Finance Watch releases expert guide to the EU sustainable finance framework

• In a new report, Finance Watch maps the different elements of the EU sustainable finance framework and highlights how they connect. 
• Designed as a guidebook, the report shines a light on progress made in sustainable finance regulation thus far, and the gaps that must be addressed to ensure maximum efficiency.
• It recommends EU policymakers enhance the current framework by giving investors the means to participate in the sustainable transition of the economy, introducing clear targets for managing sustainability risks, and strengthening enforcement to ensure rules are followed.

In 2018, as part of the European Green Deal, the European Commission came forward with an EU Action Plan on sustainable finance. The goal was to redirect capital towards sustainable investment while also managing the financial consequences of climate change. The plan also called for more transparency and long-termism in financial and economic activity. In the years that followed, significant work was done at the regulatory level to achieve these goals. 

In this report, Finance Watch, the non-profit association dedicated to reforming finance in the interest of citizens, takes stock of the important regulatory work done thus far, identifies the gaps that remain, and provides recommendations for policymakers on how to address them.

The EU sustainable finance regulatory framework taking shape is complex. The aim of this report is to help those working closely on sustainable finance regulation – be they politicians, policymakers or policy officers at civil society organisations – make sense of this complexity. This starts with understanding how the different parts of this framework connect. 

There are three rules that form the backbone of the sustainable finance regulatory framework – the EU TaxonomyA key element of the sustainable finance agenda that established a classification system to determine whether economic activities can be considered environmentally sustainable., the Corporate Sustainability Reporting DirectiveThe Non-Financial Reporting Directive was amended with the adoption of the CSRD, which provides details on the content and the format of non-financial reports. (CSRD), and the Sustainable Finance Disclosure RegulationThe first big milestone of the sustainable finance regulatory agenda, it sets disclosure requirements for financial products and entities that qualify as financial advisors or financial market participants. (SFDR). Together, these set the fundamental transparency requirements at investee, financial institution and financial product level. They act as the core reference points for other legislation, each of which are necessary to meet the goals of the EU Green Deal. 

The criteria outlined in the EU Taxonomy provide information that is used to create labels and schemes that boost sustainable investments, such as the EU Green Bond Standard. Likewise, both the EU Taxonomy and SFDR are being leveraged to increase transparency requirements in existing retail investment rules, such as the Markets in Financial Instruments Directive (MiFID II). This link can make the ESG characteristics of products clearer for retail investors and enable them to express their sustainability-related preferences more easily. By extension, this aims to drive retail capital flows towards a more sustainable economy.

In principle, this network of rules can help the EU meet its sustainability targets. In practice however, the loopholes in the framework have led to concerns and frustrations in the financial community. This issue will not be solved with pledges from the European Commission President to reduce the reporting requirements by 25% or deprioritising rules for sustainable finance at EU level. It can only be solved by fixing the loopholes that currently undermine the efficacy of the EU sustainable finance regulatory framework. 

Vincent Vandeloise, Senior Research & Advocacy Officer at Finance Watch and author of this report said:

Ahead of the European Parliament election next year, enthusiasm for the sustainable finance agenda is being replaced by concerns over short-term competitiveness and costs. A lot of good work has been done over the past five years, the next EU mandate must maintain the momentum by finishing and refining the sustainable finance legislation now on the table. 

Finance Watch calls on policymakers to take a step back and look at the EU sustainable finance policy from a high-level perspective. The report argues that enhancing the current sustainable finance framework requires action on three fronts:

• First, EU policymakers must finalise transparency and governance requirements. The former will ensure that information always remains accurate, fair and clear for end users, and that greenwashing and social washing do not distort risk assessments. The latter will foster long-term decision-making in the financial world.
• Second, they must set clear mandatory targets, both for managing sustainability risks and for developing a credible plan for a company’s activities to align with the target of limiting global warming as much as possible. 
• Finally, legislators must improve enforcement measures to ensure rules are followed. Special attention must be given to how the rules are interpreted across different EU countries to avoid market fragmentation. 

Reflecting each of these dimensions, Finance Watch recommends updating specific parts of the sustainable finance regulatory framework. For example, the credibility of the sustainable finance framework has been damaged by the loose definition of key concepts and product classification introduced under SFDR. Finance Watch recommends clarifying the concept of sustainable investment in SFDR, distinguishing it from transition finance, and designing a new product classification built on minimum criteria.

Creating regulation that will accelerate the transition of both the financial system and the real economy is an iterative process which must continue in the next EU mandate. The recommendations put forward by Finance Watch in this report can bring more consistency to the legislative landscape and help the EU and the financial sector meet their sustainability objectives.