The process of taking environment, social and governance (ESG) factors into consideration when making impactful investment decisions in both the private and public financial sectors, which leads the way too many long-term investments in creating and fostering sustainable economic activities and projects is popularly known as Sustainable Finance.
To begin with, environmental concerns include climate change, preservation of biodiversity, pollution responsible sourcing of raw material, waste management, water and circular economy and specifying climate change adaptation as well as mitigation. Next, social issues refer to concerns related to for example inequality, inclusiveness, lack of investment in human capital, slavery, labor relation and human rights. Lastly, the governance of both public and private financial institutions includes management structures, executive remuneration, corruption and employee relations.
European Union’s role in Sustainable Finance
In the context of EU policy, sustainable finance is perceived as finance to support economic growth while simultaneously reducing the pressure on the environment and counting in social and governance aspects. In addition to that, it also takes into account transparency when it comes to all the risks associated with ESG factors that might be concerning for the financial system.
Under both the European Green Deal as well as the EU’s international commitments towards the climate crisis, sustainable finance plays a vital role in the implementation of the objectives mentioned in the policy. They can achieve this by directing private investment towards a climate-neutral, resource-efficient, climate-resilient and fair economy. In order to recover from the impacts of the coronavirus pandemic, sustainable finance will ensure that all further investments support resilient economic growth. The EU encourages the transition to a low-carbon and more resource-efficient economy. Moreover, it has been at the forefront to build a financial system that supports sustainable growth based on ESG factors.
The adoption of international agreements like the UN2030 agenda , the UN sustainable development goals (SDGs), and the Paris climate agreement includes a commitment to align financial flows towards low-carbon and climate-resilient growth.
In addition to that, the European Green Deal presented by the commission aims to make Europe the first-ever climate-neutral continent in the world by 2050. The European green deal investment plan involves the mobilization of a minimum of €1 trillion in sustainable investments over the coming decade. All this will enable the right framework to promote and stimulate both Private & Public investment sectors to shift towards a climate-neutral, inclusive and green economy.
Moreover, under its 2030 climate target plan, the commission plans to reduce carbon emissions by 55% and to reach this milestone, the European Union needs to invest approximately €350 billion more every year from 2021 to 2030. In order to reach these 2030 climate and energy deadlines, both public and private sector play a key role.
Public and private financial institutions can redirect investments towards sustainable businesses and technological development. This will finance growth more sustainably over the long run and significantly contribute to the creation of a sustainable circular economy.
The Commission has also started developing a comprehensive policy agenda on sustainable finance consisting of an extensive action plan on financing sustainable growth and the development of a renewed sustainable finance strategy regarding the framework of the European Green Deal and its commitments towards climate change.
The European Union Action Plan on Sustainable Finance
The Sustainable Finance Action Plan by the European Union aims to promote sustainable investment across the continent to widen the sustainable finance framework with the help of a broad set of new and enhanced regulations, including a new set of sustainable finance disclosure regulations. The purpose of introducing new guidelines is to improve the classification of sustainable credentials of investment funds and a new EU Taxonomy. These will help define economic activities that are climate-resilient for the very first time. In addition to that, the commission also plans to enhance the sustainability requirement of existing laws, for instance, UCITs for fund registrations and Mifid for financial disclosures.
The three objectives of EU sustainable action plan:
- One of the main objectives of the sustainable finance action plan is to direct the capital flow towards sustainable investments and away from organizations/ sectors adding to global warming.
- Another objective is to improve the management of financial risks originating from non-renewable resource depletion, environmental degradation, deforestation and climate change.
- Lastly, through this plan, the Commission aims to nurture greater transparency and increase the longevity in economic and financial activities to accomplish sustainable and inclusive growth.
These regulations are extensive and apply to everyone from EU banks and pension funds to asset managers and insurers, among others. The essence of the sustainable finance action plan is to develop realistic sustainable benchmarks against which investment decisions and strategies can be judged. Moreover, it aims to better integrate sustainability into market research, development and ratings.