainable development, it needs a technically robust classification system to establish market clarity on what is 'green' or 'sustainable,'" it said. "Introducing a sustainability taxonomy, starting with climate mitigation around mid-2018, will enhance market efficiency and help to channel capital flows towards assets that contribute to sustainable development."

The EU also needs to introduce an official EU green bond standard and consider a EU green bond label or certificate to help the development of the market, according to the recommendations.

The European Banking Federation, a lobby group, said having clearly defined standards would help the banking sector take a key role in increasing sustainable financing and investment.

"To properly serve society banks need to be able to act constructively when addressing climate change and the decarbonization of industry," EBF CEO Wim Mijs said in a statement. "Banks can only do so when there are clear definitions and clear rules that also maintain financial stability."

The EU estimates it will need to invest €180 billion annually to meet its pledge of reducing CO2 emissions by 40% by 2030 and intends to invest in energy efficient buildings, renewable energy generation and low-carbon transportation.

Other measures set out in the report include upgrading disclosure rules to take into account risks from climate change; reforming corporate governance to build "sustainable finance competencies;" and increasing the role of the three EU supervisory bodies — the European Banking Authority, European Securities and Markets Authority and European Insurance and Occupational Pensions Authority — to promote sustainable finance as part of their mandates.

Creation of new body

The report also recommends the creation of a new body known as Sustainable Infrastructure Europe, designed to encourage investment sustainable infrastructure projects. It would start as an incubator and become a stand-alone organization by 2020.

The report also makes specific recommendations for segments of the financial sector. In banking, it stops short of recommending a "green supporting factor" that would lower capital requirements on green assets, saying there is insufficient evidence to demonstrate that green investments carry "significantly lower risk at the micro level."

But it does recommend that the EC examine whether such a differential does exist, and it also suggests that the EC "explicitly consider" the impact on sustainable lending before imposing the December 2017 revisions to the Basel III global regulatory framework.

EC Vice President Valdis Dombrovskis, whose mandate includes financial stability, said in December 2017 that the EU's executive could consider such a green supporting factor, suggesting that it might be modeled on an existing capital requirement discount for lending to certain small and medium-sized businesses.

The working group warned, however, that a capital requirement discount could foster a "green bubble," given that "prudent banks would hold capital in line with their economic risk. If capital requirements were reduced below that, lending could become concentrated in less prudent lenders."

It said that to avoid the risk of a bubble or "undercapitalization coming from market distortions, there should be a cap on lower capital requirements on green assets. That cap could evolve over time."

The EBF, which has called a green supporting factor for banks, said it had taken note of the report's recommendations, noting that such a measure should not contribute to risk.

"It is extraordinarily difficult to create proper definitions that are not at odds with the need for accuracy and purity in risk weights in banking," it said.

The report also says supervisory reviews of insurance companies should be assessed as to whether climate risk needs to be more explicitly monitored, while on the investment side it urges officials to look at the way Solvency II rules for the sector could be adapted to facilitate longer-term investments, specifically those that are sustainable.

Insurance Europe, a lobby group, said the group's recommendations around Solvency II were welcome. "While the insurance industry does not believe that prudential regulation should be used to provide artificial incentives to green investment, policymakers should focus on identifying and removing the disincentives, for example by recognizing the important difference between short-term and long-term investment risks," said Insurance Europe Director General Michaela Koller.

The working group also said asset managers should build up their competence in green investment and reward long-term approaches, while also working with both retail and institutional clients to ensure that their ESG concerns are adequately reflected.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.