Combatting Climate Change and Promoting Sustainability with Sustainable Finance
Sustainability has long been a hot topic. Sustainable finance means business activities within the financial sector that promote sustainable development goals. As the name implies, it usually refers to loan financing or investing that takes environmental and social considerations into account.
Sustainable finance plays a key role in mitigating climate change and promoting sustainability. Achieving the climate targets set by the EU will require allocating funds into environmentally friendly initiatives efficiently with a long-term perspective, and the financial market has started to act upon these challenges.
To combat climate change and to finance initiatives mitigating its impact, the financial market has introduced various forms of sustainable finance.
The EU Regulation Package for Sustainable Finance in a Nutshell
Transitioning to a global low-carbon economy will require massive and long-term investments into environmentally friendly initiatives using both public and private equity. EU regulation on sustainable finance has seen major changes in the last few years, including, among others, the sustainable finance package.
This package can be seen as a major step towards a more sustainable future, as its regulations are legal acts that apply automatically to all EU Member States. The package consists of three regulations:
- the Taxonomy Regulation on a framework facilitating sustainable investments
- the Disclosure Regulation on sustainability-related disclosures in the financial services sector
- the Low Carbon Benchmark Regulation on disclosures of ESG factors of benchmarks.
These regulations aim at directing equity towards sustainable investment targets and promoting sustainability in the European internal market.
The Taxonomy Regulation uses a classification system to determine sustainable economic activities in different sectors. It also defines principles, environmental objectives and disclosure obligations. The technical screening criteria for different economic activities are defined in lower-tier regulation as Commission Delegated Acts.
The goal of the Disclosure Regulation is to strengthen investor protection and improve transparency of sustainability-related information. It also aims at promoting the comparability of investment products marketed as sustainable.
The purpose of the Benchmark Regulation is to guarantee the integrity and harmonisation of regulation-compliant benchmarks, making it possible to evaluate and compare the sustainability of different investment products in a reliable manner. Benchmarks are deemed important particularly in measuring the performance of investment products, and they are considered a reliable information metric.
As is customary with financial markets regulation, all three Regulations will be complemented with delegated acts, technical screening criteria and regulatory standards.
Guidelines from International Loan Market Associations Clarify the Playing Field
Different guidelines and principles exist to clarify and harmonise the playing field of the different forms of sustainable financing the financial market has created. These include the Sustainability Linked Loan Principles, Social Loan Principles and Green Loan Principles published by the Loan Market Association (LMA) together with Asia Pacific Loan Market Association (APLMA) and Loan Syndications and Trading Association (LSTA).
These principles aim at supporting sustainable economic activities by creating stable and internationally accepted market practices and by harmonising practices in the sustainable loan market. The principles have also succeeded in alleviating the financial markets’ uncertainty created by the inconsistency of the many different guidelines.
It is, however, important to note that adhering to the LMA principles is voluntary, and not doing so does not result in any external sanctions.
Based on the principles, sustainable loans can be used to finance:
- Pre-determined and pre-approved projects with green, social or sustainable considerations. With these loans, the use, monitoring and management of the funds is material; and
- Sustainability-linked loans where the borrower’s sustainability performance is measured and evaluated against key performance indicators (KPIs) and pre-defined sustainability performance targets (SPTs).
The Developing Field of Sustainable Finance Posing a Challenge
Lastly, it is important to emphasise that sustainable finance and its different forms and guidelines are still taking form. It can be stated that for now, the lack of detailed model clauses and the recency of the guidelines can make it difficult to evaluate sustainable finance arrangements.
We are interested to see if and how the Loan Market Association will amend its guidelines and how the EU regulation around sustainable finance develops. Sustainable finance will no doubt have a major role in solving many of the important challenges of this century.