Sustainable Finance in Europe: The EU Taxonomy and Green Bond Standard

Introduction

Europe wants to be the first climate-neutral continent, and the European Green Deal (European Commission, 2019a) is the action plan to face this challenge: achieve European Union climate neutrality by 2050 and advance toward fulfilling the United Nations’ Sustainable Development Goals by 2030. But on this path towards decarbonization and the fight against climate change, the coronavirus pandemic has represented a new challenge, and countries must face a double objective: to restore the social situation and the environment.

All decisions have consequences, though the financial impacts of climate change and social inequality are not always considered as risks. The financial risks derived from climate change include economic damages from adverse natural phenomena (physical risk), as well as the costs certain companies may incur in the face of stricter legislation to preserve the environment (transition risk), for example, the penalty for a high carbon footprint (Marqués & Romo, 2018). The ecological transition to a low-carbon economy involves all stakeholders, including governments, companies, and consumers, as well as financial institutions and investors. In fact, many investors are already interested in sustainable financial products and base their investment decisions on social and environmental factors.

Such investors consider long-term environmental and social issues in investment and financing decisions; include environmental, social, and governance (ESG) factors in their analyses; and redirect capital flows towards sustainable investments. Where am I investing? What does the company do with the financial resources raised? The financial sector must be able to cope with these new demands and understand that this new business model does not have to mean lower profitability.

The Paris Agreement, adopted in December 2015, sets very ambitious goals to address climate change and reduce carbon emissions. The decarbonization of the economy, through energy, transport, heating systems, and many other economic activities linked to fossil fuels, is a challenge that cannot be financed only by the governments of the countries of the European Union; the private sector must intensify its investments in sustainable projects in order not to lose competitiveness and industrial leadership in the path to decarbonization. However, currently fewer than 10% of European companies are Paris aligned (CDP Worldwide, 2021).

One of the requirements for finance to be sustainable is the reorientation of capital flows towards sustainable investments. Europe has an annual deficit in investment to support a sustainable economic system. The objectives set by the European Union for 2030 call for reducing greenhouse gas emissions by 40% (in relation to 1990 levels), reaching a 27%-renewable share of energy, and improving energy efficiency by 27% (European Commission, 2018).

One of the weak points of current regulations is the classification of which activities can be considered sustainable and which cannot. Legislation on labeling sustainable financial products can help investors search for such products and ensure the transparency of the objectives pursued with their investments. Several countries and institutions have created sustainable finance taxonomies. Taxonomies can improve market confidence and assurance to investors, by guaranteeing the environmental and social sustainability of investments.

The new European Taxonomy (European Commission, 2020) “establishes the criteria for determining whether an economic activity qualifies as environmentally sustainable” and constitutes a tool for real implementation of the European Green Deal, specifically when it comes to adopting a common language in financing Europe’s sustainable growth. This straightforward and practical approach to classifying assets and measuring impacts has already fostered accountability and comparability in green finance and the green economy (Technical Expert Group, 2019).