Sustainable Finance: The EU’s Legislative Trilogy and the Need for Global Convergence

Professor Christos Vl. Gortsos, Professor of Public Economic Law at the Law School of the National and Kapodistrian University of Athens & President of the Academic Board of the European Banking Institute (EBI), and Dimitrios Kyriazis, DPhil (Oxon.), Postdoctoral Researcher in Public Law at the Law School of the National and Kapodistrian University of Athens

Sustainable finance is topical for several reasons. Not only is it aligned with the global shift towards increasingly rigorous standards of environmental protection in all industries, but it is also appearing to create its own “microcosm” within the global financial ecosystem. Soft and hard law instruments are being implemented to regulate this booming field, or at the very least nudge market operators towards a certain direction. In this new world, the EU is standing front and centre. The aim of this short piece is to outline the main characteristics of the so-called EU sustainable finance law “trilogy”, while also highlighting the need for global convergence in the area of sustainable finance regulation.

To begin with, some definitions are apposite. In accordance with the authoritative 2018 Report of the G20 Sustainable Finance Study Group, ‘sustainable finance’ is defined as the aggregate of financing and related institutional and market arrangements that contribute to the achievement of strong, sustainable, balanced, and inclusive growth, through supporting directly and indirectly the framework of the Sustainable Development Goals (SDGs). These are laid down in the 2015 United Nations (UN) global sustainable development framework (“The 2030 Agenda for Sustainable Development”), which covers sustainability’s three dimensions, namely environmental, social, and governance (ESG).

Making available financial instruments that follow environmentally friendly goals is one effective method to do this. Sustainable finance, according to the European Banking Authority (EBA), aims to integrate environmental, social, and governance (ESG) criteria into financial services, support sustainable economic growth, and raise financial actors’ awareness and transparency about the need to mitigate ESG risks through appropriate management, taking into account their longer-term nature and the uncertainty surrounding their valuation and pricing.

Even though the initiatives undertaken by the EU cannot fully be summarised here, reference will be made to the key relevant milestones. To begin with, it is worth remembering that, in February 2015, the Commission issued a Green Paper on “Building a Capital Markets Union”, paving the way for further action, followed, in September 2015, by its Communication on an “Action Plan on building a capital markets union” (CMU Action Plan). A series of soft law instruments ensued, including the 2016 Communication on “Capital markets union – accelerating reform”, the 2017 “Mid-Term Review of the [CMU] Action Plan”, the January 2018 Report on “Financing a Sustainable European Economy” and the March 2018 “Sustainable Finance Action Plan”.

Hard law solutions followed suit. More specifically, the regulatory “trilogy” implementing the Commission’s 2015 CMU Action Plan in relation to sustainable finance consists of three Regulations, which were adopted by the European Parliament and the Council in 2019-2020: initially, on 27 November 2019, the co-legislators adopted Regulation (EU) 2019/2088 “on sustainability-related disclosures in the financial services sector” (the ‘Sustainable Finance Disclosure Regulation’, hereinafter SFDR) and Regulation (EU) 2019/2089 “amending Regulation (EU) 2016/1011 [of 8 July 2016] as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks” (the ‘Low Carbon Benchmarks Regulation’); then, on 18 June 2020, they adopted Regulation (EU) 2020/852 “on the establishment of a framework to facilitate sustainable investment and amending [the just above-mentioned] Regulation (EU) 2019/2088” (the ‘Taxonomy Regulation’, hereinafter TR). In a nutshell, the objectives of the three above-mentioned  instruments are as follows.

First,  the aim of the SFDR is to lay down harmonised rules for financial market participants and financial advisers on transparency regarding the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability‐related information with respect to financial products. 

Second, the purpose of the Low Carbon Benchmarks Regulation is to lay down specific rules as regards EU climate transition and EU Paris-aligned benchmarks and sustainability-related disclosures for benchmarks. 

Finally, the aim of the TR, which also amended the SFDR, is to set out a unified classification system called ‘Taxonomy framework’, which sets out the criteria for determining whether an economic activity qualifies as environmentally sustainable for the purposes of establishing the degree to which an investment is environmentally sustainable as well. The harmonisation of these standards aims to remove hurdles to the internal market’s functioning in terms of obtaining finance for sustainability projects and to avoid future barriers from arising.

The principal aim of the EU is to become the main global standard-setter in the area of sustainable finance, i.e., to provide the “gold standard” for sustainability reporting, in order to assist investors, allocate funds to green activities, and prevent greenwashing. However, the EU is not alone in adopting a classification for sustainable finance; China, the United Kingdom, Mexico, Canada, and Russia are, inter alia, all working on (or already completed) their own sustainability taxonomies. This raises concerns about how different taxonomies will interact, as well as on how global businesses and investors will comply with overlapping – and potentially contradictory – rules.

Of course, all taxonomies do share certain similarities. The majority of the existing or proposed taxonomies provide a classification tool to assist investors and companies in making educated investment decisions about sustainable finance operations. They aim to provide legal certainty on what constitutes sustainability from an environmental or social standpoint. The most frequent green taxonomies focus on the environmental impact of economic activity, but social and transitional factors are also being incorporated.

However, since many taxonomies are still under development, detailed comparisons across these diverse frameworks are yet unwise. Still, it is worth noting that many of these jurisdictions have studied the EU criteria and incorporated them into their frameworks. For instance, the UK Green Technical Advisory Group is analysing EU indicators in order to adapt them for the UK market. Moreover, in 2020, the EU and China formed a taxonomy working group to conduct a complete review of existing taxonomy standards and find commonalities and discrepancies in procedures and outcomes. A common ground taxonomy was published as a result of the collaboration, but its assessment escapes the scope of this piece.

To conclude, the EU is leading the way in sustainable finance regulation, with more instruments in the pipeline. However, for its influence to radiate outside the strict confines of EU-related finance projects, more major jurisdictions will need to converge around implementing a common set of standards, or at least certain key principles.