by Aime Boscq*
On July 16, 2019, then-candidate to the presidency of the European Commission, Ursula von der Leyen published a series of political guidelines, stating “we need to tap into private investment by putting green and sustainable financing at the heart of our investment chain and financial system. To achieve this, I intend to put forward a strategy for green financing”. This statement highlights one of the major challenges associated with the mitigation of and adaptation to climate change – financing the related measures and investments. Since the energy sector accounts for over 80% of the European Union’s greenhouse gas emissions as of 2017, financing the energy transition is going to be an essential step to reach the Union’s target of carbon neutrality by 2050.
Over the past years, rising public awareness regarding the risks associated with climate change has prompted a rise in green marketing in all sectors, including finance. Financial institutions have developed multiple tools and mechanisms ensuring that funds are directed towards financing projects mitigating climate change or adapting to its consequences. These notably include green funds – investment vehicles pooling funds from multiple investors to finance environmentally-friendly companies – and green bonds, defined by the World Bank as financial instruments “issued to raise capital specifically to support climate-related or environmental projects”. Since the launch of the first green bonds by the European Investment Bank (EIB) in 2007 and the World Bank in 2008 and after a slow start in the early 2010 decade, the market for these financial instruments has gained in popularity: 36 billion US dollars’ worth of green bonds were issued in 2014 whereas this figure amounted to 271 billion in 2019.
Green finance directs funds towards a large variety of initiatives (low-carbon transport, land use, industry, water&waste etc.). However, the energy sector is by far its largest beneficiary. According to the International Renewable Energy Agency, half of all green bonds issued between 2010 and 2019 globally were partly or totally directed towards renewable energy projects. In Europe, 21% of the green bond emitted were fully dedicated to the financing of renewable assets, the highest regional share globally. Although the Covid-19 pandemic is having a significant impact on the level of investment in all energy projects, renewables, energy efficiency and clean transport/heat projects have shown much more resilience than their carbon-intensive counterparts. Compared to 2019, investments in oil and gas fell by more than 30 % whereas investments in renewables fell by less than 10%.
While its necessity is sustained by scientific and economic literature as well as European political institutions, the contribution of institutional finance to the energy transition has often been met with widespread scepticism over the past years. Banks, states and other financial institutions have often been targeted by accusations of greenwashing, labelling products or actions benefiting from green financing even when they have no positive impact on climate change. In the energy sector, some extremely carbon intensive processes have benefited from preferential financial conditions in the past on the basis of their hypothetical impact on mitigating climate change.
The reluctance over the sincerity of the financial sector’s efforts is largely due to the lack of standardized definition based on which investments are labelled as green from an environmental standpoint. In 2017, the European Commission published a report aimed at identifying a clear definition of green finance which disclosed over 50 different labels, certifications, guidelines and standards utilised worldwide by financial institutions, international cooperation bodies and research organizations, each using its own different categories, criteria and eligibility principles to qualify projects and companies.
While these efforts contribute to transparency, the lack of a unified definition framework is a major source of risk, largely undermining the trust of public and private investors in the ability of green bonds or funds to efficiently deliver money to projects mitigating climate change. Poor reporting from projects and firms benefiting from green finance also plays a major role in this distrust. Even green bonds respecting the strictest definition standards risk being diverted from their initial goal and can sometimes end up financing greenhouse gas-intensive projects, as the data reported to investors is largely of a voluntary nature and non-standardised, undermining the reliability of its content and thoroughness. Moreover, green bonds are often seen by financial institutions as illiquid products compared to conventional bonds due to the emerging status of the market. Indeed, the volume of green bonds available on the market makes them a niche compared to their conventional counterparts. As of early 2020, green bonds only represented between 1% and 2% of the overall bond market globally.
In addition to the lack of effectiveness of current mechanisms directing finance towards climate mitigation efforts, including clean energy projects, the current level of investment in these projects is largely under par compared to the sums estimates deem necessary for the energy sector to meet the climate change requirements of the Paris Agreement.
