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Emerging Incongruence Emerging Incongruence

Despite its relatively short existence, the EU sustainable finance agenda has already undergone an extensive design and change process which has influenced the design of the current EU Sustainable Finance policy mix. Based on Rogge and Reichardt’s (2016) framework for the extended policy mix, this chapter will trace how the EU sustainable finance agenda emerged and how this had an influence on the incongruence between the policy objectives and instruments.

In line with Rogge and Reichardt’s (2016) building blocks of the extended policy mix concept, the EU Sustainable Finance policy mix is made up along the lines of three requirements: the inclusion of a strategic component, the incorporation of associated policy processes, and the consideration of certain characteristics of policy mixes. These requirements are demonstrated in the three building blocks: elements, processes, and characteristics.

2018: EU Action Plan for Financing Sustainable Growth

Before diving into the characteristics of the current mix, it is important to go back to the very beginning of the EU Commission’s ambition to forward sustainable finance in Europe and establish: In what context did the policy mix emerge and develop?

High-Level Expert Group

This ambition predates the EU Green Deal and can be traced back to 2016 when the EC, under the lead of President Jean-Claude Juncker, appointed a High-Level Expert Group (HLEG) to develop a blueprint of reforms along the investment chain to transform the financial system to be in line with the—at the time recently signed—Paris Agreements. The membership of the HLEG was made up of EU policymakers, financial sector representatives, and other sustainable (finance) experts from NGOs and other platforms. They wanted a diversified stakeholder input.

After two years of consultation, the HLEG published a report concluding that sustainable finance was about two urgent imperatives: 1) “to finance sustainable and inclusive growth by funding society’s long-term needs,” and 2) “strengthening financial stability by incorporating environmental, social and governance (ESG) factors into investment decision-making” (HLEG 201: 5). They published a roadmap that outlined eight key recommendations and several cross-cutting recommendations and actions targeting specific sectors of the financial system. Figure 3 provides an overview of all the HLEG’s recommendations.

Notable from the report is that, despite the EU Green Deal not being in existence yet, the HLEG already recognized that the scale of investment necessary to reach the Paris Agreements would be well beyond the capacity of the public sector alone and therefore it would be crucial to increase private finance for sustainable development (HLEG 2018: 12–13).

Further, the HLEG hinted that sustainable finance would be a powerful tool for “achieving its goals of economic prosperity, social inclusion, and environmental regeneration” and that a

“joined-up approach” with a “multi-dimensional roadmap” would be necessary to achieve the transformation (HLEG 2018: 9–10). These are early hints that sustainable finance can serve multiple objectives with multiple policy instruments. The HLEG laid the foundation for what would later become the EU sustainable finance policy mix.

Figure 3: HLEG’s (2018) Final Report Recommendations

Action Plan

Following the HLEG’s recommendation report, on 8 March 2018, the EC (2018a) launched the initial “Action Plan on Financing Sustainable Growth.” The EC stated that this Action Plan was a part of the Capital Markets Union’s (CMU) efforts to connect finance to the specific needs of the European economy to benefit the planet and society (idem: 1).

To achieve those broader objectives, the EC outlined three different goals and ten concrete actions that would be necessary to achieve those goals. The stated goals were to:

Key recommendations Other cross-cutting recommendations Sectoral recommendations

Create common sustainable finance taxonomy;

EU omnibus proposal to clarify investor duties to extend time horizons and bring greater focus on ESG factors;

Upgrade Europe’s disclosure rules to make climate change risks and opportunities fully transparent;

Empower and connect Europe’s citizens with sustainable finance issues;

Develop official European sustainable finance standards;

Establish a ‘Sustainability Infrastructure Europe’ facility;

Reform governance and leadership of companies to build sustainable finance competencies; and

Enlarge role and capabilities of ESAs to promote sustainable finance as part of their mandates.

• Tackle short-termism;

• Empower citizens to engage and connect with sustainable finance issues;

• Establish an EU Observatory on sustainable finance to support evidence-based policy-making;

• Greater transparency on indices and benchmarks;

• Consider sustainability issues as part of accounting standards;

• Accelerate action to finance energy efficiency investments;

• ‘Think Sustainability First’ Principle; and

• Leveraging EU Action to enshrine sustainable finance at global level.

