European green wave to reach the financial sector
Even though the response to the pandemic and the economic recovery remain the main focus of the Old Continent, the climate-related matters are still on top of the EU’s political agenda. The pandemic has even reinforced the goal of the EU to transform the economy and become the first climate-neutral continent on the planet. The green transformation will undoubtedly bring new developments to all areas of the economy, including the EU’s financial sector, which has the potential to become a global hub for green finance.
Comments by Emilė Šreiberytė, Senior Economist at the Economic Policy Analysis Division of the International Relations Department of the Bank of Lithuania
Why have the climate-related matters become the focus of the EU in the context of the pandemic?
At the beginning of its 2019-2024 term, the European Commission (EC) announced a new EU strategy for growth, i.e. the European Green Deal. The main objective is to create a resource-efficient and competitive EU economy with net-zero greenhouse gas emissions by 2050. One of the milestones of this ambitious target is reducing greenhouse gas emissions by 55% before 2030, compared to 1990 levels.
At first glance it may seem that the unexpected COVID-19 pandemic could have altered the EU’s ambitious plans on climate change. The health crisis has become the centre of focus, followed by the worst economic recession since World War II. Despite this, the EU leaders have decided that the economic recovery plan after COVID-19 will be based on the concept of green economic transformation.
The main instrument of the recovery plan is Next Generation EU fund of €750 billion, which was agreed upon in the summer of last year. This fund is a temporary instrument to support a faster recovery of the Member States, aiming to strengthen their resilience and ensure a sustainable growth. In fact, the challenges created by the pandemic opened a window of opportunity to fundamentally transform the EU economic model, as the major part of the unprecedented financial aid provided for the Member States has to be allocated for the green and digital priorities.
Under the Recovery and Resilience Facility, which lies at the heart of the recovery fund, at least 37% of the funds will be allocated for the implementation of the objectives of the European Green Deal. Lithuania should consider this when drafting its national financing plan: of €2.2 billion grants allocated for the country, over one third has to be dedicated to the green transition. Proper use of the EU funds is also important considering that the EC sees a potential risk that Lithuania will not reach its national climate change targets by 2030.
However, the EU financing alone will not suffice. According to some estimates, reaching the objectives of the climate-change plan by 2030 requires €300 billion additional investment annually at the EU level, thus additional public and private investment will play a fundamental role in this process.
The ambitions of the EU finance sector
Ambitious climate change targets and the growing need for green investments will undoubtedly change the EU finance sector. To start with, it is planned to raise 30% of the Next Generation EU recovery fund through the issuance of green bonds (it could amount up to €225 billion). Funds attracted via such bonds will be used for the financing of projects which tackle climate change, biodiversity loss, depletion of natural resources, water, air or soil pollution and other related issues.
Even though the green bond market is currently relatively small, the interest of investors is rapidly growing. In fact, the EU is a current leader in the green bond market: in 2019 over half of the issuers of green bonds were operating in the EU and almost half of all the bonds were denominated in euro. In order to further promote the development of the green bond market, in the first half of 2021, the EU will present a proposal on the EU Green Bond Standard which would increase the effectiveness of the market, ensure transparency and comparability.
The EU Green Bond Standard will be based on a taxonomy, i.e. a classification system for sustainable economic activities, which would ensure that investments are directed towards sustainable technologies and companies, thus contributing to the EU goal of climate-neutral economy by 2050. Despite the fact that the EU’s Taxonomy Regulation has already been adopted, technical preparatory work is still in progress. Once the provisions of the Regulation will be implemented, the EU will have the first green taxonomy in the world.
The EU is at a great starting point, therefore, it has an unprecedented opportunity to further secure its position and become a global hub for green finance, but the EU needs to take advantage of this opportunity. It will soon be possible to evaluate the extent of the EU’s ambition: in the first half of 2021, a renewed strategy of sustainable finance should be presented, including a wide range of proposals on the development of the green finance system.
The role of central banks
In 2017, 8 central banks and financial supervisory authorities decided to establish a Network for Greening the Financial System the main goals of which are to contribute to the management of environmental and climate risks in the financial sector as well as mobilise the funding needed for the transition to a sustainable economy. Since its establishment, the Network has grown significantly: in the beginning of 2021 the Network was comprised of 87 members, including to the Bank of Lithuania.
It is no surprise that the central banks and the supervisory authorities joined their efforts, as their role in the green transformation of the financial sector is indeed significant. These institutions ensure the financial stability of a country via the supervision of the financial market participants, drafting of the macroeconomic projections, carrying out research, etc. In the course of the transformation, central banks and supervisory authorities will have to integrate climate-related risks into their activities more consistently. As an example of good practice, it is worth mentioning the Bank of Finland which is a leader in this area among the Nordic and Baltic countries, as it is implementing a wide scale strategy ‘Sustainability programme’. According to this Strategy, the green component is included in all the activities of the bank from integration of climate risks to the monitoring of financial stability to making the internal bank procedures more efficient.
In addition to this, central banks manage sizeable investment portfolios. When shaping their investment strategies, central banks could integrate the sustainability factors, i.e. ensure the promotion of sustainable and socially responsible investments. For example, when performing the analysis of its foreign reserves, Riksbank, the Sweden’s central bank, already includes the GHG emission intensity indicator. It is assessed as the investment eligibility criteria, together with such factors as the risk level or returns. That is precisely why this bank has sold bonds of certain Canadian provinces and Australian states which failed to meet the sustainability indicators.
Even though central banks and supervisory authorities are taking only the first steps by including the matters related to climate change into their activities, there is no doubt that over time this will become common practice. The sooner the EU and the national institutions, including the central banks, join this green wave, the faster Europe will be able to establish itself as a global hub for green finance.