Executive summary
The European Union has sought to steer corporate behaviour to support its climate goals by adopting a large body of rules on sustainable investment, sustainability disclosures and sustainability labelling of financial products, underpinned by a taxonomy of activities considered sustainable. It is unclear, however, if this effort has had significant results. Examination of financial market data and metrics of investment flows towards green and sustainable investment shows up several weaknesses – both contingent and structural – in the EU sustainable finance framework, which could limit its effectiveness in aligning capital flows with climate objectives.
The Sustainable Finance Disclosure Regulation (SFDR) is aimed at making the sustainability content of financial products more transparent but rests on a concept of ‘sustainable investment’ that is too broad and loosely defined. Meanwhile, the EU Taxonomy Regulation has not yet become established as the reference framework for corporate bond issuance or sustainable investing. The EU also lacks a coherent framework for transition finance – or investment that is not yet classified as sustainable but that represents progress to greater sustainability – despite this being the market segment to which the largest volumes of investment will need to flow in the short to medium run.
Five adjustments would make the EU sustainable finance framework more effective at delivering the desired alignment of incentives. First, the taxonomy framework should be completed and clarified. Second, the SFDR definition of sustainable investment should be toughened. Third, the neutrality of the framework across capital market instruments, in particular debt versus equity, should be ensured. Fourth, a dedicated framework for transition finance should be developed. Finally, formal sustainable and transition labels for financial products should be introduced.
This approach would make the sustainable finance framework more easily applicable to all kind of companies and all types of capital market instruments, regardless of whether they limit the use of proceeds, and it would be naturally extendable into a framework for transition finance and into a transparent sustainability labelling regime for financial products.
About the Author
Silvia Merler is an Affiliate fellow at Bruegel. She is also the Head of ESG and Policy Research at Algebris Investments.