Banking: align lending and financing with EU sustainability objectives;

Insurance companies: underwrite sustainability conditions;

Asset management: Ensure that governance, expertise and stewardship practices take account of sustainability;

Pension funds: Consult beneficiaries on sustainability preferences and build those into investment strategies;

Credit ratings and sustainability ratings:

incorporate ESG factors;

Stock exchanges and financial centres:

provide market infrastructure supporting sustainable asset classes;

Investment consultants: incorporate ESG into advice towards clients; and

Investment banks: incorporate ESG into sell-side research.

1) reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth;

2) manage financial risks stemming from climate change, resource depletion, environmental degradation, and social issues; and

3) foster transparency and long-termism in financial and economic activity (ibid.).

Figure 4 demonstrates how the EC designed the three goals and actions. As demonstrated, they designed multiple instruments per goal. For instance, to “reorient capital flows towards a more sustainable economy,” an EU Taxonomy and EU Green Bond Standard should be implemented, to meet the goal of “manage financial risks stemming from climate change, resource depletion, environmental degradation, and social issues”, the action of “better integrating sustainability in rating and market research” must be achieved (EC 2018a: 2–11).

In the Action Plan communique, the EC recognized that it presented multiple actions by stating that its strategy “combines non-legislative and legislative actions” to achieve its “three main objectives” (EC 2018a: 12).

In sum, to achieve the broader policy objective of taking steps to align EU economies with CMU goals, the EC adopted an Action Plan. This plan can be considered the foundation of the current EU Sustainable Finance policy mix because the design included multiple goals along with various instruments to achieve those goals that have not changed much since. Figure 5 also highlights how the EU envisioned the actions to interact. This illuminates the complexity of real-world policy mixes as highlighted by scholars such as Rogge and Reichardt (2016).

Layering

In its report, the HLEG stated that it did not seek to “augment the regulatory burden and complexity”, hence why its recommendations were largely focused on simply updating or extending existing regulations (HLEG 2018: 7). The EC created a policy mix that emerged through a pattern of layering in which it added a sustainability filter to many already existing instruments. This includes benchmarks, prudential requirements, rating and market research, and disclosure and accounting rulemaking. The few instruments that were ‘new’ focused on increasing transparency. Considering the small size of the sustainable finance sector at the time and the equally small objective of the Action Plan to only ‘connect’ finance with sustainability needs, the proposed actions were in congruence with the overall goals.

Figure 4: 2018 Action Plan on Financing Sustainable Growth

Figure 5: ‘Visualization of the actions’ – a demonstration of the policy mix (EC 2018a: 20)

2021: A Renewed Strategy

In the Action Plan communique, the EC stated that it would further elaborate on the implementation of the Action Plan in 2019 (idem: 12). However, less than a year later, the landscape around sustainability in Europe had significantly changed. The EC, under the new leadership of President Ursula von der Leyen, adopted “Communication on a European Green

This Action Plan is part of broader efforts to connect finance with the specific needs of the European and global economy for the benefit of the planet and society.

1) To reorient capital flows towards sustaianble investments in order to achieve sustainable and inclusive

growth;

2) Manage financial risks stemming from climate change, resource

depletion, environmental degradation, and social issues;

3) Foster transparency and long-termism in financial and economic

activity.

1. EU Taxonomy

2. Create standards and labels for green financial products 3. Foster investment in sustainable

projects

4. Incorporate sustainability in providing financial advice 5. Develop sustainability

benchmarks

6. Better integrating sustainability in rating and market research 7. Clarifying asset managers and institutional investors’ duties regarding sustainability

8. Introducing a ‘green supporting factor’ in the EU prudential rules for banks and insurance companies

9. Strenghtening sustainability disclosure and accounting rule-making

10. Fostering sustainable corporate governance and attenuating short-termism in capital markets Policy Objective

Principal Plans

Instruments (mix)

Deal” and the COVID-19 outbreak sparked renewed ambition for a green recovery from the pandemic (EC 2019). This new context significantly increased the EU’s climate and environmental action policy ambitions and subsequently had an impact on the Action Plan.