In order to tackle the lack of a unified definition hindering the proper development of green finance, hence favouring greenwashing, the EU has made green finance a key element of its “European Green Deal”. Presented on December 11, 2019, this plan includes a series of legislative projects and policy objectives across multiple economic sectors aimed at creating the conditions for the EU to reach its 2030 climate and energy targets and achieve carbon neutrality by 2050. One of the cornerstones of this plan is the EU taxonomy for sustainable activities, which establishes a clear list of activities and investments that can be considered environmentally sustainable by financial institutions. The foundations of this taxonomy were set by the EU Taxonomy Regulation (Regulation (EU) 2020/852).
Under the EU taxonomy, “generating, transmitting, storing, distributing or using renewable energy” as well as efforts to enhance energy efficiency are considered a substantial contribution to climate change mitigation. The key role of the energy sector in this taxonomy, and as such in the Union’s overall climate political agenda, was confirmed by the delegate regulation of the Commission of June 6, 2021, detailing which renewable energy generation technologies qualify as substantially contributing to climate mitigation. Another key delegate regulation is expected by the end of the year, which will detail the sustainability disclosure obligations applying to financial institutions and products included in the EU taxonomy, marking a significant step in the fight against greenwashing.
This new legally binding taxonomy is considered to be a major milestone to effectively direct financing towards the energy transition and other climate mitigation efforts. However, the potential inclusion of natural gas and nuclear energy as sustainable technologies or as transition fuels in the EU taxonomy has sparked heated debates both in Brussels and within EU member states.
Concerning nuclear energy, while some member states argue that the safety and environmental concerns disqualify it totally from being considered sustainable, others, such as France, are heavily reliant on this low-emission technology in their current electric mix and could see its exclusion from the taxonomy as an industrial risk for their energy transition. Some member states such as Romania also have plans for new nuclear reactors that could be threatened by an exclusion from the taxonomy. Concerning natural gas, this fossil-fuel is seen by those member states with a coal-intensive electric mix such as Poland as a way to gradually reduce the carbon footprint of their electric mix, limiting the social and economic consequences of their energy transition. Major lobbying efforts have been undertaken by firms and member states to include both natural gas and nuclear energy in the taxonomy. Expert groups have been mandated by the Commission to assess the role of both technologies and the relevance of qualifying them as green investments. Their reports should prompt a decision by the European executive in the coming months.
Beyond these technological considerations, the overall efficiency of the EU taxonomy in directing investments towards the energy transition has been questioned by multiple organisations. The taxonomy will not prevent investors from financing activities actively contributing to climate change, which is a major issue considering investments into fossil-fuel extraction, exploration and end-use still significantly dwarf those into renewable energy and energy efficiency. Economic stimulus packages that boost post-pandemic recovery have included various degrees of sustainability-based conditionality. Nonetheless, fossil-fuel intensive industries have also received significant funding on the basis of their major socio-economic impact (job creations, tax revenue for local and national administrations, etc.). The level of investments into clean energy required to meet carbon neutrality remains extremely far from being met, both on a European and global scale. Although the EU’s taxonomy efforts are exemplary, they remain an exception on a global scale, where obscure reporting and shady labelling remains the norm.
Moreover, financial institutions have seen the past decade be the source of multiple consecutive reinforcements of their reporting obligations, both regarding financial and non-financial data, with a very limited degree of international harmonization. The addition of complementary obligations to the pre-existing concerning the sustainability of their activities could be met with criticism. The costs associated with the compliance obligations vis-à-vis both financial and non-financial reporting could prompt market players to develop alternative, less regulated mechanisms with an even lower degree of international standardization and, thus, lower market liquidity.
While the EU has led the way to make the financial sector’s contribution to the energy transition more ambitious and effective, the impacts of climate change and efforts to mitigate it need to be thought of on a global level. European legislation needs to prompt larger multilateral action to accelerate the energy transition and finance the associated steps. Multilateral organisation such as the United Nations, the G7 and G20, as well as financial institutions such as the World Bank and the International Monetary Fund need to invite stakeholders to the negotiations table in order to finance the energy transition on a global level before greenhouse gas emissions supported by generous financing make the objectives of the Paris Agreement unachievable.
United Nations Framework Convention on Climate Change – Biennial Reports – Data Interface https://www4.unfccc.int/sites/br-di/Pages/GHGInventory.aspx?mode=1
https://www.sciencedirect.com/science/article/pii/S0301421520305802 Also see notes 9 and 4
* Aimé Boscq is an EPG Fellow. The views expressed in this paper are those of the author and do not necessarily reflect the opinions of EPG.