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The Instruments of Sustainable Finance

Watch Jan Cornillie introduce the sustainable finance instruments proposed by the EU.
Hello. In this session, I will talk about the instruments of sustainable finance and I will mainly talk about two of the principal instruments, the taxonomy of sustainable economic activities and the disclosure of climate risks to financial institutions. So, the sustainable finance taxonomy, what is this about? Well, the sustainable finance taxonomy is trying to give a collective answer to the question which economic activity is sustainable and its goal is to direct investment toward sustainable projects, making sure that capital is being reallocated from the fossil fuel-based economy to the renewable energy-based economy and to scale up the sustainable investment making sure that we are investing enough to be able to achieve the Paris Agreement goals on CO2 reduction and to increase transparency and limit greenwashing.
So, that if a financial institution sells a financial product that it’s saying that is sustainable, then it can be verified that this is also really true and that as a consumer, a financial consumer you can be confident that what you’re buying is really sustainable. What EU taxonomy does not is mandating sustainable investment. It’s not an obligation to invest sustainably, it is just saying if you call your investment sustainable, then it has to correspond to a set of rules. Now, what are the set of rules to economic activities to qualify as economically sustainable? Well, there’s four conditions for it. The first is that an economic activity is only sustainable when it substantially contributes to at least one of six environmental objectives.
These objectives are climate change mitigation, so reduction of carbon emissions, climate change adaptation, the management of water, the management of biodiversity, the management of pollution and the integrity of the whole atmosphere. Now, for an economic activity to be called sustainable it has to substantially contribute to at least one of them, but it can also do no significant harm to any of the others because obviously if you would say, well, we are going to reduce carbon emissions by a process which takes a lot of wood from virgin or tropical rainforest and that will in the end reduce emissions but it will also lead to lesser biodiversity and deforestation, obviously, we cannot call such a situation sustainable.
So, the economic activity has to substantially contribute to at least one of six, but it can also do no significant harm to any other. Furthermore, an economic activity has to comply with minimum social safeguards, which are some of the international labour organization standards for decent work and for the treatment of workers. And, finally, it has to specifically comply with a number of technical screening criteria and these technical screening criteria are being made explicit in great detail for each of the economic activities that have to do with sustainability. And, just to give you an example of this, what does this mean in practice? Take the example of carbon capture and storage.
So, basically capturing the carbon from an industrial process so to avoid that it goes into the atmosphere and storing it underground or in another material so that it does not escape again. Well, that is carbon capture and storage and it is eligible under the taxonomy of sustainable economic activities because it does substantially contribute to the reduction of emissions, climate change mitigation and it has no, does not do harm to any of the other environmental objectives. Now, obviously, this can change in the future, so it’s subject to regular review and it is also subject to a number of very detailed technical criteria.
The CO2 that is captured must be offloaded into a storage facility which does not leak, and this leakage has been defined as a leakage of less than 0.5%. It also has to be shown that the storage facility is permanent and that the CO2 will not in a natural way release back into the atmosphere. So, those are technical screening criteria that make sure that carbon capture and storage as an activity when it is performed can be called sustainable and then it can lead to sustainable investments into that sector.
Now, carbon capture and storage is mostly used in combination with other technologies such as electricity generation from fossil fuels or use of fossil fuels in cement and steel and there again that has been a definition of the technical screening criteria where it is said that only if the carbon capture and storage is sufficient, leading to a low carbon content of the electricity, the electricity can be considered as sustainable, although it’s coming from fossil fuels like gas, but when the carbon is captured it can still be considered sustainable if that is done in a way that is meeting the thresholds in the technical screening criteria.
And these thresholds they are reduced every five years, so in the end, by 2050 this threshold should be zero and the carbon capture should either be complete or fossil fuel-based electricity generation could not be considered sustainable any longer. So, this is a concrete example of how the four economic conditions on the taxonomy for sustainable economic activities work in practice in a sector like electricity generation with carbon capture and storage. A second instrument that is crucial to the Sustainable Finance Action Plan is the disclosure.
Disclosure is about reporting on the risks to the climate and the risks that climate change poses for the investments of financial institutions and again the objectives are to be to create transparency about so-called ESG, so environment, social and governance topics that are related to the investments. It’s about the integration of these risks by financial market participants in their daily work in the financial markets. Thirdly, it’s about the disclosure of adverse impacts on sustainability matters.
So, not only saying when an investment is sustainable and is contributing positively to climate change, but also saying which economic activities or which investments are creating adverse impacts both at the level of the complete corporation company or at the level of financial products in a detailed matter. And, lastly, just as with the taxonomy, there is the direct regulation with regulatory technical standards which make, go in great detail to explain what these disclosure obligations mean for a concrete set of financial products. So, what are these obligations to disclose?
Well, a financial market participant must be transparent about the policies about integration of sustainability risk, that is to say how it approaches in a general way published on the website what these policies are about and how sustainability risks are integrated into its activity. The second thing a financial market participant has to do is to show which is the principal adverse impact of their investment on sustainability, so it’s about the adverse impacts not only about the impacts that could be positive for climate change. Thirdly, the sustainability risks should be linked to remuneration, so the policies about remunerating the asset managers, the fund managers of a financial market participant should be linked to sustainability.
And then there are a number of definitions of financial products. There is financial products that have no characteristic which is linked to sustainability and those are so-called art. 6 financial products, but there are also products which do have as an objective to promote sustainability or social characteristics or are claiming that they are a pure sustainable investment, those art. 8 and 9 products are subject to a number of definitions and a number of obligations about reporting, about consumer information about what is exactly in these funds that backs the statement that sustainability is being promoted or is at the core of this project. So, where does this lead to?
This sustainable finance disclosure regulation has entered into force in this year 2021 and there’s a number of obligations about the general statement on the website, the disclosure on the remuneration and disclosure on some of the light and dark green funds, the art. 8 and 9 funds, have to be done this year. But there’s also a number of obligations that will only kick in in the next year. So, basically this sustainable finance disclosure regulation is being rolled out in the next years with extra obligations coming online.
These obligations have to do with the use of indicators to show the principal adverse impact, have to do with disclosure in the annual reporting on the taxonomy objectives, is about gathering information on the first period on which then has to be reported and is about reporting on green funds. Later on in 2023, the disclosure will be generalized to all taxonomy objectives and the annual reporting of all funds will need to make a statement on the non-financial information, so the information about the climate impact and the impact on other environmental objectives.

In this video, Jan introduces the sustainable finance instruments proposed by the EU, namely the Sustainable Finance Taxonomy and the Sustainable Finance Disclosure Regulation.

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