Critical Juncture

The adoption of the European Green Deal sparked a renewed ambition in Europe to implement sustainable finance plans. This was stated in the press release of the 2020 public consultation:

“the European Green Deal announced a Renewed Sustainable Finance Plan” (EC 2020: 1).

As a new green growth strategy, the ambitious EU Green Deal was launched in December 2019 to use this framework to transform the EU into a fair and prosperous society with a modern, resource-efficient, and competitive economy (EC 2019: 2). To achieve this transformation, the EC set out targets to reduce greenhouse gas emissions by 55% in 2030 and net-zero emissions in 2050 to decouple economic growth from resource depletion (idem: 4–5).

The EU Green Deal is therefore also an integral component of the EC’s strategy to adhere to the objectives set by the UN’s 2030 Agenda and the UN SDGs (idem: 3).

To achieve these goals, the EU introduced the European Green Deal Investment Plan which has three objectives:

1) mobilize 1 trillion euros in sustainable investments over the next decade;

2) create an enabling framework for private investors and the public sector to facilitate sustainable investments;

3) provide support to public administrations and project promoters in identifying, structuring, and executing sustainable projects (Bush et al. 2021: 22).

To generate that massive amount of investment, the Investment Plan includes several instruments, including InvestEU, the External Investment Plan (EIP), and the European Fund for Sustainable Development Plus (EFSD+) (ibid.).

However, the EC recognized that its efforts would not be sufficient to meet the goal of 1 trillion euros. Therefore, it would need 350 billion euros a year of additional private investment (EC 2021a: 1). The EC also stressed the urgency to act to curb biodiversity and climate crises before they reach dangerous tipping points. To prevent this, much of the investments would need to happen in the next 5–10 years. On top of that, the EC stated that the COVID-19 outbreak had exposed the critical need to strengthen the sustainability and resilience of European societies and how the economies function.

Conversion

To accomplish those new goals, EC policymakers established that it would decouple the initial Action Plan from the CMU Plan and repurpose it to be part of the broader investment plan of the European Green Deal under the new name: “Renewed Sustainable Finance Strategy.” This was also affirmed in the press release of the 2021 Renewed Strategy “with today’s proposals, the EU is taking another major step towards achieving the goals in the EU Green Deal by ensuring a comprehensive approach to funding the green transition” (EC 2021b). In practice, this Renewed Strategy is almost the same as the Action Plan except that it had been repurposed to a new set of much larger goals that demand a step up in channeling private capital towards sustainable investments. This is the process of conversion.

Figure 6: EU Sustainable Finance Policy Mix

Current Policy Mix

Thus, the current EU Sustainable Finance policy mix (see Figure 6) is rooted in the Action Plan with the added elements of the Renewed Strategy (see Figure 7). An elaborate outline of the policy mix will illustrate 1) how EC policymakers simply repurposed old instruments to new goals and therefore engaged in conversion following the critical EU Green Deal juncture, and 2) how the policy mix has new goals that are incongruent with the old instruments.

Following the 2020 stakeholder consultation, EC policymakers introduced the Renewed Strategy and introduced four new areas of additional action to complement the Action

To transition towards a sustainable financial system and economy aligned with the quantified targets of the EU Green Deal, Covid-19 recovery plans, the Paris Agreements and the 2030 SDG Agenda.

1) To reorient capital flows towards sustainable investments in order to achieve sustainable and inclusive

growth;

2) Manage financial risks stemming from climate change, resource

depletion, environmental degradation, and social issues;

3) Foster transparency and long-termism in financial and economic

activity.

