Sustainable Finance – A Frameworks Overview

The green economy is growing rapidly and environmental, social and governance (ESG) considerations are now top of the agenda across multiple sectors. COVID-19 has also caused an intensification of focus on ESG matters. Increased engagement on climate issues, while necessary and welcome, has led to a proliferation of guidance, commentary and regulation from interest groups, legislatures and regulators. As a consequence, the landscape of applicable frameworks is fragmented and can be difficult to navigate. We provide an overview of the primary sources of guidance and regulation on sustainability, as it intersects with the financial services sector, both in Ireland and at EU level.

EU measures and guidance

Recent legislative development in the area of sustainable finance has its origins in the European Commission’s Action Plan on Financing Sustainable Growth (the Action Plan). The Action Plan, published in March 2018, contains a package of measures designed to integrate sustainability and finance. These measures aim to mainstream sustainability, to mobilise capital to meet sustainability goals and to foster transparency and long-termism in the sustainability agenda. The measures include:1. The establishment of an EU classification system for sustainable activities

In line with this objective, the Taxonomy Regulation (Regulation (EU) 2020/852) was adopted and entered into force in July 2020. The Taxonomy Regulation is intended to provide market participants with clear metrics for assessing whether a financial product is, or can be marketed as ‘green’ or ‘sustainable’. It will do this through the establishment of specific performance thresholds. Under the Taxonomy Regulation, an economic activity will be considered environmentally sustainable if it:

• Contributes substantially to one of the following six environmental objectives and does no significant harm to the other five:

  1. Climate change mitigation

  2. Climate change adaptation

  3. Sustainable use and protection of water and marine resources

  4. Transition to a circular economy

  5. Pollution prevention and control, and

  6. Protection and restoration of biodiversity and ecosystems

• Complies with minimum human rights / social safeguards, and

• Complies with performance thresholds known as technical screening criteria

The criteria have not yet been established but will comprise lists of environmentally sustainable activities under each of the six environmental objectives. The criteria are intended to be organic and may be amended or supplemented over time as knowledge develops. The first draft delegated regulation has been published and deals with climate change mitigation and climate change adaptation. It is expected that the first delegated regulation will be adopted in April 2021. Criteria for the four other environmental objectives are to be established by the end of 2021 and will be in force by the end of 2022.

Under the Taxonomy Regulation, a company which is subject to the Non-Financial Reporting Directive (Directive 2014/95/EU) will be required to include in its statements disclosures as to how its activities align with the taxonomy. The European Commission is mandated to adopt a delegated act specifying the information that must be disclosed.

2. Creating standards and labels for green financial products

​European green bonds are growing in popularity and the lack of harmonised criteria around choice of projects, monitoring and reporting has given rise to concerns about ‘greenwashing’. See our overview of green bonds in our article Green Bonds: Revolutionising Debt Capital Markets. Under the European Green Deal Investment Plan, the European Commission announced its intention to establish in 2020 a green bond standard, though it has not yet been established. A technical expert group (the TEG) established by the European Commission has published a usability guide with an updated proposal for a green bond standard. The TEG’s usability guide contains recommendations and information on (i) identifying eligible green projects, (ii) alignment with the EU taxonomy and (iii) mandatory reporting on use of proceeds, among other things. The European Commission was expected to make a decision on how to take the Green Bond Standard forward in Q4 2020 based on the report and on public consultations and stakeholder dialogues.

The European Commission is also working on an EU ecolabel for financial products and it is expected to decide on the extension of the existing ecolabel framework to investment products in the third quarter of 2021.

3. Clarifying asset managers' and institutional investors' duties regarding sustainability

In pursuance of this objective, the Sustainable Finance Disclosure Regulation (SFDR) was published in December 2019 and will apply from 10 March 2021. The SFDR places obligations on financial market participants to disclose ESG risks in the provision of investment advice. We reviewed and discussed the SFDR in detail in our article Sustainable Finance Disclosure Regulation: New Requirements for Investment Funds and Financial Institutions.

4. Incorporating sustainability considerations in the provision of investment and financial advice

Further to the Action Plan, amendments to the UCITS Directive, AIFMD and MiFID frameworks will apply from the fourth quarter of 2021 to require the integration of ESG considerations in the investment decision making process.

5. Strengthening sustainability disclosure and accounting rule-making

The European Commission has also undertaken to review the Non-Financial Reporting Directive to promote transparency and standardisation in reporting. The Commission expects to adopt a proposal regarding the Non-Financial Reporting Directive in the first quarter of 2021.

