Sustainable Finance:
what is it and what is it for?

Definition and characteristics of sustainable finance

Already immersed in the early stages of the 21st century, participants in any sphere of society (including agents directly involved), may find themselves in their day-to-day lives with the doubt: “hey, what does that mean, Sustainable Finance?”

Well, in short, it is the tool to align the economy with environmental and social responsibility. In short, it is to unite money and commitment to good practices, as a catalyst to achieve the goals set by this society of the 21st century.

More and more investors are trying to combine their profitability objectives with the desire to use their money to improve the environment and society. The aim of this sustainable finance is to promote economic models in companies that favor respect for the environment, human rights, social justice and good corporate governance. There are several examples such as investment funds that apply ESG criteria, solidarity investment funds, green and social bonds, etc.

As commented by Climate Policy Initiative (CPI) in its latest ‘Global Landscape of Climate Finance 2021’, annual flows increased to $632 billion (about €543.98 billion), on average, in the period 2019-2020, which means an increase of $85 billion (more than 15%) (€73.169 billion) compared to the period 2017-2018.

However, while sustainable finance has reached record levels, action still falls short of what is needed. Estimates of the investment required to meet climate targets of no more than a 1.5°C increase in global warming indicate that by 2030 annual climate finance must increase by at least 454%, to an average of USD 4.13 trillion (less than EUR 4 billion).

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How is sustainable financing regulated?

Sticking to the European level, we find the European Union (EU) Action Plan on Sustainable Finance and its three reference acronyms (SFDR, NFRD and EU Taxonomy).

  • NFRD is the EU’s legal framework for regulating the disclosure of non-financial information by corporations. It was adopted in 2014 and states that companies must report ESG information starting in 2018 (for the 2017 financial year).
  • SFDR is the new EU regulation that introduces rules for financial market participants and financial advisors to report on how they account for sustainability risks. SFDR applies at the “entity level” (i.e., requiring financial firms to report on how the entire organization manages such risks) and also at the “product level” (i.e., requiring firms to report on how their financial products are affected by such risks). The regulation asks all financial market participants and financial advisors to report on sustainability risks, even if they do not offer ESG-related products. If an entity does offer ESG-related products, SFDR requires additional disclosures depending on how “green” the product is deemed to be. SFDR became effective on March 10, 2021.
  • The EU Taxonomy Regulation (hereinafter: Taxonomy), which entered into force on July 12, 2020, reflects a common European classification system for environmentally sustainable activities. Basically, the Taxonomy sought to answer the question: What can be considered an environmentally sustainable activity? Answering this question is essential for investors to avoid “greenwashing”, i.e. a situation where financial products are marketed as sustainable without meeting sustainability criteria. The Taxonomy defines six environmental objectives, and defines an economic activity as sustainable if this activity contributes to at least two of these objectives without, at the same time, significantly harming any of the other objectives.

First, the scope of the Taxonomy is defined through NFRD and SFDR. In other words, if an organization is affected by NFRD and/or SFDR, the Taxonomy will also be relevant to its disclosure practices. It is important to note here that the EU Taxonomy defines other mandatory disclosures in addition to what is established by NFRD and SFDR.

Second, the taxonomy asks companies (including asset managers) to report the percentage of their turnover and capital as well as operating expenses that are aligned with the taxonomy. It also asks asset managers to report the percentage of their portfolio that is invested in economic activities that are aligned with the Taxonomy. 

What there is no doubt about is that we will witness a lot of technical specification of the three regulations over the next few years. 

At Euro-Funding we accompany our clients in the process of implementing energy efficiency measures and the development of actions that reduce environmental impact through the development of specialized consulting services, adapted to the needs and legal obligations.

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