1. EU Taxonomy

2. Create standards and labels for green financial products 3. Foster investment in sustainable

projects

4. Incorporate sustainability in providing financial advice 5. Develop sustainability

benchmarks

6. Better integrating sustainability in rating and market research 7. Clarifying asset managers and institutional investors’ duties regarding sustainability

8. Introducing a ‘green supporting factor’ in the EU prudential rules for banks and insurance companies

9. Strenghtening sustainability disclosure and accounting rule-making

10. Fostering sustainable corporate governance and attenuating short-termism in capital markets Policy Objective

Principal Plans

Instruments (mix)

2021a: 4). The four areas are Global Ambition, Inclusiveness, Financial Sector Resilience and Contribution, and Financing the Transition to Sustainability. Figure 7 provides an overview of the six new actions introduced as part of the four new areas.

Again, aligned with Rogge and Reichardt’s (2016) building blocks of the extended policy mix concept, the EU policy mix is made up along the lines of three requirements: the inclusion of a strategic component, the incorporation of associated policy processes, and the consideration of characteristics of policy mixes. These three requirements are demonstrated in the three building blocks: elements, processes, and characteristics.

Building block 1: Elements

This block consists of the policy strategy with its objectives and principal plans and the instrument mix with all its interacting instruments.

As outlined in the framework and Figure 6, the policy objective is the long-term strategic orientation of the policy mix to transition towards a sustainable financial system and meet all the targets of the signed international agreements. The principal plans to achieve the objective are the three initial goals from the Action Plan.

The second component is the instruments that form the concrete tool to achieve the overarching objectives and set goals. These instruments are the ten concrete actions set by the Action Plan and the six additional actions introduced in 2021 as part of the Renewed Strategy (see Figure 7). The single instruments combined are interdependent and together form an instrument mix. The interdependency is an important characteristic and in the case of the EU Sustainable Finance policy mix, this is, for instance, the EU taxonomy instrument (which defines the activities that are considered sustainable) upon which all the other instruments (such as SFDR or Green Bonds labels) rely for their classification of what is considered an environmentally sustainable practice.

As stated, the Renewed Strategy’s actions do not differ from the Action Plan actions.

All the proposed actions only extend or propose to extend existing actions of the Action Plan.

For instance, Action 1 of the Renewed Strategy wants to achieve an extension of the EU Taxonomy but states it will “consider proposing legislation”, “consider options for extending the EU Taxonomy framework”, and “adopt a Complementary EU Taxonomy Climate Delegated Act and a delegated act under the EU Taxonomy”, and “consider a general framework for labels for financial instruments” (EC 2021a: 7). Similarly, Action 2 also only seeks to “improve” the inclusiveness of sustainable finance through existing instruments, Action 3 wants to “enhance economic and financial resilience to sustainability risks” but only

offers to “propose amendments” to existing regulations like the Capital Requirements Regulation and the Solvency II Directive (EC 2021a: 11–14). Furthermore, Action 4 seeks to

“increase the contribution of the financial sector to sustainability” by “improving” financial institutions' disclosures of sustainability targets and transition planning and reliability and comparability of ESG ratings (EC 2021a: 16). Action 5 states it wants to “monitor an orderly transition and ensure the integrity of the EU financial system” by “monitoring greenwashing risks and assess and review the current supervisory and enforcement toolkit” and “work towards a common approach to monitor an orderly transition” (EC 2021a: 17).

Figure 7: Six New Actions as Part of 2021 Renewed Sustainable Finance Strategy

One could argue that the only exception to the prior examples is that Action 6 called on

“setting a high level of ambition in developing international sustainable finance initiatives and standards” and wants to, among others, “seek an ambitious consensus in international forums”,

“propose to expand the work of the IPSF6 to new topics and strengthen its governance” (EC 2021a: 20). However, these objectives do not include any substantive actions but only express ambition to work on the action.