Under the Capital Requirements Regulation (EU) No. 575/2013 (as amended) the European Banking Authority (EBA) has been charged with developing draft implementing technical standards for ESG disclosures by credit institutions and investment firms. On 1 March 2021, the EBA published a consultation paper on the draft implementing technical standards putting forward proposals on tables and templates for disclosures on ESG risks, climate change transitional risk, climate change physical risk and KPIs on climate change mitigating measures. The EBA proposes that the KPIs include the green asset ratio on taxonomy-aligned activities.

The European Green Deal, published in December 2019 builds on the Action Plan. It provides a roadmap with specific actions and timetables for completion. The investment plan aims to mobilise funds through the EU budgetary measures and associated instruments. The Green Deal further recognises the role of the financial services sector in achieving sustainability objectives as it is fundamental in the redirection and allocation of capital and funding for green activities. In the framework of the Green Deal, the Commission announced that it will introduce a Renewed Sustainable Finance Strategy to further facilitate sustainable investments and to integrate climate risks into the financial system. The Commission launched a consultation in April 2020 on its sustainable finance strategy to gather targeted feedback. The Renewed Sustainable Finance Strategy is expected to be adopted in the first half of 2021.

The European loan market continues to embrace ESG principles as evidenced by the increase in green loans and sustainability linked loans. We reviewed the principles of both green loans and sustainability linked loans in our article Sustainable Lending – Banking on a Sustainable Future.

Irish measures and guidance

1. Ireland for Finance

The Irish Government has recognised that sustainable finance is a priority for Ireland’s financial services sector in its ‘Ireland for Finance Strategy 2025’. In February, the ‘Ireland for Finance Action Plan 2021’ was launched. It includes sustainable finance as one of three priority areas (along with diversity and regionalisation). In addition, the Finance Green Ireland Committee has been established and is supported by the Irish Government to develop a national blueprint for the development of sustainable finance activities. It will provide expert advice on the sustainability agenda and aims to promote Ireland as a leading sustainable finance hub. The Government has acknowledged that the changes under the SFDR and Taxonomy Regulation will require continued work to raise awareness and develop expertise in the financial services sector and one of the stated aims of the Ireland for Finance Action Plan 2021 is the development of sustainable finance education programmes.

2. Central Bank of Ireland

Climate events pose prudential and financial stability risks in the financial system. The Central Bank of Ireland has acknowledged its duty to implement safeguards in relation to such risks and the imperative that the financial system must be resilient to climate risks. The Central Bank, which has recently established a dedicated Climate Change Unit, has also indicated its intent to clamp down on 'greenwashing'.

The Network of Central Banks and Supervisors for Greening the Financial System, of which the Central Bank is a member, recommends the integration of climate risks into prudential supervision by central banks and published a guide on this setting out recommendations for supervisors and the financial community.

In November 2020, the European Central Bank (ECB) published its Guide on Climate-Related and Environmental Risks, which is a non-binding guide for institutions to incorporate environmental risks in their business and risk management strategies. The guide sets out supervisory expectations for institutions and the ECB has stated that it will ask banks to conduct a self-assessment against these expectations and to draw up action plans on that basis. The ECB will then engage with the bank on their self-assessments and action plans and challenge them in the supervisory dialogue. The ECB has proposed that, in 2022, it will conduct a full supervisory review of banks' climate-related practices and take follow-up action as needed.

What is next for stakeholders?

Investor demand for sustainable finance products is rising. Credit rating agencies are increasingly incorporating ESG factors into their credit ratings. Globally, there has been a political shift in favour of the sustainability agenda with the United States re-entering the Paris Agreement and China agreeing to achieve carbon neutrality by 2060. The COVID-19 pandemic has brought about an opportunity to build back better. Delivering on the Green Deal is a top priority for the European Union. As a result of these factors, targets and regulatory implementation deadlines will continue to be ambitious. Stakeholders in the Irish financial services sector will need to be aware of the existing and imminent EU and Irish frameworks as they apply to them.

As set out previously, these include in particular, the Taxonomy Regulation, the SFDR, the Green Bond Standard and the Renewed Sustainable Finance Strategy. Financial market participants in Ireland will need to prepare for increased supervision and evaluation on ESG factors by the Central Bank. Companies will also need to be aware of the potential for further anticipated developments, including mandatory and standardised reporting obligations for ESG factors. Measures designed to address the inherent short-termism in the capital markets are also expected as this is one of the big challenges in the green transition, as recognised by the Action Plan. These measures may include regulations to implement long-term sustainable business strategies, changes to remuneration policies to incentivise a longer-term outlook and strengthening disclosure requirements regarding long-term risks and opportunities.

For more information and expert advice on navigating the sustainable finance landscape both in Ireland and at EU level, contact a member of our Financial Services team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.