6 The International Platform on Sustainable Finance (IPSF) is a multilateral forum of dialogue for policymakers who are in charge of developing sustainable finance regulatory measures. See:

https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/international-Strategy’s six sets of actions:

1. Extend the existing sustainable finance toolbox to facilitate access to transition finance;

2. Improve the inclusiveness of small and medium-sized enterprises (SMEs), and consumers, by giving them the right tools and incentives to access transition finance;

3. Enhance the resilience of the economic and financial system to sustainability risks;

4. Increase the contribution of the financial sector to sustainability;

5. Ensure the integrity of the EU financial system and monitor its orderly transition to sustainability;

6. Develop international sustainable finance initiatives and standards, and support EU partner countries

These findings are affirmed by two of the interviewees. Carolina Vigo (2022) from BusinessEurope stated that the Renewed Strategy (which is now the current policy mix) was predominantly a “change of tone” that put more emphasis on the role of all actors (including non-financial ones) in the transition as opposed to only the financial sector. Victor van Hoorn (2022) also confirmed that there was not that much difference between the Action Plan and the Renewed Strategy. He stated that the only difference between the renewed framework and the initial Action Plan was that in 2021 EU policymakers were more aware of the difficulties that came with the implementation of this agenda given that certain components, like the EU Taxonomy, had proven to be very politically sensitive.

Building block 2: policy processes

While the elements building block considers the content of the policy mix, the policy process block looks at policy making and policy implementation processes that gave rise to it. This is especially important to consider when understanding how the policy mix or elements thereof may change over time.

Part of the policy-making process is policy learning and policy implementation. Given the relatively short existence of the entire EU sustainable finance agenda, policy learning has not developed very significantly yet. However, as suggested by EU policymakers and experts, the agenda is always evolving and the fact that it was renewed in 2021 does prove that policymakers have adjusted and improved the agenda over time.

Policy implementation is a very important component of the policy mix because, without successful implementation, no policy mix can be put into action. The standard procedure for all decision-making in the EU is the Ordinary Legislative Procedure (OLP) (European Parliament n.d.). In simple terms, this entails that any legislative proposal comes from the EC and is passed on to the European Parliament and Council. The European Parliament votes by a simple majority and can submit amendments. The Council may then decide whether to adopt Parliament’s position (ibid.). Another important aspect to analyze is whether the policy mix includes binding and/or voluntary instruments. With regards to this policy mix, the EU has implemented both. For example, a binding instrument is the SFDR or the regulation amending benchmark regulation whereas following a climate benchmark is voluntary.

Important to consider as part of this building block is the role of power, politics, and agency in the policy process. This will be further explored in the next chapters.

Building block 3: characteristics

The characteristics block captures how the elements of the policy mix are aligned with each other and based on that it can be evaluated. To do so, consistency, coherence, credibility, and comprehensiveness are analyzed.

Consistency

Regarding consistency, the different instruments do not appear to conflict with each other.

Furthermore, the policy strategies also work together in a supportive fashion. The layering process, therefore, did not have adverse effects on the consistency.

Nevertheless, when looking at consistency between the interplay of the instrument mix and the policy strategies following the conversion to the Renewed Strategy, there is incongruence. This is because the broader policy objective of the policy mix is to transform the financial sector to be more sustainable and contribute to achieving the quantified emission reduction targets as set under the EU Green Deal, COVID-19 recovery plans, Paris Agreements, and the 2030 SDG goals. However, out of the three principal plans, only the first one directly targets that objective. The other two seek to accomplish the objective indirectly.

That would not necessarily be problematic if the instruments also work to achieve Goal 1.

However, that is not the case. All the instruments—including those of Goal 1—target increasing transparency and disclosure. Although that is important and a prerequisite for a sustainable finance transition, greater transparency, and disclosure in itself does not accomplish a reorientation of capital towards more sustainable investments. Therefore, the current instrument mix is incongruent with Goal 1.

Incongruence

To further illuminate the incongruence, one can look at Action 1 proposed to achieve Goal 1. Action 1 very clearly only seeks to increase transparency as it wants to “establish an EU classification system for sustainable activities” with an EU taxonomy for climate change, environmentally and socially sustainable activities, and a technical expert group on sustainable finance (EC 2021a: 7). A taxonomy is frequently used in the context of biology but refers to naming, describing, and classifying certain things (Cain n.d.). In this case that would be all activities that are considered ‘green’ or ‘sustainable.’ Creating a classification framework and requiring (non) financial actors to use the framework to prove that their activities are green is not a manner to reorient capital and instead would be more aligned to achieve Goal 3: “foster